Retention of title THE RECENT DECISION OF THE HIGH COURT IN assets) - - PDF document

INSOLVENCY AND CORPORATE RESTRUCTURING Jones Day

84 The In-House Lawyer December 2007/January 2008 THE RECENT DECISION OF THE HIGH COURT IN Re CKE Engineering Ltd (In Administration) is a useful reminder of the basic principles that apply in relation to retention of title and, in particular, where goods of the same nature have been mixed with goods belonging to a third party. FACTS Coseley Galvanising Ltd (the company) was placed into administration on 17 November 2005. On 10 March 2006, the company’s parent, CKE Engineering Ltd (CKE), was also placed into administration. Upon the appointment of administrators to the company, there existed on its premises a tank containing 265 tonnes of zinc. Of this amount, 217 tonnes had been supplied to the company by CKE and 48 tonnes had been supplied by other parties. Zinc supplied to the company was delivered in the form of solid zinc ingots. Upon receipt, the ingots were deposited into a zinc tank and maintained in a molten state. Subsequently, the company added to the molten zinc a very small quantity (approximately 1%) of other chemicals (principally nickel) including a chemical ‘brightener’. The zinc ingots were mixed in the tank with zinc ingots from different sources and possibly different grades, and with other chemicals. When zinc was recovered from the molten mass and turned back into ingots, each ingot was worth approximately 70% of the value of an original ingot (because it would not be one of the recognised grades and would contain impurities). The retention of title clause in question provided as follows: ‘Until full payment has been received by [CKE] for all goods whatsoever supplied (and all services rendered) at any time by [CKE] to [the company]: a) property in the goods shall remain in [CKE] b) should the goods… be converted into a new product, whether or not such conversion involves the admixture of any other goods or thing whatsoever and in whatever proportions, the conversion shall be deemed to have been effected on behalf of [CKE] and [CKE] shall have the full legal and beneficial ownership of the new products…’ By agreement between the company’s administrators and the administrators of CKE, the zinc tank and its contents were sold (with other assets) for £60,000. This money was placed on an interest-earning account pending the determination

• f the Court as to the entitlement to the fund as

between CKE and the company. JUDGMENT The essential question before the Court was who owned the zinc. The issues were whether: (i) the fund was to be divided by reference to the

• wnership of the zinc or to the zinc and other

chattel assets; (ii) the company or CKE was the source of the 265 tonnes of zinc in the tank; and (iii) CKE had retained title to any zinc it had supplied. The judge summed up the basic principles of retention of title as follows: 1) Pursuant to s19 of the Sale of Goods Act 1979, a seller of goods is entitled to retain title in the goods until it has been paid. 2) The point at which title passes from the seller to the buyer is a matter of agreement between the parties, as a reservation of title is merely an agreement between the parties as to when title should pass. 3) What the parties have agreed with regard to the passing of title is essentially a matter of construction of the contract. As well as the documentation and communications between the parties, the court will also consider the practical consequences of the agreement. 4) A key factor in determining a retention of title claim is the extent to which the goods supplied retain their identity in the buyer’s hands, for it is not possible to ‘retain’ title in something that cannot sensibly be identified. 5) In determining whether goods retain their identity, the judge cited the judgment of Bryson J in Associated Alloys Pty Ltd v Metropolitan Engineering and Fabrications Pty Ltd at 209: ‘The question whether goods which have been used in some manufacturing process still exist in the goods produced by that process, or have gone out of existence on being incorporated in the derived product is, in my opinion, a question

• f fact and degree not susceptible of much
• exposition. When wheat is ground into flour, it is

reasonably open to debate whether the wheat continues to exist; when flour is baked into bread there is little doubt that the flour does not… Where goods of a homogenous character are mixed, co-ownership might be a correct conclusion… whether goods are reducible to the

Retention of title update

BY KAY MORLEY

associate, Jones Day

INSOLVENCY AND CORPORATE RESTRUCTURING Jones Day

December 2007/January 2008 The In-House Lawyer 85

• riginal materials is not just a matter of physics.

