With 4,000 companies going into compulsory or creditors’ voluntary liquidation in the second quarter of 2010, the biggest threat to the livelihood of the SME can still be considered to be bad debt. A sub-contractor business, which relies on a small number of large contracts for its livelihood, is highly vulnerable to crippling loss when a main contractor goes into liquidation. Careful management of cashflow is essential to make sure that exposure to this is kept to a minimum. Subcontractors can find that they have paid for and fitted expensive goods to the end user’s building for which they have no chance of getting paid.
In many cases, the main contractor will have simply failed to pass on payment to the subcontractor. The client has a nice complete building but the subcontractor, who kitted it out, is left out of pocket. Alternatively, a wholesaler may have boxes of unsold goods in a retailer’s premises which have not been paid for.
A “Retention of Title”, or “Romalpa” clause is one of the most common tools used to preserve the supplier’s rights to unpaid-for goods. These clauses typically say that goods remain the property of the supplier until paid for in full.
These clauses can be difficult to enforce, however. For example, in a typical construction contract, the contractors are paid specific stage payments on a general valuation basis rather than for specific goods or services. So it is hard to identify which goods have been paid for in full.
Equally, retention of title clauses may cease to be enforceable when the goods have been incorporated into a finished product, or a building. For example, resin manufacturers were unable to rely on their retention of title clause when the resin had been used to manufacture chipboard. The resin had “lost its identity” and could not be traced into the chipboard. A diesel engine incorporated into a generator could however be unbolted and removed, and that could keep its identity.
Different rules apply to land and buildings. An air conditioning unit could physically be unbolted and carted off by the unpaid supplier, but it was deemed to be a fixture of the land, and so thoroughly connected to the services and pipes of the building that it had to remain, although the supplier had not been paid for it by the main contractor.
The effectiveness of retention of title clauses when a company enters into an insolvency or debt management process depends upon which process is used.
Use of retention of title clauses to seize stock held in a closed down shop can be worthwhile considering. However, once a company goes into administration, the consent of the administrator or permission of the court is needed to repossess the goods. A receiver may be asked to give an undertaking to pay for any goods which are used or sold, when a company goes in to receivership.
Retention of title clauses therefore need careful drafting to function as a preventative, and careful enforcement if the creditor is not to be throwing good money after bad by way of damage limitation. They also need to be drawn to the attention of main contractors and end customers by the subcontractor. Specific accounting advice needs to be taken on their effect on VAT bad debt relief too.