7/15/2019
Master Thesis
Towards an EU Common
Framework of Prepaying Consumer
Protection on Retailers’ Insolvency
Name: Shan HUANG
Institution: Universiteit van Amsterdam (UvA)
Programme Name: European Private Law (LL.M Track) Supervisor: mw. mr. S. (Selma) de Groot
1
Towards an EU Common Framework of Prepaying Consumer
Protection on Retailers’ Insolvency
Shan HUANG 11709170
Abstract
Prepaying consumers are in need of special legislation to protect their interests in case of retailers’ insolvency. They are usually unaware of the risky nature of prepayments, and may not scientifically assess the retailers’ insolvency risk. Also, insolvency law does not guarantee a consumer-favorable solution. An EU Common Framework is capable of providing a fine solution to that problem. Three types of mechanisms: security (preferential priority), segregation and rule of appropriation can be taken into account for providing effective prepaying consumer protection while minimizing the negative effect of regulations on economic operators.
Key words: EU law, prepayment, consumer protection, insolvency law, substantive law, competition law, transfer of ownership
Part I: An Introduction
Suppose that you bought the membership card of a fitness club and quickly recharged it. You made the decision for various reasons: you have made a schedule of fitness in the coming year, one friend of you recommended you this club, and thanks to its recent campaigning, you can charge 200 euro for 100 euro free. Not long after you recharged your membership card, however, you received the message that the fitness club went bankrupt. You claimed for a refund of the money in your card, but you are told that you may not get the money right now. Instead, you have to join in the long queue of distribution, and very likely you would be informed that the insolvent club has no available fund to pay you.
What you may not have realized, is that you are joint by plenty of peer consumers, and the same stories take place every year around the world. Prepayment has become a popular mean of the transaction between consumers and retailers (or service
providers, like that fitting club), for it does provide great convenience.1 Statistics
have shown that the scale of prepayment has expanded dramatically during the last several decades, and shows no sign of deceleration yet.2 Behind the prosperity of
1
Prepayment is particularly popular with the youngest. In a survey covering millennials’ use of prepaid cards, 83 percent of respondents are happy or satisfied with prepaid cards overall, and Over 60 percent of respondents described their cards as “more useful than expected. See Mike Clark,
“Millennials and Prepaid Debit Cards: A Survey of Views, Selection, and Use in 2018”,
https://www.prepaidcards123.com/millennials-and-prepaid-debit-cards-a-survey-of-views-selection-and-use/, updated on November 9, 2018.
2
. It is said that the global prepaid card market is anticipated to reach nearly $3,7 trillion by 2022. See, e.g. "Prepaid Card Market by Card Type (Single-Purpose Prepaid Card, Multi-Purpose Prepaid Card),
2
prepaying market, however, lays its highly risky nature which the consumers are usually (if not always) unaware of. Once the prepayment is finished, the money consumers have paid turns into a part of the retailer's assets, while consumers play the role of (unsecured) creditors since then. In case of insolvency, consumers are put under a particularly disadvantaged position. Usually, they rank at the bottom of the hierarchy of distribution, which means their chance to get paid from the pool of assets is frustratingly slim. Besides awareness, prepaying consumers also lack the ability to assess the financial status and insolvency risk of the retailers.
To make it clear, the term “prepaying consumers” in this paper refers to consumers who pay a certain amount of money to the business in exchange of goods or services that the business promise to offer by a deadline or within a period of time. Unlike ordinary consumers who pay exactly for the goods or services whose content and quality have been confirmed, a prepayment does not obligate the business to
immediately perform its duty under the contract, rather it provides the consumer with a pledge to take something from the business or to request the business to provide services. For example, a consumer who ordered a pair of shoes online falls outside our scope of discussion: the content (shoes) of the contract is already ascertained, and the business bears the obligation of delivering the shoes without unreasonable delay. A consumer who bought a gift voucher from a retailer and planned to buy a pair of shoes with that voucher, however, can be regarded as a prepaying consumer: the seller’s obligation of delivering what, at what time (and to whom, if that voucher is anonymous) depends on the consumer’s future behavior.
All prepayments can be classified into three categories: prepaid vouchers, which enable consumers to “pick up” goods whose value equalizes the face value of the voucher (e.g. Chiasmas voucher sold by retailer like Zalando); prepaid services, which the consumers pay for before they enjoy them, and prepaid properties, which refer to individualized or customized goods which the seller produces for one particular buyer (e.g. a private yacht). I consider that the classification above is necessary for my further analysis in the following parts, as different mechanisms apply to different types of prepayments.
