Taking counsel

  • 2005-05-11
  • Leho Pihkva, an associate at Sorainen Law Offices in Tallinn
Retention of title 's securing your claim more effectively

In common trade practice goods are often delivered before payment is received. This creates the need for the seller to secure his position should the buyer fail to pay.

Retention of Title. RT gives the seller the opportunity to remain the owner of the sold goods until full payment is received. Establishing RT requires a retention clause in the sales contract, which is effective and recognized in the jurisdiction where the goods have been delivered to the buyer. Article 4 of directive 2000/35/EC (European Commission) prescribes to member states the obligation to allow RT in their legislation.

In case of the buyer's bankruptcy, RT grants the seller rights to exclusion of the sold goods from the buyer's bankruptcy estate instead of leaving the seller with a nonsecured claim of payment. The seller must, prior to claiming exclusion, terminate the sales agreement containing the retention clause.

If the buyer sells the goods to any third party acting in good faith (i.e., unaware of RT), the RT on sold goods is terminated (i.e., title to the goods passes to a third person), and the seller can claim the purchase price and/or damages from the buyer, who is in breach of the RT clause.

In case the buyer has sold the goods to a third person acting in good faith prior to becoming insolvent and the purchase price has not yet been paid to the buyer, then the seller can demand from the buyer the assignment of claims against the third person who contracted with the buyer.

If the purchase price has been paid to the buyer while it is insolvent, the seller can demand payment of purchase from the bankruptcy estate prior to other claims.

RT can also be extended. The buyer and seller often wish to grant the buyer rights to sell the goods under RT to give the buyer the opportunity to finance the purchase price out of the proceeds of such sales. The RT can be extended so that the buyer agrees in advance to assign any claims arising out of such sales to the seller. This creates a benefit for the seller in cases where the goods under RT have been sold and money for the goods has been paid before the buyer has become insolvent. In such case the extended RT grants a right to claim the unpaid sums from the party who purchased the goods from the buyer (instead of leaving the seller with a last-ranking unsecured claim against the buyer).

The RT can be further extended. This means that the RT secures not only the claim for payment of purchase price but also any other claims the seller may have against the buyer from time to time. An even further extension would be to secure not only the claims of the seller but the claims of any seller's affiliates and/or associated companies as well. Stipulating regular RT (without any extension) in standard terms of contract is not likely to present problems. The use of extended RT in standard terms may need some consideration as to whether it might be regarded as unreasonably harmful contract term.

For the above reasons RT helps to overcome the main weaknesses of the Commercial Pledge (i.e., anything disposed of in due course of business is automatically excluded from the scope of CP, mortgage extends to accessories of the immovable 's e.g., industrial equipment 's which obtain a ranking above CP).

In many cases an extended RT can be more suitable for securing the seller. For these reasons CP is often used not as primary security but rather as a defensive security to discourage other creditors.

The above was written with respect to the laws of Estonia. Lithuanian law also contains similar RT provisions; however, the possibilities to effectively enforce it during bankruptcy proceedings might be affected by certain particularities of Lithuanian bankruptcy law.