Incoterms_® and Commercial Contracts

1. What rules, if any, govern retention of title (RT) in your country? In the absence of rules, what are the principal mechanisms, if any, on which RT is based in your country?

In Hong Kong, RT is determined by the operation of contractual principles, the case law and statute. Hong Kong is a common law jurisdiction, and following the Chinese resumption of sovereignty over Hong Kong on 1 July 1997, all laws of Hong Kong previously in force in Hong Kong, including the English common law and rules of equity, have been maintained by virtue of the Basic Law (Hong Kong’s constitutional document). Subsequently, the law and statutory regime in Hong Kong has developed independently of English law, although there remain considerable similarities between the two systems of law. Of note, the Hong Kong Sale of Goods Ordinance (SGO) (Cap.26 of the Laws of Hong Kong) which applies to contracts for the sale of goods is based on the UK Sale of Goods Act 1893 (as amended).

2. Please describe the characteristics and scope of your country’s RT rules

To be effective, any RT provision will need to be drafted appropriately and validly incorporated into a binding contract between the seller and the buyer. See also below at Q.7 for recommended drafting tips.

A simple RT clause (otherwise known as a Romalpa clause¹), by which the seller of the goods reserves ownership (both legal and beneficial²) until the buyer pays for the goods, is in principle enforceable in Hong Kong. This position is reflected in the SGO. Section 19 of the SGO provides that where there is a contract for the sale of goods, the property in such goods will pass when the parties intend it to be transferred. Section 21(1) of the SGO states that, notwithstanding delivery of the goods, a seller may contractually reserve the right to dispose of the goods until certain conditions are met. Even though goods may be physically delivered to the buyer, or to a carrier or other bailee, property in the goods (ownership) will remain with the seller until the conditions imposed by the seller are fulfilled.

Subject to the exceptions set out in the below answer to question 6, a valid RT clause will normally prevent the goods in question from forming part of the general assets of the buyer in the event of its insolvency or liquidation³, and thus may entitle the seller to a proprietary claim, at least so long as they remain in the form in which they were sold⁴.

However, a more elaborate RT clause which attempts to do more than retain title over the goods
[Page105:]
which are the object of the sale and purchase contract, and looks to follow the goods or the proceeds of sale of the goods, will most likely be construed as a ‘floating charge’ created by the company and would be void if not registered in accordance with section 335 of the Hong Kong Companies Ordinance (CO) (Cap.622 of the Laws of Hong Kong).

An ‘all monies’ RT clause provides that the seller will retain title over the goods until all money due from the buyer is paid⁵. Here the seller reserves title over all goods pertaining to the seller which remain with the buyer. It obviates the need to link the seller’s goods to a specific invoice. An all monies clause was considered by Mr.Justice Poon in the Hong Kong Court of First Instance in Re. Five Oceans Supply Services Ltd⁶. Albeit obiter, the court indicated that it was prepared to accept the enforceability of an all monies RT clause. That said, there is no authority dealing with part-payment, and there is uncertainty on this issue. Further there remains a real risk, that an all monies clause may be held to create a charge which would be void against any liquidator and creditor of the charger unless duly registered in accordance with section 335 of the CO.

A ‘proceeds of sale clause’

In circumstances where a buyer resells the goods, a ‘proceeds of sale’ clause seeks to give a seller rights over the proceeds of sale. Such a clause is most likely to be construed as a clause creating a ‘floating charge’ and as mentioned above, will be void and unenforceable against any liquidator and creditor of the charger unless registered in accordance with section 335 of the CO. It is noted that there is an alternative legal analysis whereby the situation gives rise to a trust, with the buyer holding the proceeds of sale on trust for the seller. A trust is not a registrable security interest under the CO. Obiter comments made in the case of Hong Kong Hua Guang Industrial Limited v Midway International Limited and Another⁷ suggested that the Hong Kong Court of Appeal may be receptive to the concept of an extended RT clause whereby the clause provided that the seller would be entitled to the proceeds of sale in the event that the buyer disposes of the goods. In the English case of Re. Bond Worth Ltd.⁸, the court held that where property passes to the buyer on payment which refers to “equitable and beneficial ownership”, a bare trust is not created for the benefit of the sellers, but a floating equitable charge is granted by the buyers, which as such is registrable and void for non-registration. Whether the Hong Kong courts will diverge from the English position in the future is yet to be seen.