It should be noted that not all prepaying buyers are regarded as the "weaker party." Prepayment has been adopted in transactions of expensive goods like customized private yacht, aircraft, and jewelry. Nevertheless, the safeguard measures discussed in this paper is supposed to protect ordinary consumers, although buyers of deluxe goods can be benefited from regulations of such as well.
Incentive/Payroll Card and Others), and Industry Vertical (Retail Establishments, Corporate Institutions, Government & Financial Institutions, and Others) Global Opportunity Analysis and Industry Forecast, 2014 - 2022", https://www.alliedmarketresearch.com/press-release/prepaid-card-market.html, published by Allied Market Research
3
In most insolvency cases, the amount of money each consumer has paid is small,3 but
a significant number of consumers suffering loss contemporarily would be another thing.4 Investigations have shown that a big proportion of prepaying consumers
(especially those buying paper gift cards and vouchers) are low-income earners who may have saved money for the whole year in order to buy gifts for their families during important festivals.5 The fact that the money prepaying consumers have saved
is used to pay secured creditors (like banks) who are financially much stronger while the former get almost nothing from the distribution would easily trigger public anger and the feeling of injustice,6 although such an arrangement is not inconsistent with
the insolvency law.7
Most Member States (and countries outside EU) have realized the seriousness of the consequence, and have more or less introduced regulations on prepayments, the forms of which vary from increasing the threshold of entrance to imposing obligation on retailers (and card issuers, if credit cards or debit cards are used in prepayment) to secure or separate the consumers' money.8 However, the effectiveness of national
legislation can be questioned from three main perspectives: firstly, Member States may lack the motivation to impose strict regulation. To strengthen the regulation would also undermine the competitiveness of that country.9 Secondly, consumers
groups, compared with trade organizations, are much less consolidated and lack the leadership and internal disciplines indispensable for taking collective measures,10
their appeal of interests may be easily ignored. Thirdly, restrictions imposed on the freedom of doing business may give rise to concerns regarding infringements of EU substantive law and competition law.11
From EU's perspective, the wild growth of national regulation is not desirable, for it makes doing business in EU more onerous and burdensome,12 particularly for
3 Consumer Prepayments on Retailer Insolvency: A Consulting Paper. UK Law Commission
consulting paper No. 221, 6.18.
4 Ibid, pp 40-41. See also “some retailer insolvencies since 1998 in Hong Kong that have attracted
much public attention”, Consumer Protection on Prepayment and Retailer Insolvency Review of
Chargeback and Beyond, published by Consumer Council of Hong Kong, May 2017, pp 4
5 Ibid, pp. 65.
6 Secretary of State -v- Fowler and others (formerly known as Home Retail -v- Farepak)- Day 15-
Judge’s Statement https://www.judiciary.gov.uk/judgments/farepak-judges-statement, pp.47.
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Consumers were often astonished to find that money paid in good faith had simply been lost, and that the law allowed this to happen. See UK Law Commission, Consumer Prepayments on Retailer
Insolvency, 4.5-4.7
8 Currencycloud, The Regulation Behind Prepaid Cards,
https://www.currencycloud.com/company/blog/the-regulation-behind-prepaid-cards/, posted on 4-8-2015.
9 See Philippe Gugler and Jacylyn Y. J. Shi, Corporate Social Responsibility for Developing Country
Multinational Corporations: Lost War in Pertaining Global Competitiveness? Journal of Business
Ethics (2009) 87, pp.18.
10 See pp.10 of this paper. (start from ‘Outside the statutory process of decision-making’)
11 In part IV of this paper, I would analyze the potential negative influence of the proposed EU act on
fundamental freedom and free competition.
12 See M. Artz, ‘Die "vollständige Harmonisierung" des Europäischen Verbraucherprivatrechts,'
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enterprises in a small and medium size (SMEs), who are regarded as the backbone of Europe's economy.13
The European Union, which has established a high level of protection as one of its primary goals, declaim itself as the firm defender of EU consumers' interests. By far, however, only a tiny proportion of prepayments have been regulated under EU legislation. Two primary documents regarding regulation on prepayment are the Travel Package Directive14 and the Electronic Money Directive15, the effectiveness of
which have already been proven after years of practice.16 Under the Treaty on the
functioning of the EU (TFEU), the Union possesses vast legislative and administrative power.17 Besides, the Union has a speech in the process of balancing different (and
even conflicting) values and principles by weighting them differently according to its policy preference.18
The urgency of protecting prepaying consumers, the Union’s power of harmonization and the Member States’ predicament together lead to the very interesting topic of this paper: should the European Union establish a common framework to protect
prepaying consumers on retailer's insolvency? If the answer is affirmative, we then need to consider: which type of mechanisms can be adopted in the proposed common framework? In this paper, I would make a distinction between securities, segregations, and other legal mechanisms. The main difference between the first two is that
segregation requires the retailers to separate the money they have received from the pool of assets for the sole purpose of refund, while security merely obligates the retailers to return the money if conditions laid down in statutory rules have been fulfilled. Besides, there are other feasible approaches to the same objective (e.g., a new ownership-transfer system).
