Retention of title in international transactions for the supply of goods

Beware of supplier insolvency!

The global economy continues to be firmly in the grip of the COVID-19 pandemic. In light of uncertain economic forecasts for the future, it is more important than ever for Austrian entrepreneurs operating in an international environment to take precautionary measures so as to protect themselves comprehensively against the potential insolvency of business partners. As a legal instrument, retention of title is an effective and recognised means of achieving this in practice. However, retention of title does sometimes entail major legal challenges for the buyer. This is illustrated by a specific case in connection with which the authors of this article recently provided advice.

Insolvency in the cross-border supply chain

The circumstances of the case under consideration are as simple as they are widespread: An Austrian entrepreneur (the buyer) placed an order with a domestic supplier (the main supplier) for parts needed to carry out a complex work order. The main supplier, in turn, engaged the services of a Chinese sub-supplier for the purpose of manufacturing and supplying the goods in question.

In the case at hand, the Chinese sub-supplier had agreed with the Austrian main supplier upon a retention of title to the goods it was under contract to deliver, whereas no such retention of title had been contractually agreed upon between the Austrian parties, i.e. between the main supplier and the buyer. As contractually agreed, the sub-supplier shipped the goods ordered via an external forwarding company to the main supplier's place of business in Austria.

The main supplier found itself in dire straits while the goods were still in transit from China to Europe. The question for the buyer then became how to obtain ownership of the goods that were intended for it as quickly and as securely as possible from a legal viewpoint so as to protect itself in the event of the insolvency of the main supplier.

The "expectant right" as a reflection of retention of title

An essential characteristic of retention of title is that the supplier remains the owner of the goods until the purchase price for the goods subject to retention of title has been paid in full, with the conditional buyer (in our example: the main supplier) merely having a so-called expectant right to acquire full ownership of the goods. This expectant right can be transferred in accordance with general principles under substantive law. Generally, which principles these are in detail is assessed on the basis of the location of the goods at the time of the intended transfer of rights.

Depending on where the goods are located, there may be completely different requirements for a valid acquisition of title or expectant right. Under Austrian law, the transfer requires a valid title (executory transaction, e.g. purchase contract, contract for work and services, deed of gift) as well as a valid mode (disposition, in particular in the form of the physical transfer of the goods). If goods are in international transit and travel through various countries and legal systems within a short period of time, the question arises as to which substantive law of which jurisdiction is decisive for assessing the effective transfer of rights.

The "country of destination principle" as a basic rule

Under international private law, the so-called country of destination principle applies to the cross-border sale of goods. According to this principle, the transfer of rights in rem is governed by the law of the country to which the goods are ultimately to be delivered.

In this example, Austria was the country of destination, meaning that its (substantive) law was decisive. The buyer therefore concluded a transfer agreement with the main supplier, under which the main supplier was required to hold the goods subject to retention of title in the name and for the account of the buyer as soon as they had come into its possession (so-called "constitutum possessorium" as a means of transferring ownership under substantive law).

After the goods originating from the Chinese sub-supplier had arrived in Slovenia by ship, the main supplier used its own vehicles to collect the goods and transport them to Austria. Based on the previously concluded transfer agreement, the expectant right to the goods passed to the buyer when the goods were collected in Slovenia or, at the latest, when they were imported into Austria. 

From expectant right to full right

To acquire definitive ownership of the goods subject to retention of title, the buyer still had to ensure that the sub-supplier received the purchase price owed to it for the goods. Only then would the expectant right transferred to the buyer be converted into a full right. The impending insolvency of the main supplier made this undertaking complex from a legal perspective, since debtors at risk of becoming insolvent (such as the main supplier) are known not to favour creditors. Alternatively, such legal acts (such as payments made to settle debts but also the transfer agreement concluded with the buyer) may be challenged under insolvency law.

This risk of a creditor being placed at a disadvantage, which is looked upon unfavourably, was avoided in the present case through the meticulously planned coordination and handling of the transaction. One part of the plan was to pay the purchase price to the sub-supplier directly, thereby successfully securing the legal and economic position of the buyer – which ultimately proved a success!

There is a duty to act with an eye to the future

The complex legal and economic issues that entrepreneurs are confronted with in connection with the international movement of goods subject to retention of title make one thing clear above all else: Anticipatory action and professional support are not only called for but essential, as is the need to take a creative approach to finding solutions.