Friday, April 22, 2011

The Romalpa Clause and Bankruptcy Protection

To a supplier or, more generally, to any commercial entity involved in the initial stages of a supply chain, protecting itself in the event of the bankruptcy or change in constitution of its principal buyers is a matter of great importance. It is therefore commonplace to find clauses in a contract creating, for example, a unilateral right to terminate in the event of change of control. Similarly, several devices are used to try to gain an advantage over other creditors in the event of bankruptcy, especially in a business that involves a substantial level of supply on credit. Of these, the most well-known mechanism is the “Romalpa clause” – a retention of title clause that provides that property in the goods does not pass until full payment is received. The recent decision of the UK Court of Appeal in Bulbinder Singh v Jet Star Retail demonstrates some of the limitations of such clause, particularly because of the buyer's implied authority to dispose of the goods.

Mr. Singh was engaged in the business of manufacturing clothing under the trade name of Isher Fashions UK [“Isher”] and was also in time the sole shareholder of Jet Star, a retailer of fashion garments. Isher supplied a large quantity of clothing to Jet Star until 2008, when Jet Star found itself unable to pay many of its suppliers. A winding-up petition was filed by some of its other creditors, and it was placed in administration on November 19, 2008. Nevertheless, it continued to trade between 20 and 24 November, and sold in that period a significant quantity of stock supplied by Isher Fashions. The contract between Isher Fashions and Jet Star contained a retention of title clause, which it is useful to set out in full:

6.2 Isher Fashions shall retain property, title and ownership of the Products until it has received payment in full in cash or cleared funds of all sums due and/or owing for all Products supplied to the Customer by Isher Fashions under this Contract and any other agreement between Isher Fashions and the Customer.


If the Customer

. . .

7.1.4 . . . has a bankruptcy petition presented against it, has appointed in respect of it or any of its assets a liquidator, . . . receiver, administrative receiver, administrator or similar officer . . . then Isher Fashions shall have the right, without prejudice to any other remedies, to exercise any or all of the following rights:

. . .

7.1.9 Isher Fashions may require the customer not to re‑sell or part with the possession of any Products owned by Isher Fashions until the Customer has paid in full all sums due to Isher Fashions under this Contract or any other agreement with the Customer

Isher Fashions had not exercised its right under Clause 7.1.4. at the relevant time. Nevertheless, it brought a claim against Jet Star for conversion. It had to be conceded that a buyer, in these circumstances, has implied authority to dispose of the goods although title has not passed – the nature of the relationship between a supplier and a buyer makes that conclusion inevitable. Isher Fashions suggested, however, that a retention of title clause is analogous to an agreement for a floating charge. If this premise is established, it would follow that that implied authority to dispose of goods automatically terminates when the buyer is placed in administration, for it is well established that an instrument that creates a floating charge prevents a company from disposing of its assets “outside the ordinary course of its business.” A detailed analysis of the scope of this expression is available in Etherton J.’s judgment in Ashborder BV v Green Gas, in which it was accepted that a transaction by a company that is intended to or has the effect of bringing its business to an end is outside the ordinary course of its business. Thus, this suggestion, if well-founded, would have considerably strengthened the effectiveness of a retention of title clause.

In Bulbinder Singh, Moore-Bick LJ agreed that the ordinary course of business test has been correctly formulated but held that there is no effective analogy between a retention of title clause and a floating charge. For one, the scope of a retention of title clause depends, in the ultimate analysis, on the intention of the parties as manifest in the particular contractual context, and it is misleading to suggest that every such clause has the same effect. For example, the provision in clause 7.1.4 (extracted above) that the seller is entitled to withdraw the buyer’s authority to sell is itself a conclusive indication that the buyer, in the absence of the seller taking such action, does have that authority. In other words, if it is the case that insolvency automatically terminates implied authority, clause 7.1.4 would have been unnecessary. Moore-Bick LJ held that this is the reason the analogy between a floating charge and a retention of title clause breaks down:

The parties clearly had in mind, therefore, that the buyer might be permitted to continue to deal with the goods even after it had become insolvent or (as here) had gone into administration. In my view that is an important distinction between this contract and a debenture creating a simple floating charge and one which has significant implications for the scope of the buyer’s authority to dispose of the goods. It is an important feature of a floating charge that it crystallises on the insolvency of the debtor and thereby provides the creditor with the protection he seeks. Under this contract, by contrast, the protection provided by the retention of title clause is contingent on the decision of Isher Fashions to withdraw the buyer’s authority to deal with the goods. I do not think, therefore, that one can draw a direct analogy between the two [emphasis mine].

It followed in Bulbinder Singh that the buyer’s authority to dispose of goods was not limited by the ordinary course of business test.

This decision is an important reminder that the step from a Romalpa clause to automatic limitations on implied authority to dispose is often one too many. The result may be different if the retention of title clause, unlike in Bulbinder Singh, provides not only that title is retained, but that authority to re-sell or dispose is terminated in advance of a seller's notice to that effect, on the event of administration.

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