Reddy, Johnson Q & A, commercial law 2009–2010 2009-1

Q&A COMMERCIAL LAW 2009–2010

The first delivery

When Victor delivered the first consignment, he was in breach of contract in one or both of two respects. First, 20 of the desks were not mahogany and therefore did not comply with what must have been part of the contract description. That put Victor in breach of the condition implied by s 13 of the Sale of Goods Act 1979. Secondly, one can say that Victor delivered too small a quantity of the contract goods (that is, mahogany desks). Either way, there has been a breach of condition, giving the buyer the right to reject the goods (see s 30(1) of the 1979 Act) and this, we are told, is what Phillip wishes to do. There are, however, two problems with that. Firstly, it is not clear whether the contract is a severable one. If it is, the defective first delivery may not give Phillip the right to reject the later two consignments. Secondly, it is possible that Phillip may have lost his right to reject the goods because he may be held to have ‘accepted’ the first defective delivery.

To take the second of these issues first, a buyer who accepts the goods or part of them is precluded from rejecting the goods (s 11(4) of the Sale of Goods Act 1979). Section 35 of the 1979 Act states three things which will amount to acceptance. The problem simply gives us no information on the first two; we are therefore unable to state whether Phillip has either intimated to Victor his acceptance of the goods or else done any act inconsistent with rejecting them. As to the third thing (s 35(4)) listed in s 35, it is debatable whether a lapse of a reasonable length of time has occurred. Phillip has had the desks for five days. It is true that a reasonable period of time will not have elapsed if Phillip has not had the goods long enough to have been able to examine them to see if they conform with the contract. However, it must have been fairly obvious almost immediately upon delivery that: (a) 20 of the desks were missing; and (b) 20 of those which were delivered were teak and not mahogany. It is arguable in those circumstances that five days is more than a reasonable period of time in which to reject. Certainly, three weeks was held to be more than a reasonable period of time in the first instance decision (on the very different facts of a defective motor car) in Bernstein v Pamson Motors (1987). We are not told what were the provisions of the contract regarding the time of payment. If a period of, say, one month was allowed for Phillip to pay, then it may be that a reasonable period of time would be held to last at least until the deadline for payment (Truk v Tokmakidis (2000)).

Since s 35 was amended, there is now a right of partial rejection which would allow Phillip to reject the desks which do not conform to the contract and to accept the rest (the other 260). However, it is clear from the facts that Phillip would prefer to reject the lot. Thus, assuming that Phillip has not ‘accepted’ the first consignment, he will have the right to reject that consignment (the whole of it). Whether that gives him the right to reject the later consignments also depends upon whether the contract is an entire contract or is a severable one. If it is not severable, then the breach of condition entitles Phillip to reject all consignments. The test of whether a contract is severable is one of construction (interpretation) of

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the contract, that is, one is trying to discover from the words of the contract what was the intention of the parties. Was it their intention that a breach in relation to one consignment should entitle the purchaser to reject all? If not, then the contract is severable – see generally Jackson v Rotax Motor and Cycle Co (1910). The fact that the desks were to be delivered in instalments is some evidence that the contract was severable. We are not told, however, whether under the contract, the consignments were each to be separately paid for. If they were, then that would be strong evidence that the contract was severable. It may be argued that the parties had themselves clearly labelled the contract as not being severable but as being entire, because of the clause in the contract which read that the ‘entire’ contract was governed by English law. It is submitted, however, that this clause is nothing more than a choice of law clause and that the word ‘entire’, in the particular context of that clause, does not bear upon whether the contract was severable, but merely means that all of the contract, as opposed to part of it, was to be governed by English law.