Other perspectives have to be considered, including the economic perspective. The scraps

• f leather produced by cutting up a

manufactured shoe could not in reality be regarded as the original leather from which the shoe was manufactured. The steel which would be produced by cutting up a pressure vessel and flattening out the cylindrical parts would not be the steel which Associated Alloys delivered under the sale; it would be scrap steel.’ 6) The judge went on to distinguish between the ‘blending’ and ‘commingling’ of goods. Where blending takes place, the resultant product is different in nature from both its original constituents and, arguably, the original goods have either been consumed or destroyed. 7) By comparison, commingling results in the production of a single bulk, any part of which is commercially indistinguishable from its original

• constituents. Where goods of the same nature

and belonging to two persons have been commingled by agreement, so that the several portions can no longer be distinguished, the proprietors have an interest in common in proportion to their respective shares. If there is a diversity in quality in the goods mixed, the whole should be divided and the greater allowance made to the owner whose substance is better or finer than that of the other. In applying the above principles to the facts, the judge said that the parties knew that the zinc ingots would not, following delivery, be retained in their

• riginal form, but would be immediately added to

the zinc tank with zinc supplied by third parties. Despite the conversion of the zinc ingots into a molten mass, the judge saw no reason why the respective suppliers of zinc could not agree that the contents of the zinc tank should be treated as

• wned in proportion to their respective contributions

to the tank. The judge found that there was: ‘… no practical difficulty in the way of the parties treating an ingot of zinc (when added to the tank) as continuing to exist as zinc because the original materials remain sufficiently identifiable to permit recovery.’ An important issue for the judge was that the molten mass remained substantially zinc and that it was physically possible to reduce the zinc to ingots

• again. If the zinc was reduced to ingots, it would

retain a substantial part of the value of the original constituent parts. Further, the judge considered it unlikely that the suppliers would consider that the zinc ingots had been consumed by conversion into a molten mass. Rather than create a new product, the parties would consider that the raw material continued to exist, albeit in a different form. Accordingly, it was held that CKE owned 217/265ths of the zinc in the tank and was entitled to receive the same proportion of the respective sale proceeds of the tank. COMMENTARY The decision in this case highlights the fact that it cannot be assumed that a retention of title clause will be defeated if goods supplied have been mixed with third-party goods. Further, it would appear that, in such circumstances, a retention of title clause will not be defeated even if it is not possible for the supplier of such goods to physically identify and recover its goods in the same form. The crucial issue for the judge in the CKE case was that the suppliers considered that their original goods continued to exist, albeit in a different form. The basic principles that apply in relation to retention of title where goods are mixed are frequently misunderstood. There is a clear distinction between goods that are mixed so that they become incorporated into the manufacturing process, and goods that are mixed but retain their

• riginal identity or can be extracted from the

manufacturing process. In the well-known case of Borden (UK) Ltd v Scottish Timber Products Ltd, resin was supplied to a chipboard manufacturer. The resin was supplied on retention of title terms. However, the resin was incorporated into chipboard shortly after its

• delivery. Upon incorporation into chipboard, the

identity of the resin was lost and the resulting chipboard was an entirely new product. Accordingly, the supplier’s retention of title claim was defeated. In Clough Mill Ltd v Martin, yarn was supplied on retention of title terms. The yarn supplied was subsequently incorporated into fabric. It was held that any claim by the supplier to the manufactured yarn was a charge void for non-registration. Gough and Oliver LJJ accepted in principle that the parties >

‘As illustrated in the CKE Engineering case, the fact that a supplier’s goods are mixed with goods owned by a third party will not necessarily defeat a supplier’s retention of title claim.’

