The fine print

 

Businesses should understand the risks involved in supplying goods on credit – especially suppliers of raw fashion materials and accessories, Lisa Egan and Gregory Pieris explain.

It is an old saying, but a ‘stitch in time saves nine’ rings true when ensuring supply contracts provide suppliers with protection against a customer who runs into financial trouble and is unable to pay. Cash flow is already tight in an industry often dependent on picking up the right trends and moving quickly, so bad debts can have a serious effect on business viability.

Every fashion garment or accessory available for sale is a result of a chain of supply contracts between fabric manufacturers and garment manufacturers, manufacturers and wholesalers, wholesalers and retailers.

Supply contracts can involve considerable risk for the supplier. In a typical supply arrangement, products are supplied on credit with terms that the customer ordering the goods pays within a certain number of days or weeks. A supplier in this situation may have handed over tens or hundreds of thousands of dollars worth of stock.  

So what happens to this stock if the customer experiences financial difficulty and cannot pay? Ordinarily, in credit purchase transactions, ownership of the goods passes from the supplier to the customer upon delivery, even though those goods have not been paid for.

This means that if a customer cannot pay, the supplier has no right to recover the unpaid goods and becomes an unsecured creditor of the company.  If ultimately the customer becomes insolvent and is wound up in liquidation, unsecured assets of the company are sold and the proceeds shared amongst unsecured creditors.

This payment is almost always far less than what was owed, and often amounts to nothing. So, the risk for suppliers is that not only are they not paid, they lose their stock too.

Retention of title clauses

To avoid this situation, suppliers should include clauses in their terms of sale which attempt to preserve ownership of the supplied goods, or proceeds of sale of these goods, until the purchase price has been paid by the customer. These are known as “retention of title” clauses.

An effective retention of title clause will give a supplier certain rights if the customer breaches the contract or goes into liquidation.  The seller will have the right to retake possession of the goods, resell the goods, and become a creditor of the company for any shortfall.

If the goods are sold for more than the amount owed, the supplier should also have the right to retain the proceeds as if it owned the goods.  If the customer has already sold the goods, in some circumstances the supplier may also recover the proceeds of those sales.

Raw materials

So what happens if the goods supplied are transformed into another product, for example, fabric is used to manufacture a garment before the fabric supplier is paid by the manufacturer?

The general rule is that a supplier is unable to enforce a retention of title clause where the supplied goods have been mixed with other goods or incorporated into a manufactured product so that the goods have lost their original identity.

The question of whether the original identity of the goods is maintained depends on the facts of the case. However, where fabric is used to manufacture fashion items, title will almost certainly be lost. Some relevant examples are considered below:

Re Bond Worth Limited, a 1980 UK decision:  fibre was supplied to be woven into yarn which was then used to manufacture carpets. The court held that ownership of the manufactured product had passed to the manufacturer.

Re Peachdart Limited, a 1983 UK decision:  leather was supplied to a manufacturer of handbags. Although it was possible to identify the high quality leather in the partly manufactured handbags, the court decided that the goods had been transformed and the supplier no longer owned the leather.  

Associated Alloys Pty Ltd v ACN 001 452 106 Pty Ltd, a 2000 Australian decision:

steel was supplied and used by the buyer to fabricate various steel products. The court held that the steel supplied had lost its original identity and that even if the steel was extracted from the manufactured product, it would no longer be the steel supplied; it would be scrap steel.

Even if the supplied goods lose their identify through the manufacturing process, with an appropriate clause in the terms of the supply contract, a supplier may still be able to recover proceeds of sales associated with newly manufactured products. It is important to ensure supply terms are carefully drafted, as a retention of title clause may be ineffective in these circumstances.

Moral of the story

Businesses should understand the risks involved in supplying goods on credit. Suppliers of raw materials, such as fabrics, prints and accessories, need to be particularly wary. Review your trading terms to ensure your rights are adequately protected and if necessary seek advice so you won’t be left high and dry if the unfortunate happens.

Lisa Egan and Gregory Pieris are intellectual property experts with Middletons law firm.