A ‘mixed goods’ clause

A further example of where a simple RT clause is unlikely to work is when the goods are consumed as part of a manufacturing process. An attempt by the seller to claim title over ‘new’ manufactured products will be construed as a charge over the goods, which will be void if not registered. Here,
[Page106:]
the proprietary rights of the seller in the goods cannot be traced to the manufactured products and no interest or charge may be implied from the contract of sale in favour of the seller⁹.

If, as is sometimes possible with mixed goods, the seller’s goods remain identifiable and retain their physical identity and can be retrieved, a simple RT provision may still be effective¹⁰. It will be a question of fact as to whether, in the circumstances, the goods retain their identity. The seller needs to demonstrate a proprietary right over the original physical goods — a claim in rem.

The court¹¹ in Hong Kong has accepted the stance adopted by the English Supreme Court in PST Energy 7 Shipping LLC Product Shipping & Trading S.A. v O.W. Bunker Malta Ltd & others [2016] UKSC 23 which concerned liability under bunker supply contracts following the insolvency of O.W. Bunker. Where a contract which provides goods that are likely to be consumed (as in the case of bunkers) includes an RT provision, a credit period, and a right to use the goods pending payment, under English law, this will be seen as a contract providing a license to use the goods pending payment, which will fall outside the operation of statutory sale of goods provisions.

3. If RT is not regulated in your country, are there similar or commercially equivalent forms of security preserving seller’s rights to the goods?

It is open to the unpaid seller, prior to property passing in the goods, to rely on the statutory provisions of the SGO:

• Unpaid seller’s lien (sections 41 (a) and 43), a lien on the goods or a right to retain them for the price (while in possession of them).
• Right to stop the goods in transitu (section 41(b)) a right to stop the goods in transit after the seller has parted with possession (in the event of the buyer’s bankruptcy).
• Right of resale (section 41(c)) in accordance with the provisions of the SGO.

The seller may also consider requiring the buyer to provide an alternative form of security. In the context of the sale of goods, this would likely take the form of a bank guarantee or requiring the buyer to make payment by way of letter of credit. The unpaid seller may also consider invoice discounting (factoring) and in so doing assign its book debts to a factoring company at a discount. Depending on the commercial relationship, the buyer and seller may agree to offset competing monetary claims. In the event that any security interest is granted over the debt to a third party, the third-party security interest is subject to the right of set-off.

[Page107:]

4. What is the relation of RT and passage of risk in your system? How may a seller protect its interest after the passage of risk?

Section 22 of the SGO provides that unless otherwise agreed, risk prima facie passes with property (ownership) irrespective of delivery. Thus, when a seller retains property in the goods by the operation of an RT clause, absent further agreement, the goods remain at the seller’s risk. Payment and delivery are by section 30 of the SGO concurrent conditions, unless otherwise agreed. In other words, the seller must be ready and willing to give possession of the goods to the buyer in exchange for the payment of the price.

Commercially, parties are often prepared to agree on contractual terms to decouple the relationship between the passing of risk and property. It is common for parties to agree that risk passes on delivery. Parties may also choose to incorporate appropriate International Chamber of Commerce Incoterms® rules which make clear provision for the passing of risk.

While the seller maintains an interest in the goods, it is open to the seller to take out insurance to protect against the risk of loss or damage to the goods. Alternatively, a seller may include a provision in the sale contract to oblige the buyer to insure the goods against all risks from delivery, and to ensure that the seller’s interest in the goods is recorded on the policy. As to the risk of nonpayment for the goods, a seller may also consider taking out trade credit insurance.

5. What are formal requirements, if any, including timing, to perfect the seller’s right?

The seller’s right to include an RT provision is recognised by the SGO. To be effective and enforceable, an RT clause shall be validly incorporated into the contract. A simple RT clause does not give rise to a security interest capable of registration as the buyer does not obtain ownership of the goods.

