[Malavika Devaya is an associate at Poovayya & Co., Advocates & Solicitors.]
A retention of title (ROT) clause is a provision that may be included in commercial contracts and purports to protect the seller’s interests by maintaining title to the goods with the seller until the occurrence of a future event, usually the receipt of payment. These clauses are, however, not very commonly utilised in India, and so Indian courts have had very few opportunities to examine and adjudicate on the same.
An ROT clause plays an important role in multiple scenarios, the most important perhaps being the buyer’s insolvency. In the supply of goods, extended credit lines and delayed payments are common features and, ordinarily, in the event the buyer undergoes liquidation before completing payment for the goods supplied, the seller would be classified as an unsecured operational creditor and placed towards the bottom of the order of priority, often receiving as good as nothing. A seller who retains title in the goods supplied, in theory, would not go to the bottom of the pile, but would instead have a direct recourse available in the form of her claim to the very goods supplied.
ROT clauses can be of various kinds, the most popular being the simple or ‘all monies’ variety, where the seller retains title to the goods supplied to the buyer until all dues from the buyer to the seller have been paid. These clauses may also be slightly more complex, such as (i) the ‘manufactured goods’ clause, where the seller retains title to goods supplied to the buyer even after such goods have undergone some sort of processing or manufacturing process; and (ii) the ‘proceeds’ clause, where the seller is entitled to the proceeds of the sale of the goods to third parties by the buyer.
This post seeks to answer the question, as far as possible, on whether Indian laws as they stand today recognise the interest created by an ROT clause as an ownership interest, as in England, or as a security interest or charge that would need to be registered to be enforceable, as in the United States, Australia and New Zealand, in the limited context of simple or ‘all monies’ ROT clauses and without delving into the ‘manufactured goods’ and ‘proceeds’ clauses.
Treatment of ROT Clauses in England vs. the United States, Australia and New Zealand
English law recognises a distinction between security interests and the interest created by an ROT clause, taking a purely formalist approach and treating the latter in its strictest form as ownership continuing to vest in the seller. Beginning with the landmark judgement in Aluminium Industrie Vassen BV v. Romalpa Aluminium Limited [1976] 1 WLR 676, the evolution of the law on ROT clauses through subsequent decisions has been abundantly clear as to the fact that, in simple and ‘all monies’ ROT clauses, as the seller retains ownership in the goods, the buyer could not possibly create a charge or security over goods that it does not have title to. English courts have, however, refused to extend the application of this concept to the ‘manufactured goods’ and ‘proceeds of sale’ clauses so far, finding that the seller could claim to retain title only as long as the goods so sold remain distinct and identifiable, and that once the goods have been altered or sold further, the nature of the original seller’s position reverts to an unsecured creditor, creating a charge that requires registration (Clough Mill Ltd. v. Martin [1984] 3 All E.R. 982).
In contrast, several developed commercial law regimes around the world have adopted a more functional approach, incorporating provisions in the relevant statutes recognising the retention of title as creating security interest and requiring compulsory registration of the same. Article 9 of the Uniform Commercial Code (UCC) in the United States of America recognises the creation of security interest by retention of title, as well as the concept of ‘purchase-money security interest’ in goods which, if perfected in accordance with the applicable law, accords it priority over a conflicting security interest over the same goods. The UCC even prioritises perfected security interests in the ‘identifiable proceeds’ of such goods, subject to certain conditions. Similarly, the Personal Property Securities Act 1999in New Zealand and the Personal Property Securities Act 2009 in Australia recognise agreements to sell subject to retention of title as creating security interests, along with the concepts of purchase-money security interests, and require the ‘attachment’ and ‘perfection’ of such interests for enforcement against the specific goods as a secured creditor.
There is, therefore, a clear distinction between the manner in which ROT clauses are treated in England vis-à-vis their treatment in countries like the United States of America, Australia and New Zealand.
Analysis of the Position in India
As in England, the sale of goods in India is governed by the Sale of Goods Act, 1930 (SOGA). The SOGA permits parties to a contract for sale of specified or ascertained goods to agree as to when the property in the goods would pass from seller to buyer (section 19) and provides that when the property in the goods supplied is to be transferred at a future time or subject to the satisfaction of some condition, the contract amounts to an agreement to sell and not a contract of sale (section 4). Therefore, in line with English common law jurisprudence, the Indian law governing the supply of goods recognises the possibility of retention of title until the occurrence of a future event, i.e., payment for the goods. The Gujarat High Court in 2002, adjudicating on whether an ROT clause in a contract for supply of goods had the effect of creating a charge over the goods in question and would, therefore, need to be registered in accordance with the provisions of the Companies Act 1956 to be enforceable, relied upon the law laid down by English courts and found that no security could be created over goods by the buyer when property in the goods itself had not passed to her.
On the other hand, a fairly recent amendment to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (the SARFAESI Act) in 2016 modified the definition of ‘security interest’ in the SARFAESI Act (section 2(1)(zf)) to include ‘title or interest of any kind, on tangible asset, retained by the secured creditor as an owner of the property, given on hire or financial lease or conditional sale or under any other contract which secures the obligation to pay any unpaid portion of the purchase price of the asset or an obligation incurred or credit provided to enable the borrower to acquire the tangible asset….’ Therefore, the SARFAESI Act now recognises the security interest created by retention of title and the concept of purchase-money security interest and provides for the enforcement of such interests by ‘secured creditors’, subject to the registration of the security interest with the Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI). However, it is pertinent to note that the enforcement of charges registered in this manner under the SARFAESI Act is available only to banks, financial institutions, non-financial banking companies and debenture trustees, entities included within the definition of ‘secured creditors’ under the SARFAESI Act (section 2(1)(zd)).
The Companies Act 2013 (Companies Act) is another legislation that defines ‘charge’ and requires any charge created by a company to be registered for the same to be taken into account by a liquidator appointed under the Insolvency and Bankruptcy Code, 2016 (IBC) (section 77). However, the definition of a ‘charge’ under the Companies Act is limited to ‘an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage’ (section 2(16)). Therefore, unless this definition is amended to bring it in line with the definition of security interest under the SARFAESI Act, in a commercial agreement for the supply of goods where the parties have set out and agreed that property in the goods does not pass to the buyer until the happening of a certain event, say receipt of payment, there is no creation of a charge requiring registration within the definition of the Companies Act, as held previously by the Gujarat High Court.
Conclusion
From the above, it is reasonable to conclude that, as the law stands today, an ordinary supplier of goods, not being a ‘secured creditor’ under the SARFAESI Act and to whom the enforcement mechanism under the SARFAESI Act is not available to begin with, is free to include an ROT clause without any registration requirements to enforce the same under common law or the provisions of the IBC. For such a claim to be successful at the time of liquidation, it is important for the goods to be in the possession of the buyer, identifiable and unchanged – therefore, these are points that must be kept in mind while drafting the ROT clause as well. The remedy available to the seller in such a case would be to seek return of possession of the goods, ensuring that the same are not included in the estate of the buyer for the process of liquidation.
– Malavika Devaya
