The Nature of a “Reserved Ownership Stipulation”

Consignment agreements are common in commercial life. These agreements exist in situations in which the first link in a chain wishes to sell to the second link merchandise, but the latter fears it will not be able to sell the merchandize and end up stuck with it. A consignment agreement transfers merchandise to the transferee for them to sell it onwards. Transferee still has the option of returning the merchandise to the first link, but that too within a limited timeframe. In typical consignment, the delivery of an asset to the transferee is not accompanied by the transfer of its ownership. Thus, ownership will transfer only should the transferee succeeds in selling the asset to a third party; or announce his desire to buy the assets completely; or where the agreed term for the use of a return option, expires.

Most of the trading actions made between buyer and seller are credit based; The wholesaler on one hand and the retailer on the other, In most cases, credit commerce immediately creates a gap between delivery date to the buyer and payment date to the seller. In between, the buyer might become insolvent. At that point, a conflict may rise between the seller wishing to return his merchandise to its possession and between the insolvent buyer’s trustee or asministrator nominated by the court. This columm will deal with the legal ramifications of the distinction between a typical consignment transaction and a credit sale.

Background

According to section 33 of the Sale of Goods Act, and ordinarily in commerce life, ownership over merchandise transfers to the buyer upon its delivery to them[1]. However, this is only the default stipulation that can be changed upon parties consent. That is how the ‘Reserved Ownership Stipulation’ was conceived, through which the seller wishes to preserve ownership over the merchandise until it is paid for in full or sold to a third party in a manner enabling its full payment.

The Supreme Court had previously overruled a stipulation’s legitimacy in the Colombo case[2], stating that in said case there was an artificial transaction, when in reality this was an ownership transfer, counterweighed by a disguised lien on the merchandise in favor of the seller. In the absence of registration, this lien is invalid  to the buyer’s creditors, and there for it was ruled that this stipulation is not valid.

Several decades later, the Colombo rule was overturned in the Northern Drilling case[3], where it was determined that ‘Reserved Ownership Stipulation’ validity should be acknowledged, while emphasizing the principle of freedom of contracts, i.e. acknowledging the right of parties in a commercial sale contract to shape its content as they please, and as a result determine the merchandise’s ownership transfer date as they accordingly. Thus, ownership over an asset may remain in the hands of the selling supplier until its sale by the buyer – the retailer.

The Northern Drilling rule means that the Reserved Ownership Stipulationis not a lien and should be interpreted as such, and not as a disguised lien. Furthermore, in order for a stipulation to be valid, it does not require registration with the Registrar of Mortgages (the exception to that is in case of an artificial stipulation, clearly made only to give  priority to the supplier  over the other creditors, and in that case the Reserved Ownership Stipulation could be classified as a disguised lien).

In that matter, it is worth mentioning, that in 2012, amendment 19 of the Companies Law – 1999, gained validity and set some ground rules and guidelines for assets that the Reserved Ownership Stipulation governs over, on , the actions the appointed court officer is authorized to make in these assets and the protection that the stipulation owner receives.[4].

The Vita Galilee Fruit verdict and its ramifications

The Vita Galilee Fruit[5] case dealt with the status of the Reserved Ownership Stipulationin a sale transaction, in a situation where there’s an insolvent buyer. The resolution clarified the legal rule and determined that the appropriate interpretation of the Northern Drilling ruling shall be made by a factual examination of each case and its circumstances, and not comprehensively, thus that a Reserved Ownership Stipulationincluded in a sale transaction, does not “automatically” award a seller validity and priority over a buyer’s other creditors, but rather said relevant factual examination is to be made. It was determined that the Reserved Ownership Stipulationshould be examined using two main tests:

The first test concerns the transaction’s term. Meaning: distinguishing long term transactions that include an ongoing supplier-retailer relationship from incidental one-time transactions. In dealing with an ongoing business relationship, parties should include the Reserved Ownership Stipulationin a detailed written agreement, as opposed to a feeble noting on an invoice or shipping certificate or in an oral manner.

The second test concerns the essence of interest a seller has in the asset he transfers to a certain buyer’s possession. Since the Reserved Ownership Stipulation is of a possessive nature and affects a buyer’s creditors, a seller has to maintain supervision and control mechanisms over the asset that are in the buyer’s possession.

In applying the tests, it is evident that in case of a Reserved Ownership Stipulation guarantying credit repayment, the stipulation’s explicit, clear wording is of crucial importance. Lack of specific reference and rather settling only for the stipulation’s mention on the invoice, might lead to its annulment.

Also, the type of asset sold is of importance. When dealing with a single/few product\s, a periodical visit to the seller’s may be enough to make sure the asset was not transferred to a third party, as opposed to inventories of considerable scopes that require separation in the buyer’s warehouses and appropriate documentation in the buyer’s and seller’s accounting books and so forth in order to distinguish the goods which is governed by the Reserved Ownership Stipulation[6]. In these cases, the seller will have to show that they constantly followed up on the merchandise transferred to the buyer through reports given to them by the buyer regarding sales made, or through frequent visits to the buyer’s warehouses, or rather through the merchandise’s marking and separation from other merchandises in the buyer’s warehouses.

Summation

There is a distinction between a true consignment transaction under which ownership over the wholesaler’s merchandise will be transferred only after its sale by the retailer, and a transaction based on a Reserved Ownership Stipulation aimed at guarantying full payment. When the parties enter a transaction of the first kind, i.e. a “distinct” consignment transaction, the wholesaler’s ownership over the merchandise delivered within that transaction will be recognized and there is no need to apply the other tests set by the ruling.

However, should the parties’ agreement include a Reserved Ownership Stipulation aimed at guarantying payment, a seller’s right shall be preferred over that of a buyer’s creditor, provided it met the rules determined in the Northern Drilling and Vita Galilee Fruit cases.

In other words, the absence of true consignment does not necessarily award priority to a buyer’s creditor in a conflict between him and a seller, but in order for the seller to gain priority over the creditor, he has to take necessary actions aimed at proving that the Reserved Ownership Stipulation was not made artificially, but rather is supported by external manifestation attesting to it in real time and as set in the tests described above.