As we reported in an earlier Client Alert, the UK Supreme Court recently handed down its highly anticipated judgment in the Res Cogitans¹ case. The Supreme Court was unanimous in finding that a contract to supply bunkers to the vessel Res Cogitans was not a contract for the sale of goods that fell within the English Sale of Goods Act 1979 (the “SOGA”), thus upholding the finding of the Court of Appeal, the High Court and the arbitrators.

The implications of this case are being closely scrutinised by the shipping industry and the numerous parties immediately impacted by the insolvency of OW Bunker & Trading A/S. As the opening paragraph of the Supreme Court’s judgment concluded: “many similar cases worldwide await our decision with interest”. In fact, the impact of the case may be wider than this and this client alert focuses on the effects of the decision in the commodities industry concerned with the sale of goods.

(1) Summary

• The finding that the supply contract in the Res Cogitans case was not a SOGA contract will inevitably extend to a large number of commodities sales contracts.
• Key elements which will trigger such an effect will be retention of title clauses, delayed timing of payment (i.e. a credit period), plus provision for the use of the commodity (for example, as fuel or a component in processing and probably tolling arrangements) during the credit period. Such contracts will now need some reconsideration.
• In appropriate cases, abandoning the standard retention of title clause or changing the ‘title shall pass on payment’ clause will avoid the unwanted effect.
• The Supreme Court’s view that most SOGA terms would still be implied into these contracts is useful but slightly uncertain. Until there are more cases, we recommend incorporating all the terms you need.

(2) Key facts and arguments If you are already familiar with the case, please skip to the potential implications. The facts themselves are straightforward and involve transactions which are everyday occurrences in the shipping and commodities sectors. The facts of the Res Cogitans case and its procedural history have been set out in detail in our previous client alert.

For ease of reference, we summarise the bunker supply chain in the below diagram:

In November 2014, OWBAS announced its insolvency, leaving RUK unpaid. RUK sent a demand for payment to Owners, asserting its ownership of the bunkers and requesting payment of the price invoiced to OWBAS. As a result, Owners faced paying twice for the same bunkers: to their immediate seller, OWBM, and RUK.

Owners therefore sought a declaration that they had no liability to pay OWBM (and its financing bank, ING). Owners argued that the Contract was a SOGA contract, but that as OWBM could not satisfy the provisions of section 49² of the SOGA, they could not maintain a claim for the price. Owners said that section 49 of the SOGA could not be satisfied as, by the time payment became due under the Contract, some or all of the bunkers would have been consumed with the result that title in them ceased to exist and so could not be transferred to Owners.

(3) Summary of the Supreme Court decision In its decision, the Supreme Court made three findings:

1. The Contract between Owners and OWBM was not a SOGA contract. The Contract was of a sui generis nature (i.e. special or unique, or in a class of its own). Rather, its essential nature was to permit consumption of the bunkers prior to payment without property passing in the bunkers consumed. It was not an agreement that required the transfer of property or title for a price.
2. The Supreme Court did not agree, as Owners had argued, that the Contract contained an implied duty on OWBM to make timeous payment to its supplier (RUK). The Court said that the only implied obligation was that OWBM was entitled to grant Owners permission to use the bunkers as had been intended, which was for the propulsion of the vessel.
3. The Supreme Court stated (obiter) that, had the SOGA applied in this case, it would have been no bar to the claim by OWBM for payment of the price, as section 49 of the SOGA is not a complete code for situations in which the price of goods may be recoverable under a SOGA contract (and in this regard, the Caterpillar case³ would have been overruled).

The Supreme Court concluded that OWBM could claim for the price of the bunkers as a debt under the Contract.

(4) Potential key implication for sale of goods contracts In finding that the Contract was not a SOGA contract, the Supreme Court considered the Contract to be within a unique or special class of contracts. The following were crucial to the Supreme Court’s decision:

1. Three special features of the Contract:

a. Payment was due 60 days after the date of delivery (i.e. the Contract included credit terms)

b. OWBM retained title until payment

c. Express permission for Owners to consume the bunkers prior to the end of the credit period and therefore prior to the point at which title was to pass under the Contract

2. The reality of the bunker industry, in that the liberty to use bunkers for propulsion prior to payment is a vital and essential feature of the bunker supply business (notwithstanding that the seller has a retention of title clause).

Which contracts could be unexpectedly impacted by the Supreme Court’s decision? As a result of the Supreme Court’s decision, any supply contract which contains all of the features mentioned above (and many do) could be caught by this decision and therefore fall outside the SOGA.

