Retention Of Title Clause And Insolvency Cases: Explained
For businesses entering insolvency, or at risk of this happening, creditor claims are a key concern – especially if a retention of title clause was involved in the initial contract.
Why? Because it means a creditor including a retention of title clause in the agreement took preventative measures, in case their customer was unable to pay for the goods or services later:
- Retention of title means that in the event that a business does not pay a supplier in full for the product or service, that provider still owns the asset.
- It is one way that creditors can increase their chances of recovering a loss if they sell to a business that becomes insolvent or enters liquidation.
In the event of a customer entering liquidation, unsecured creditors without any leverage are low in the hierarchy of parties likely to receive repayment from the limited funds available. A retention of title agreement is a means to increase the prospects of getting money back.
However, it is still not guaranteed that a creditor with a retention of title agreement in place will automatically receive the asset or its value in return.
As we’ll explore in this article, there are different types of clauses. These are: simple or basic, all-monies, proceeds of sale, and mixed goods clauses.
But also, there are several limitations that can make a retention of title clause ineffective in certain circumstances.
Retention of title clauses – what are the different types?
There are four different clauses:
- Simple or basic retention of title clause: A one-off clause relevant for an ad hoc transaction. This entitles the seller to retain legal ownership of the asset until they receive the full payment.
- All-monies clause: This applies to all transactions or orders between the seller and customer, giving the seller legal ownership over all goods until receiving payment for all of them. Creditors often include this clause on top of a simple or basic retention of title clause in a contract.
- Proceeds of sale clause: This clause refers to goods that the buyer is likely to sell on, with the aim of entitling the original seller to the sale proceeds.
- Mixed goods clause: This applies to the raw materials if the seller’s goods are subsequently manufactured and mixed with other items.
As you might expect, the mixed goods clause is more difficult to enact if the raw materials can no longer be separated without damaging the other items – property of another party.
In a recent article we also explore shareholder agreement clauses and their impact during a company insolvency.
What are the implications in insolvency or liquidation?
When a company cannot pay its debts when they are due, there are several potential options.
If an insolvency practitioner can rescue the company and arrange for creditors to be repaid with more time, a company voluntary arrangement (CVA) could save the business.
CVAs can allow companies to continue trading while paying back creditor debts in regular instalments via an insolvency practitioner. This procedure helps to improve cash flow and ease creditor pressure.
But if business recovery is not possible… A creditors’ voluntary liquidation (CVL) is a far more appealing option than a compulsory one.
During a CVL, the insolvency practitioner turns the company’s assets into cash in order to repay creditors where possible.
We discuss the legal hierarchy, implemented by the Insolvency Act 1986, determining which set of creditors receives repayment first, in these articles:
- When a company goes into administration or liquidation who gets paid first?
- Unsecured and secured loans: What if a company can’t repay?
In theory, creditors with retention of title clauses in place should receive compensation before unsecured ones and shareholders.
It’s common for unsecured creditors and shareholders to receive little to no compensation after a liquidation. That’s because often there isn’t enough money left to distribute.
Creditors need to notify the insolvency practitioner about their retention of title claims as early as possible. However, having a retention of title clause in place is not a guarantee of repayment.
How enforceable is a retention of title clause?
Ultimately, as explained in The Gazette, the law around retention of title clauses is constantly changing. Creditors need to review and update the clause accordingly before including it in the contract.
Additionally, if the buyer enters company administration, Court permission is required to enforce the clause, an external factor the creditor cannot guarantee.
Other potential enforcement limitations include:
- Insufficiently clear wording in the contract or incorrect incorporation
- Inconsistency with the overall trading relationship between the two parties
- Ineffectiveness for retaining ownership over goods that are perishable
However, while enforcement can be complex, businesses buying products or services should not assume that a creditor’s retention of title claim will be unsuccessful.
It’s important to be aware of any retention of title clauses present in contracts that directors have already signed.
These could potentially result in creditors retaining legal ownership over assets if they do not receive payment in full.
Summary: Retention of title clauses and insolvency cases
We hope this article has helped you understand how a retention of title clause works.We also explore the potential implications for an insolvent business.
There are different types of clauses including: basic or simple, all monies, proceeds of sale and mixed goods.
The intention of the clause is to allow the original seller to retain ownership over the goods in the event that the buying business is unable to pay for them in full at a later date. However, there are some circumstances whereby a retention of title clause proves to be non-enforceable.
For other informative guides, browse through the Hudson Weir blog. Recently we have explored what happens when an insolvent company owes a director money.
And in another blog post we answer a common question – what does inside IR35 mean – and explain the options for insolvent companies.
We are business rescue experts, a team of highly qualified chartered accountants and insolvency practitioners. To find out more about how our team can help you, please don’t hesitate to contact us.