If Phillip has not ‘accepted’ the first consignment and if the contract is not severable, then he is entitled to reject all the goods, including the later two consignments. If he has not ‘accepted’ the first consignment and the contract is severable, then he may still be able to regard the whole contract as repudiated and thus be able to reject the two later consignments. Whether the whole contract is repudiated depends upon the following two factors: (a) the ratio that the breach bore quantitatively to the whole contract; and (b) the likelihood of the breach being repeated in later instalments (Maple Flock Co v Universal Furniture Products (1934)). This is not so easy to determine. At the time that the breach occurs, one cannot tell anything about the second of these factors. As to the first, it could be said that the breach is fairly small in relation to the whole contract. First, it relates to only one consignment out of the three and, within that consignment, it affects only a small proportion of the total quantity of the desks.

Thus, based on the first defective delivery, one’s advice to Phillip would be cautious since: (a) he may have ‘accepted’ the goods; (b) the contract may be severable; and if it is, the Maple Flock test may not be satisfied so as to allow him to regard the whole contract as repudiated.

The second delivery

The breach in relation to the second delivery is simply a delivery of too small a quantity. The missing five desks would appear too many for the courts to be prepared to ignore the breach on the de minimis non curat lex principle. Thus, it is a breach of condition.

If the contract was not severable and Phillip has not ‘accepted’ the first consignment, then he is entitled to reject all three consignments because of the breaches of condition in relation to the first two consignments. If the contract was not severable

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and Phillip has ‘accepted’ the first consignment, then the position is clouded by the fact that the effect of s 11(4) and the new s 35A is not entirely clear. Section 35A introduced the concept of partial rejection, allowing the buyer to reject some or all of the non-conforming goods, provided he accepted all of the conforming goods. One thing which does seem clear is that ss 11(4) and 35A do not allow the buyer to reject any goods (whether conforming or not) which he has actually accepted. Thus, if the contract is not severable and Phillip has ‘accepted’ the first consignment, he cannot now reject any of the first consignment (though he may claim damages in respect of the breaches relating to the first consignment). As regards the second consignment, he is entitled to reject any non-conforming goods, but not conforming goods. However, there are no non-conforming goods, since the only breach relating to the second consignment is a shortfall in the number of desks. Section 30(1) entitles the buyer to reject all the goods if a quantity less than the contract quantity is tendered. The buyer appears, however, to be precluded from exercising this right by his acceptance of the first consignment. This is the effect of s 11(4) in the case of a non-severable agreement. Although s 11(4) is subject to s 35A, the latter is of no help to the buyer in this instance. Section 35A(1) applies only where it is non-conforming goods which are being rejected. Section 35A(2) also appears to be of no help, since it applies only where the buyer has a right to reject an instalment, and that is the very issue which we have to determine (that is, does the buyer have a right to reject the second instalment?). If this seems an odd result, it is explicable on the basis that the agreement is not severable. In the case of a non-severable agreement, acceptance by the buyer of any conforming goods precludes rejection of any goods. Perhaps this makes it more likely that the courts will regard contracts for delivery in instalments as severable contracts.

If the contract was severable, then Phillip would certainly be entitled to reject the second consignment because of the breach of condition in relation to that consignment, and that is so even if he had ‘accepted’ the first consignment; s 11(4) does not apply to severable contracts. In the event that the contract was severable, then the Maple Flock test again needs to be applied to determine whether Phillip is entitled to reject the third instalment as well. This time, however, it seems much more likely that the test is satisfied. This is because, on two out of the three instalments, Victor has made a non-conforming delivery. Thus, the ratio that the breach(es) bear quantitatively to the whole contract is much higher and would also seem to suggest a higher probability that he will repeat this with the third and last delivery. On that interpretation, Phillip is entitled, even if the contract is severable, to regard the whole contract as repudiated and thus to reject the third consignment as well as the second. Whether that entitles him also to reject the first consignment is debatable. Although on its wording s 11(4) does not apply to severable contracts, it would seem unlikely that the law is such as to allow rejection of any goods which have actually been accepted. Of course, if Phillip has not ‘accepted’ the first instalment, then the breaches relating to the first two instalments entitle him, for the reasons just given,

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to regard the whole contract as repudiated, to reject all the goods delivered under the first two instalments and to refuse to accept the third.