This paper is organized as follows. Part II justifies the necessity of establishing a common EU framework for prepaying consume protection. In this part, I would reveal the necessity of providing extra protection to prepaying consumers from these four dimensions: prepaying consumers’ unawareness and inability, their disadvantaged
B.M. Loos, Full harmonization as a regulatory concept and its consequences for the national legal
orders. The example of the Consumer rights directive, Centre for the Study of European Contract Law
Working Paper Series No. 2010/03, pp. 5
13 Entrepreneurship and Small and medium-sized enterprises (SMEs),
https://ec.europa.eu/growth/smes_en
14 Council Directive 90/314 EEC, later amended by Directive (EU) 2015/2302 Of the European
Parliament and Of the Council
15 Directive 2006/46/EC of the European Parliament and of the Council, later amended by Directive
2009/110/EC
16 See European Commission: Stronger EU protection for package holidays; OECD: Report on
Consumer Protection in Online and Mobile Payments
17 Under Article 290 (1) TFEU, the Commission may adopt non-legislative acts of
general application to supplement or amend certain non-essential elements of the legislative act. Besides, under Article 291(2) TFEU, the Commission possesses the power of implementing binding Union Acts.
18 See Wolf Sauter, Proportionality in EU Law: A Balancing Act? Cambridge yearbook of European
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position under the current insolvency distribution hierarchy, administration under insolvency law, which is unable to guarantee a consumer-favorable solution, and last but not least, the existing EU regulations in the field of prepayment (which is
considered to be insufficient). Having regard to that, we then turn to the construction of an EU common framework for prepaying consumer protection in Part III. The key of this framework is the mechanism we can adopt to safeguard consumers' money: should it be a security, a segregation, or another mechanism (like a new rule regarding the transfer of ownership)? Those possible options would be presented on the table and evaluated in light of three main benchmarks: their utilities, their restrictive effects on business and fair competitions and their technical difficulties of operation. The purpose of the evaluation is not to choose the "superb" mechanism, but to suggest that multiple approaches should be adopted in the proposed framework in order to strike a balance between the interests of consumers, business and other stakeholders (e.g., secured creditors, insolvency administrator). And finally, part IV, a conclusion of this paper and some prospects.
Part II: The Vulnerability of Prepaying Consumers: why Special Legislation is Needed?
a. Consumers’ unawareness and inability
Think about the example given at the beginning of this paper. If you are the owner of a fitness club, prepayment would be particularly attractive to you: running the club costs plenty of money, and many customers are "three-minute passion" people19: they
only come to your club once or twice before they lose passions.20 With the money
prepaid in the membership card, you can "bind" them for a considerable long period, and you can make use of the money they have paid before the performance of contracts.21 So how would you persuade consumers to recharge their membership
cards?
In the absence of any information obligation, a "reasonable" retailer would never inform consumers of the risk of prepayment. Instead, it would try to make full use of their passions, recklessness as well as their (gratuitous) reliance on the retailer's market power.22 In order to encourage consumers to pour money in prepayments,
retailers often carry out gimmicky promotions and activities, which in turn increase their financial burden. It seems irrational and shortsighted, but companies are
19 “Three-minute passion” is a Chinese saying which refers to a person having a limited passion or a
passion that doesn't last long toward something that he liked about.
20. A survey of 5313 American gym members found that 63% of memberships go completely
unused. See Gym Membership Market Analysis, https://www.statisticbrain.com/gym-membership-statistics/ published by Statistic Brain
21 Prepayments provide an important source of working capital. See, e.g., GAME Digital plc, Annual
Report and Accounts 2014, http://www.gamedigitalplc.com/~/media/Files/G/Game-Corp/documents/year-in-review- 2014/game-ar2014-dr-final.pdf, pp. 37
22 James W. Clark, Richard R. Tansey, George W. Wynn, The Planning Fallacy: Consumers’
Unrealistically Optimistic Marketplace Expectations, Proceedings of the 1996 Academy of Marketing
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motivated to do so. With those funds, companies can make investments or pay mature debts. Not long before, consumers who have paid deposits and added balance at several Chinese bike-sharing firms (MoBike, OFO, Xiaoming, etc.) requested a refund of their money after reports of the bankruptcy of those companies were exposed, but most of them have not received anything yet.23 Further investigation shows that those
companies put deposits in highly risky peer-to-peer (P2P) lending without informing the consumers ex-ante,24 turning consumers’ money into bad debts on their balance
sheets.
