Australia: Supplier's remorse: protecting your retention of title security interest against subsidiaries

A decision of the Supreme Court of Victoria serves as a timely reminder that suppliers must take care to ensure their supply terms will entitle them to enforce their registered retention of title (ROT) security interests against subsidiaries of the entity they supply. The importance of clear drafting was highlighted by the Court's findings in Warehouse Sales Pty Ltd (in liq) & Lewis and Templeton v LG Electronics Australia Pty Ltd & Ors [2014] VSC 644, where competing interests were examined in the context of the supplied entity going into liquidation.

The facts

Warehouse Sales Pty Ltd (WHS) was in the business of selling white and brown goods, supplied by a number of suppliers including LG Electronics and Panasonic. In addition to selling those goods to its own retail customers, WHS often on-sold some of the goods to its subsidiary, WHS2 Pty Ltd (WHS2).

The key elements of the relevant arrangements were:

• the goods were supplied by the suppliers on credit to WHS – there was no contractual relationship between the suppliers and WHS2
• from time to time, the goods were transferred between the stores of WHS and WHS2
• WHS and WHS2 had a very close operational relationship and largely shared ownership
• each of WHS' suppliers had registered purchase money security interests in respect of their goods
• the suppliers' ROT terms generally provided that:
• • ownership of the goods remained with each supplier until paid for in full
  • WHS had the right to dispose of the goods in the ordinary course of business. However, Panasonic's terms contained an important caveat which expressly prohibited WHS from freely on-selling goods to WHS2: "Sale of the Goods to a third party for further resale is not permitted unless the Buyer and Panasonic have entered into a current distribution agreement" (the On-selling Prohibition Clause).

After both WHS and WHS2 went into liquidation, their liquidators sought judicial guidance under section 511 of the Corporations Act 2001 (Cth) as to whether the various suppliers' ROT security interests attached to the goods in the possession of WHS2.

Recap on ROT security interests

A ROT supplier must protect its security interests by obtaining a signed security agreement that describes the collateral, and further perfecting that security interest by registering a financing statement on the Personal Property Securities Register. However, section 32 of the Personal Property Securities Act 2009 (Cth) (PPSA) provides that a buyer can take goods free of a security interest given by a seller in circumstances where the ROT supplier's security agreement authorises the sale of the goods in the ordinary course of the seller's business.

The Court's decision

In this case, the Court readily found that the suppliers did not have a security interest in the goods sold by WHS to its own retail customers (other than by layby sales) because such sales were specifically authorised by the suppliers – they were sales in the ordinary course of WHS' business. This finding was not controversial.

The particularly interesting conclusion reached by the Court was that all but one of the suppliers had also lost any security interest in the goods sold by WHS to WHS2. The Court noted that there is no Australian authority considering the meaning of "in ordinary course of business" in the context of the PPSA. However, the Court found that on balance in the circumstances, sales to WHS2 were sales in the ordinary course of WHS' business, noting that the transactions were entirely cogent, explicable and consistent with the operation of the business of WHS. Because the suppliers' security interests were extinguished by the ordinary course sales by WHS to WHS2, the goods were not subject to any security interest in WHS2's hands and therefore WHS2's own retail customers were also unaffected.

Importantly, the position was different in relation to Panasonic. Because Panasonic's terms had included the On-selling Prohibition Clause, WHS2 had actual or imputed knowledge of the prohibition on resales and therefore WHS' sales to WHS2 were not authorised. As a result, Panasonic retained its security interests in goods sold by WHS to WHS2.

Key takeaway

Although each of WHS' suppliers may have theoretically retained an entitlement to the proceeds of sale of the goods sold by WHS, this offered them no real consolation in circumstances where WHS had gone into liquidation. Only Panasonic's interests had been preserved in any meaningful way.

Cases like this must be kept front of mind when drafting supply terms. The case serves as an important reminder to suppliers to protect their interests by using clear language in their supply/ROT terms and taking into account their customers' operational or ownership structure. In appropriate cases inclusion of a clause like the On-selling Prohibition Clause should be considered in ROT based supply arrangements. Tailored drafting can avoid a supplier's security interest being defeated by a sale or transfer of goods between related entities in the ordinary course of business.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.