The rider

Would it have made any difference if the second delivery had been made only on 3 February? This would affect the consideration of two issues discussed above. Firstly, the time lapse between the first delivery and today would be longer (that is, from 20 January to 3 February) and that would increase the likelihood that Phillip would be held to have accepted the first consignment and thus be precluded from rejecting that consignment or, if the contract was not severable, any of the consignments. Secondly, it would increase the seriousness of the breach in relation to the second consignment, which would suggest that there is a greater degree of breach as compared with the contract as a whole, for there would be no doubt that the breach in relation to the second consignment did indeed affect the whole of that consignment. Thus, if the contract is severable, it would be much more likely that by the time the second delivery has come, several days late and with five desks short, Victor has committed a breach entitling Phillip to regard the contract as repudiated and therefore to reject the third consignment immediately.

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CHAPTER 3

PASSING OF PROPERTY AND RISK

INTRODUCTION

This chapter covers the passing of property and risk. It incorporates the topic of retention of title clauses, and also deals with perishing goods.

Question 12

Latham plc sells cashmere wool to various garment makers on terms that require payment 30 days after delivery. About 50% of its sales are to regular customers while the rest are to ‘one-off ’ customers. Some of its customers resell the cashmere wool, while other customers use it in the manufacture of suits and other garments which are then stored or sold.

Advise Latham plc on why it ought to consider incorporating a retention of title clause into its standard terms of sale and what protection such a clause might provide.

Answer plan

The question invites an explanation of the purpose of retention of title clauses and a discussion of the effects and effectiveness of them. You should approach the question as follows:

•explain the purpose of retention of title clauses;

•deal with the passing of risk;

•state the requirements for an effective clause;

•explore the limits on effectiveness without being registered where:

(a)the buyer sub-sells the goods (and can the seller take an interest in the proceeds of the sub-sales?);

(b)the buyer pays for the goods (and what if he only makes part-payment or if the buyer owes other money to Latham plc?);

(c)the goods lose their identity.

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Answer

The reason why Latham plc ought to consider incorporating a retention of title clause into its standard terms of sale is to protect itself against the risk of one of its customers becoming insolvent and hence going into liquidation before the customer has paid Latham plc for the cashmere wool supplied. Without a retention of title clause or some other form of security, Latham plc would in that event be a mere unsecured creditor of the insolvent buying company and would be lucky to get more than a small proportion of the debt owed to it. The purpose of a retention of title clause would be to put Latham plc in a stronger position in the event of the buyer going into liquidation – that is, if the goods had not been paid for, to enable Latham plc to retake possession of the goods (Latham plc’s goods) and to do so irrespective of how many other creditors the insolvent buyer might have.

Passing of risk

Before dealing with the effectiveness of a retention of title clause to protect Latham plc, a warning should be given about the passing of risk. A retention of title clause, when it works, will result in title (that is, ownership, or what the Sale of Goods Act 1979 terms ‘property’) being retained by Latham plc (that is, not passing to Latham plc’s buyer) for some considerable time after delivery. However, by s 20(1) of the Sale of Goods Act, the goods will, unless the contrary is agreed, remain at the seller’s risk until the property in them passes to the buyer. Thus, Latham plc would be well advised, when including a retention of title clause in its conditions of sale, either to include also a clause stating that the goods will be at the buyer’s risk from the moment of delivery, or else to see that Latham plc is covered by its own insurance for loss or damage caused after delivery by accident, act of God or act of a third party.