Example 1: A coal supply agreement contains the following provisions:

• DAP Taichung Power Station
• Payment due 30 days after delivery
• Title to pass upon payment
• The agreement permits (expressly or impliedly) the coal to be consumed immediately following delivery

The parties are aware that the coal will in all likelihood be consumed (in whole or in part) by the buyer, the operator of the power station, prior to title transferring. Even without an express term permitting immediate consumption, it is likely that such a term would be implied to give business efficacy to the agreement in light of the buyer’s position as operator of the power station.

Based on the Supreme Court’s decision, such coal supply agreement would not be a SOGA contract: the transfer of property for the price is not the essential nature of the agreement (because the coal will be consumed before the price is paid). Other similar examples could include supplies of any fuel or biofuels supplied to plant operators.

The Supreme Court’s decision could also potentially extend to supply agreements where not only are the goods consumed, but also where they are converted or changed in substance.

Example 2: A buyer and a seller enter into the following deal:

• A buyer (B) owns a flour factory in the Netherlands and urgently requires a cargo of wheat.
• B buys wheat from seller (S), CIF Rotterdam.
• S is aware that B urgently requires wheat for use at B’s flour factory.
• The wheat is loaded in Italy.
• The supply agreement provides: (i) a credit period of 60 days from the date of delivery at the load port, (ii) a usual retention of title clause in favour of S until payment, and (iii) express or implied permission that the wheat may be used by B to make flour prior to the date of payment.

This example could similarly be about raw vegetable oils sold for refining, crude petroleum for refining, petroleum products sold for blending, metals concentrates sold for refining and so on.

The above wheat supply agreement and similar contracts could now fall outside the SOGA as it features all the criteria considered by the Supreme Court, namely: (i) a credit period; (ii) a retention of title clause; and (iii) express or implied permission for the wheat to be used prior to payment. In addition, in light of the urgent delivery, it is likely to be implied that the wheat would be used as soon as possible, before the time of payment and so before the time at which title passes.

It has long been established that where goods are incorporated into other goods owned by the buyer or subject to the buyer’s manufacturing processes, title in the new goods will generally vest with the buyer where the original goods are no longer distinguishable or recoverable. The classic case⁴ relates to the resin used to manufacture chipboard, where the seller’s title ceased to exist once the resin lost its identity. The Supreme Court’s decision recognised the possibility that this case “could and should have been analysed as sui generis”. This shows that the Supreme Court’s decision could apply to such cases where the original goods purchased no longer exist in the form in which they were purchased. The ultimate effect is therefore the same as if the goods had been consumed.

What does it mean to fall outside the SOGA? The key consequence of a supply contract falling outside the SOGA is that the statutory protections will no longer automatically apply to the supply contract. This could be to the detriment of both the buyer and the seller.

For example, if a supply contract is not a SOGA contract, the buyer cannot rely on section 14 of SOGA which implies into the supply contract a condition that the goods supplied are of “satisfactory quality” (which in appropriate cases may include “fitness for all the purposes for which goods of the kind in question are commonly supplied”, the “appearance and finish” and that the goods are “free from minor defects”). Similarly, a buyer would not be able to rely on the protection afforded by section 14(3) which provides that where a buyer makes known to the seller the particular purpose for which the goods are purchased, the goods will be “reasonably fit for that purpose”.

By contrast, a seller could benefit from the statutory limitations on the implied terms by way of section 14(2C) of the SOGA, which provides that the implied terms in subsection (2) do not make the quality of goods unsatisfactory in respect of any matter which is “specifically drawn to the buyer’s attention before the contract is made”.⁵

Notwithstanding the above comments, it is likely that in reality, the significance of such changes are not in fact material as the Supreme Court’s decision suggests that terms “as to description, quality etc” could be implied into contracts of this kind in any event and that the terms of the Contract may be “closely analogous to a Sale”.

Two immediate questions follow:

1. How are terms “as to description, quality etc” to be implied, if not by way of the SOGA?
   
   It is suggested that arbitrators and the Court will now have to look to the parties’ intentions and concepts such as business efficacy, matters of trade practice or the historic dealings between the parties to consider whether such terms are to be implied, if they are not expressly stated in the supply contract. Relying on such concepts is clearly not as certain as reliance upon the SOGA statutory provisions.
2. What precisely will be implied?
   
   This will depend on the facts in each case and as set out above, will entail a review of the contractual terms and dealings between the parties. Again, this creates an element of uncertainty.