There are, however, registration requirements when security is granted by a Hong Kong company or registered non-Hong Kong company. It is a requirement of section 335 of the CO that a registrable security shall be registered within one month from the date of creation of the charge.

As discussed above, more complicated and far-reaching RT clauses may be held to be charges created by the buyer company in favour of the seller and therefore form a registrable security interest. A failure to register a security interest when required can render the security interest void¹² as against the liquidator and any creditor of the company and/or expose the individuals responsible for the registration (which could include the seller) to a fine¹³. There is no statutory guidance as to which forms of RT clause will be registrable — this is viewed as best decided by the
[Page108:]
courts¹⁴.

6. Effectiveness

1. Does sale to a third party break RT? What if goods have been transformed or sold?

An RT clause will not be effective against a bona fide third-party purchaser of the goods for value without notice of the clause. It will also not be effective if the goods have lost their identity such as being consumed in a manufacturing process, have been annexed to the buyers’ premises or become mixed with other third parties’ goods.

However, if the goods remain identifiable in their original form, the original seller may be able to make a proprietary claim to recover the goods from the third party, or claim damages if the goods cannot be redelivered in the same order and condition as they were upon delivery. If a third party acts in a manner which is inconsistent with the seller’s RT clause, the seller may have a cause of action in conversion.

Under section 49 of the SGO, the unpaid seller’s right of lien, or retention or stoppage in transitu over the goods (pursuant to sections 43 and 46 of the SGO) shall not be affected by the buyer’s sale to a third party. However, in circumstances where the buyer has lawfully transferred a document of title in respect of the goods to a purchaser in good faith for value, the unpaid seller’s rights fall away in respect of a lien, retention or stoppage in transitu. If such transfer is by way of pledge, the unpaid seller’s rights to lien, retention or stoppage in transitu can only be exercised subject to those of the transferee¹⁵.

If yes, is there a possibility to transform the RT in case of a sale to a third party?

The original sale contract can provide that any on-sale includes an RT provision. If the original buyer and/or third party act in a manner inconsistent with the original sale contract, this will constitute a breach of contract and give rise to a claim in damages. The seller may have a claim against the third party for the tort of conversion provided that the seller is not deemed to have consented to the on-sale by its conduct or by the terms of the contract.

2. Enforcement of RT if delinquent buyer is not insolvent — What is the judicial procedure and what is its likely timeline?

The court will enforce an RT clause in circumstances where the buyer fails to pay pursuant to any
[Page109:]
contractual term. The seller may seek an order requiring the buyer to deliver up the seller’s goods. This can take the form of an injunction or an application to court for specific performance of the contract. The unpaid seller, as the innocent party, can claim damages as compensation for any loss arising directly and naturally in the ordinary course of events from the breach.

Further specific remedies for non-payment or late payment are set out in the SGO:

• Action for the price (section 51) — once title in the goods has passed to the buyer, the unpaid seller can claim the price of the goods. As a rule, property in the goods must vest in the buyer for the unpaid seller to be able to bring an action for the price. However, if payment was to be made on a specific day, even if title has not passed, the seller can claim the price from that day¹⁶.
• Unpaid seller’s lien (sections 41 and 43) — see above. Until the price is paid, an unpaid seller, if still in possession of the goods, has a lien over the goods or a right to retain possession of the goods.

Generally speaking, if a buyer is not insolvent, the time required to pursue this from the commencement of proceedings to the enforcement of judgment would be between 12 to 18 months in Hong Kong. If the goods are located abroad, the time to pursue enforcement abroad would be significantly longer.

3. What happens in case of conflict between RT and a buyer’s creditors’ rights, including carrier’s liens?

Assuming that a simple RT clause is validly incorporated into the sale contract, the seller’s proprietary claim over the original goods will be enforceable and take priority over claims of the buyer’s creditors. The goods remain in the seller’s ownership and are not available to satisfy the buyer’s creditors’ claims. That said, a seller will need to overcome practical difficulties and take practical steps to enforce the clause and repossess the goods.

If an RT clause seeks to go further than merely asserting the seller’s proprietary rights over the original goods (e.g. a ‘proceeds of sale clause’, see above), it is likely to be construed as a creating a registrable charge over the goods which is void as against the liquidator and other creditors for lack of registration.