INSOLVENCY AND CORPORATE RESTRUCTURING Jones Day

86 The In-House Lawyer December 2007/January 2008 could agree that title to the manufactured product should vest in the supplier, but held that, in the circumstances, if the supplier’s title had extended to the manufactured product, this would have resulted in a windfall for the supplier which could not have been intended. In Re Peachdart Ltd, leather was supplied to make

• handbags. The conditions of sale included a

retention of title clause. The Court held that title to the leather was lost when the leather was incorporated into the handbags, even though the supplier was still able to identify the handbags that had been made with its leather. Vinelott J held that the parties had agreed that the leather would be used for the manufacture of handbags. Accordingly, any interest of the supplier in the resulting handbags was a charge, void for non-registration. In the above cases, the identity of the original goods was lost when the relevant goods were incorporated into the manufacturing process. Accordingly, it was not possible for the relevant suppliers to retain title to their goods, as something had happened to the goods causing title to pass to the buyer. However, as illustrated in the CKE Engineering case, the fact that a supplier’s goods are mixed with goods owned by a third party will not necessarily defeat a supplier’s retention of title claim. In Mercer v Craven Grain Storage Ltd, a supplier delivered grain on retention of title terms. The grain was subsequently mixed with grain of a similar quality supplied by third parties. The grain supplied by one supplier was indistinguishable from the grain supplied by another. Further, the volume of grain being stored fluctuated from time to time. Whilst it was not possible for any one supplier to identify the grain it had delivered, the Court held that the relevant suppliers retained title to the bulk quantity

• f grain as tenants in common in proportion to their

respective tonnages. In circumstances where goods have been wrongly mixed with third-party goods, the courts appear even more willing to protect the innocent supplier. In the case of Indian Oil Corp Ltd v Greenstone Shipping Co SA (Panama) (The Ypatianna), crude oil was mixed on a ship with crude oil belonging to the ship’s owners. In mixing the oil, the owners of the ship had acted in breach of the contract of carriage. Staughton J held: ‘… where B wrongfully mixes the goods of A with goods of his own, which are substantially of the same nature and quality, and they cannot in practice be separated, the mixture is held in common and A is entitled to receive out of it a quantity equal to that of his goods which went into the mixture, any doubts as to that quantity being resolved in favour of A.’ Accordingly, the innocent suppliers of oil were entitled to receive the entire quantity of oil they had supplied to the ship, even though this would result in them receiving a greater proportion of oil than their respective share in the balance of oil remaining in the ship. CONCLUSION CKE Engineering is a useful reminder of the basic principles that apply in relation to retention of title and, in particular, where goods have been mixed with goods of a third party. It cannot be assumed that if a seller is unable to identify its particular goods, its retention of title clause will be defeated. In the first instance, it will be necessary to establish the extent to which the

• riginal goods supplied have retained their original
• identity. If the identity of the original goods has been

lost, title will pass to the buyer. If the original goods, having been mixed with third-party goods, remain substantially the same, the respective suppliers will retain title and will own the resulting bulk as tenants in common. The judgment in CKE Engineering suggests that this will be the position even if the form of the original goods has been changed and the suppliers would be required to ‘reverse’ the manufacturing process in order to recover their

• goods. Further, in the event that goods are wrongly

mixed, any doubt as to quantities supplied will always be resolved in favour of the original supplier. By Kay Morley, associate, Jones Day. E-mail: kmorley@jonesday.com. Re CKE Engineering Ltd (In Administration) (unrep, 19 September 2007) Associated Alloys Pty Ltd v Metropolitan Engineering and Fabrications Pty Ltd (1996) ACSR 205 Borden (UK) Ltd v Scottish Timber Products Ltd [1981] Ch 25 Clough Mill Ltd v Martin [1985] 1 WLR 111 Re Peachdart Ltd [1984] Ch 131 Mercer v Craven Grain Storage Ltd [1994] CLC 328 Indian Oil Corp Ltd v Greenstone Shipping Co SA (Panama) (The Ypatianna) [1988] QB 345