Retention of title clauses When considering the impact of the Supreme Court’s decision on supply contracts, it is also important to reconsider the purpose of a retention of title clause. A retention of title clause, although common place, is often not immediately logical or protective: where a seller has departed with physical control over the goods, to try to maintain certain rights in those goods is somewhat contradictory. This is particularly so in the fast moving world of commodity supply chains, where a single cargo can be sold several times before its final use by a distant buyer. Where the commodity is likely to remain in the same physical condition and place (such as metal stored in warehouses), retention of title clauses can potentially increase security while awaiting payment. However, for petroleum products, coal, oils or grains which are likely to be used or consumed, they are less logical.

Section 49 is not a complete code This part of the decision (see point 3 of the Supreme Court’s decision above) is likely to be of more academic, rather than practical, interest. The effect of this decision is that it widens the circumstances where a seller may sue for the ‘price’ of goods.

(5) What should you do? Best practice:

• If there is a chance that a deal for the supply of goods may have characteristics which feature the Supreme Court’s criteria, for certainty, terms that would otherwise be implied by the SOGA should now be expressly incorporated into the written contract.
• Sellers should consider carefully whether it is in fact beneficial to include a retention of title clause. Without the retention of title clause in the Res Cogitans case, title would likely to have passed earlier, with the result that the Contract may have satisfied the requirements of section 2(1) of the SOGA and therefore would have been a SOGA contract.
• If retaining security prior to payment is important, rather than relying on a retention of title clause, the seller should consider other methods of securing payment. For example, payment by letter of credit (L/C) or the use of a standby L/C. In circumstances where the security is diminishing as the goods are consumed, such tools provide greater security against the risk of insolvency for a seller.

(6) Some final thoughts The Supreme Court did not consider the merits of any claims which could be pursued by RUK against Owners, as this issue was not before the Supreme Court. However, the High Court decision of Mr Justice Males briefly considered Owners’ potential liabilities in this case.

Mr Justice Males was of the view that Owners would not be liable to RUK in the tort of conversion as Owners’ consumption was not a wrongful act, but an act carried out with the permission of RUK. His view was based on RUK’s knowledge that: (i) OWBAS was not the end user of the bunkers and (ii) any contract with the end user would allow (either expressly or by implication) that the bunkers would be consumed immediately and therefore prior to the expiry of the credit period in the contract between RUK and OWBAS. However, Mr Justice Males acknowledged that Owners might be exposed to the risk of liabilities to RUK under other systems of law and that the vessel may therefore be exposed to the risk of arrest in other jurisdictions. Equally, other systems of law may offer mechanisms for resolution of the complex disputes that have arisen out of the insolvency of the OWB Group.

The impact of the Supreme Court’s Res Cogitans decision is indeed significant in the context of SOGA claims and should merit serious consideration of contract terms going forward to manage risk in commodity transactions. However, the decision is limited to its specific facts. Therefore, it is questionable whether the decision will apply to or affect on-going cases arising out of OWB Group’s insolvency, especially interpleader cases, those cases where the SOGA is not in issue and on-going cases outside England and Wales.

The decision does not address other issues common to the many pending actions around the world. Such issues include disputes relating to unjust enrichment between competing claimants to payment, the application of US maritime law and maritime lien rights available to the physical supplier of fuel bunkers, the priority of such liens where more than one party asserts a maritime lien, and the priority of claims as between and among lien claims and contract claims for payment.

1. PST Energy 7 Shipping LLC and another v OW Bunker Malta Ltd and another [2016] UKSC 22.
2. Section 49 (1) and (2) provides: (1) Where, under a contract of sale, the property in the goods has passed to the buyer and he wrongfully neglects or refuses to pay for the goods according to the terms of the contract, the seller may maintain an action against him for the price of the goods, and (2) where, under a contract of sale, the price is payable on a day certain irrespective of delivery and the buyer wrongfully neglects or refuses to pay such price, the seller may maintain an action for the price, although the property in the goods has not passed and the goods have not been appropriated to the contract.
3. Caterpillar (NI) Ltd (formerly known as FG Wilson (Engineering) Ltd) v John Holt & Company (Liverpool) Ltd [2013] EWCA Civ 1232.
4. Border (UK) Ltd v Scottish Timber Products Ltd [1981] CH 25 (CA).
5. Other examples included in section 14(2C) of the SOGA that benefit the seller are that the implied terms in subsection 14 (2) do not make the quality of goods unsatisfactory in respect of any matter where the buyer examines the goods before the contract is made and that examination ought to reveal the matter or in sales by sample, where the matter would have been apparent on a reasonable examination of the sample.

Client Alert 2016-138