A common carrier is described as having a ‘possessory lien’ over the goods for the payment of freight as it can be exercised while the goods are in the carrier’s possession. The lien may continue at the end of the transit and while the carrier remains in possession of the goods¹⁷. The carrier can
[Page110:]
in certain circumstances sell the goods to pay the outstanding freight.

4. Bankruptcy — interaction of RT (which is not contract law) and bankruptcy law

1. Goods still with buyer

Within limits, RT is a useful device to protect the unpaid seller in the event of a buyer’s insolvency prior to payment for goods. A liquidator will recognise and uphold a simple RT clause provided that:

• the clause is validly incorporated into the contract;
• the clause covers the goods being claimed;
• the goods can be identified; and
• the goods relate to a specific invoice for which full payment has not been made (unless ‘all monies clause’).

That said, the seller should take prompt action to put the liquidator on notice of the proprietary claim over the goods. The seller will need to provide the liquidator with sufficient evidence of ownership and may need to seek court approval to reclaim the goods.

It is in this situation that a simple RT clause operates to best effect in protecting the unpaid seller’s proprietary claim to the goods. Without an RT clause, in the event of the buyer’s insolvency, the goods delivered to the buyer are included in the company assets available to satisfy the creditors pari passu.

It is noted that Hong Kong does not have any formal corporate rescue procedures, and there is no moratorium on creditor actions until any scheme of arrangement is sanctioned by the court. As such it is open to creditors to bring proceedings, including applications for interim relief, to recover their debts.

2. Goods already sold by buyer

The seller’s position is significantly weaker in the event that the goods have already been sold to a third party. The RT clause will generally cease to have effect against a third party. However, if the sub-purchaser was aware of the insolvency at the time of the sub-sale, and on notice of potential ‘hidden liabilities’, the original seller may have a claim against the sub-purchaser for conversion (and see 6a above).

3. Time limits to declare title to receiver

[Page111:]
The seller will need to bring its proprietary claim to the notice of the receiver/liquidator as soon as possible.

There is no legal limit but the later the claim is made, the more probable it is that the assets of the company are distributed by way of dividend to creditors, by the liquidator, and the seller will then have no recourse.

4. Who pays storage, insurance and transport during discussions with receiver?

Practically, the seller is likely to be liable to pay such costs. Given that the costs arise from the buyer’s breach of contract for failure to pay, the seller has a right of recourse against the buyer for damages. However in circumstances where the buyer is insolvent, recovery is unlikely.

7. Model clause(s) — Drafting tips

NOTE: The following language is based on contractual provisions commonly seen in this country, but readers should always consult legal counsel before including an RT clause in a contract.

Standard clause including an ‘all monies’ provision:

Practical drafting tips:

1. Ensure that the intended operation of the RT provision fits within the commercial relationship of the parties — particularly as concerns re-sale or consumption of the goods.
2. Consider the nature of the goods: RT will be of little benefit if the goods are perishable, of low value or cannot be identified or segregated from goods supplied by other parties, for example coins or bank notes.
3. Ensure that the simple RT provision is in a separate clause, and include a severability clause. Any extended RT clause should be in a separate sub-clause so it can be severed if held to be void.
   [Page112:]
4. Include a list of insolvency events, any one of which will trigger the seller’s right to demand immediate payment for the goods, even if payment has not fallen due, and a right for the seller to take back the goods.
5. Check that the sale contract includes a right for the seller to access the buyer’s premises to repossess goods.
6. To ensure that the seller is able to identify and readily retake goods in the event of non-payment, the sale contract should include the following provisions:
1. obligation to label goods;
2. obligation to store goods separately;
3. a right for seller to access buyer’s premises to ensure that the seller’s goods are stored appropriately.
7. Depending on the nature of the goods, if the goods are likely to be annexed to the buyer’s premises — include a provision requiring the buyer to seek prior consent from the seller for this annexation.
8. Consider including a provision in the sale contract for the seller to elect that title/ property in the goods has passed to the buyer — action for the price¹⁸.

---

---