Effectiveness without being registered

By a properly drafted retention of title clause, Latham plc can ensure that it retains property in the goods supplied until one of three events occurs. As soon as one of these events occurs, property will pass (that is, Latham plc will lose title to the goods). Those three events are: firstly, that the goods are sold by the buyer and property passes under that contract to the buyer’s sub-buyer; secondly, that the buyer pays Latham plc; thirdly, that the goods, although still unsold by the buyer, lose their identity on becoming incorporated in something else. The point is that, until one of these events occurs, Latham plc will have retained title to the goods and will be able, on the buyer going into liquidation, to retake the goods, thereby enforcing its rights of ownership. Such a right does not have to be registered as a charge, because the requirement (in s 860 of the Companies Act 2006) to register applies only to charges created by the

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buying company. Thus, both the Court of Appeal (in Clough Mill v Martin (1985)) and the House of Lords (in Armour v Thyssen (1990)) have held that retention of title clauses are enforceable without being registered. Attention will now be paid in turn to each of the three possibilities which will cause Latham plc to lose ownership in the goods even where there is a retention of title clause.

Buyer sells the goods

Latham plc may think that it would be wise to retain title until the goods have been paid for and to ensure that if they have not been paid for, Latham plc still retains title even if the buyer sells the goods. This, however, would be unrealistic. It is very likely that Latham plc’s buyer needs to be able to sell the goods in order to maintain its own cash flow and thereby to be able to settle its debts, including those owed to Latham plc. On the other hand, if that buyer were unable to pass on good title to a sub-buyer to whom it sold the goods, it would be very unlikely to be able to find willing sub-buyers. In any case, even if the retention of title clause were to purport to retain title for unpaid goods even after they had been sold on to a sub-buyer, there is always the risk that the sub-buyer, if unaware of the retention of title clause, would claim nevertheless to obtain title by virtue of one of the exceptions to the principle nemo dat quod non habet – in particular, the one in s 25(1) of the Sale of Goods Act 1979. Therefore, a sensibly drafted retention of title clause will authorise the buyer to sub-sell the goods (see the Romalpa case) so that the buyer in subselling the goods will, vis-à-vis the sub-buyer, be selling as a principal and, vis-à-vis Latham plc, be selling as an agent of Latham plc. Technically, of course, Latham plc would not lose ownership and the sub-buyer would not acquire ownership until, according to the terms of the sub-sale, property passes from the buyer to the subbuyer.

If then, as seems inevitable, Latham plc is not to retain ownership after the time when property is to pass to the sub-buyer, is there any way that Latham plc can continue to protect itself against the subsequent insolvency of the buyer? The answer, confirmed by the decision in the Romalpa case, is that an appropriately worded clause may give Latham plc an interest in the proceeds of sale received by the buyer from the sub-buyer. For such a result to be achieved, the clause will need to make it clear that in having possession of and sub-selling the goods, the buyer is agent of, bailee of, fiduciary of, and selling for the account of the seller. Then, if the buyer has kept any such proceeds of sale in a separate account, Latham plc will, in priority to the buyer’s other creditors, be able to take those proceeds of sale to satisfy the outstanding debt due to Latham plc. If the proceeds have been mixed by the buyer with other monies, then Latham plc would be able to trace according to the equitable principles of tracing (Re Hallett’s Estate (1880)). It is important that the clause complies with the requirements set out above. Even then, there is uncertainty surrounding clauses aimed at securing to the seller (here, Latham plc) an interest in the proceeds of subsales by the buyer. Some of this uncertainty was exposed in Pfeiffer GmbH v Arbuthnot

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Factors (1988), where the clause authorised the buyer to sub-sell and required the buyer to pass on to the seller all the buyer’s rights under those sub-sales contracts, requiring this to be done up to the amount of the buyer’s indebtedness to the seller. It was held in the High Court that this was a charge created by the buyer and was void because it was not registered under the Companies Act. There were two significant distinctions between the clause here and that in Romalpa. Firstly, the clause providing that the buyer in sub-selling was doing so for the account of the seller was expressly limited to the amount of the outstanding debts owed by the buyer to the seller. Secondly, it failed expressly to state that the buyer was, in selling the goods, a fiduciary of the seller. One possibly significant uncertainty in all of this is that in Romalpa, the one case where a seller has successfully claimed an interest in the proceeds of sub-sales, the decision rested on a concession made by counsel for the buyer’s receiver, namely, a concession that the relationship of seller and buyer was that of bailor and bailee. Advice to Latham plc is therefore to include in the contractual retention of title provisions a clause which deals with the proceeds of subsales and satisfies the requirements indicated above, but to recognise the uncertainty over its legal effect, if not registered as a charge created by the buyer.

Buyer pays Latham plc

For those customers of Latham plc that are ‘one-off ’ customers, the clause need retain title only until the purchase price has been fully paid. The effects of such a clause were set out in Clough Mill v Martin (1985) (partly ratio and partly obiter). If the buyer goes into liquidation before paying for the goods, then Latham plc can retake the goods. Latham plc can then resell the goods itself, since they are its property. If Latham plc sells them for more than the original price that the buyer had agreed to pay, then Latham plc will make a profit which it would not have made if the buyer had paid for the goods before going into liquidation; Latham plc will be entitled to retain that profit. If Latham plc is able to resell the goods only for a lower figure than the buyer had agreed to pay, then Latham plc will have a claim for damages against the buyer for the consequent loss; however, Latham plc will be unlikely to recover much of that loss, in respect of which it will be merely an unsecured creditor of the insolvent buyer. If, at the time when the buyer had gone into liquidation, the buyer had paid part of the purchase price to Latham plc, and if Latham plc, having repossessed the goods, is able to sell them for the same price that the buyer had agreed to pay, Latham plc will be under a duty to refund the buyer’s part-payment. If, however, Latham plc has been able to resell the goods only at a lower figure than the buyer had agreed to pay, then Latham plc will be able to deduct that loss from the amount of any refund.

For Latham plc’s regular customers, the clause should, in the interests of Latham plc, be an ‘all liabilities’ clause; it should retain title until the buyer has satisfied all his liabilities to Latham plc, whether arising under this or any other contract. That such a clause can be effective was confirmed by the House of Lords in the Scottish case

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of Armour v Thyssen (1990), and it is not thought that the law is any different in this respect in England. Indeed, the reasoning in that case would seem also to legitimise a clause which retains title to Latham plc until all debts owed to Latham plc by the buyer or by any subsidiary or associated company of the buyer have been paid.

Goods lose their identity

It has been established in various cases that a retention of title clause will cease to be effective once the goods have lost their identity by becoming incorporated in something else. This usually occurs in the buyer’s manufacturing process, for example, resin becoming incorporated in chipboard (Borden v Scottish Timber Products Ltd (1981)), or pieces of leather becoming incorporated into handbags made by the buyer (Re Peachdart Ltd (1984)). It seems that Latham plc cannot retain title to the cashmere wool once that wool has been used in the manufacture of other products, such as suits, jackets, bedspreads, etc. It seems unlikely that the cashmere wool (unlike the engines in Hendy Lennox v Grahame Puttick Ltd (1984)) could be incorporated in something else without losing its identity. Thus, Latham plc cannot protect itself where the wool has been incorporated in something else in the buyer’s manufacturing process, without registering a charge created by the buyer over the manufactured product.

Conclusion

Latham plc would be well advised to include retention of title provisions in its contracts, which, if carefully drafted, should serve to give some security against the risk of the buyer becoming insolvent. Without being registered as a charge, those provisions should be effective in the case of unmixed goods and, possibly, the proceeds of sale of unmixed goods.

Question 13

Gallant Wines Ltd is a wine merchant. Its stock in its warehouse a month ago was:

•100 bottles of 1960 Château Magret;

•200 bottles of 1970 Château Pouilley which, unknown to Gallant Wines Ltd, were the last bottles of that vintage remaining unconsumed anywhere in the world;

•350 bottles of 1980 Château Darcey;

•assorted other wines.

In the last month, Gallant Wines has made and received no deliveries of wine, but has made the following agreements to sell wine:

• ‘100 bottles of 1960 Château Magret’ to Mark;

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