One can argue that the Chinese consumers' tragic experience in the abovementioned example justifies the necessity of imposing more extensive information obligations and stricter prohibitions of fraudulent commercial practices which enable the retailers to take advantage of the consumers' unprofessionalism, infirmity, and credulity.25 I
agree that legislation in this field would contribute to the transparency of commercial relationship and consumers' confidence. But even when the company has well
fulfilled its information obligation, those "lawful" advertisements and promotions can nevertheless confuse prepaying consumers.26
Some suggest that a campaign is needed in order to raise consumers’ awareness of the retailers’ potential failure of performance due to insolvency or bankruptcy. Again, I really doubt whether this is a feasible approach. Still, most consumers fail to understand insolvency as a normal outcome of economic development.27 For most
consumers, the insolvency risk is an abstract and vague concept.28 Their judgment on
the retailer's prospects is not based on the statistics provided in annual reports, but on the “appearance” of that retailer. When a retailer is running in a good momentum, consumers would easily base their confidence on it, believing that the retailer would have no problem providing the goods and services they have prepaid for. The
potential failure of a business, instead, would be easily ignored by the mass of public. The UK Law Commission, when discussing the tragic stories of holders of gift vouchers in several insolvency cases, stated that
23 For relevant news, see, for example, CEO of bike-sharing start-up Ofo vows to battle on despite
'immense' cash flow problem, https://www.straitstimes.com/asia/east-asia/chinese-bike-sharing-startup-ofo-considering-bankruptcy-as-chinese-users-seek-deposit, the Straits Times, updated on 20-12-2018.
24 Troubled Ofo says refund process 'normal,' despite P2P reports, written by Nicholas Moore for
CGTN, https://news.cgtn.com/news/3d3d674d786b444f30457a6333566d54/share_p.html, updated on 27-11-2018.
25 Similar wordings can be found in, e.g. the recital of Directive 2005/29/EC concerning unfair
business-to-consumer commercial practices in the internal market, para.19
26 J. Jacoby, MC Nelson, WD Hoyer, Corrective advertising and affirmative disclosure statements:
their potential for confusing and misleading the consumer, Journal of Marketing, 1982 Volume: 46
issue: 1, page(s): 61-72
27 Commission communication of 5 October 2007 Overcoming the stigma of business failure – for a
second chance policy – Implementing the Lisbon Partnership for Growth and Jobs (COM 2007, 584),
pp. 3
28 Tibor Tajti (Thaythy), Unprotected Consumers in the Digital Age: The Consumer-creditors of
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‘The gift voucher industry only survives because consumers have confidence in it. At present, consumer confidence in gift vouchers is not based on a careful assessment of the insolvency risk and regulatory protection. Rather, consumers have confidence because they have not considered the insolvency risk at all.’ 29
I find this conclusion applicable to almost all industries where consumers’
prepayment is needed. After all, if advertisements of the retailer are found everywhere in the city and new department stores open every month, who is not going to be optimistic for its prospect?
Even when consumers have fully realized their disadvantaged position ex-ante, there is very little they can do to make economically rational decisions. Unlike financial institutions and other loaners who have equipped themselves with professional knowledge, consumers acquire little, think little and understand little. They acquire very little crucial commercial information since it is made unavailable for unsecured creditors on the ground of protecting commercial secrets.30 They think little because
they fail to see the whole picture, i.e., the risk of insolvency of all undertakings on the relevant market in general.31 They understand little as they usually struggle to figure
out the meaning behind the tables and statistics on the reports, not to mention their unawareness of the retailer’s overly risky commercial behaviors.
The difficulty of assessing the risk of insolvency also generates from the construction of prepayment framework. Usually, there are several parties involved in one prepaid program. In transactions where credit cards are used the relationship can be even more complicated.32 Consumers cannot monitor the financial health of each participant or
understand the domino effect that might arise if one participant becomes insolvent or violates one of the myriad compliance rules.33 Even if consumers obtain all
information necessary for evaluation, one may not expect them to assess the risk of each participant accurately.
As some scholars have rightfully pointed out, prepaying consumers factually play the role of generous loaner who loans money without carefully evaluate the risk behind
29 Consumer Prepayments on Retailer Insolvency: A Consulting Paper 7.60
30. Security is not merely a preferential priority. It also provides access to information and a degree of
control over the conduct of the debtor's business. See R. M. Goode, Is the Law Too Favorable to
Secured Creditors? 8 Can. Bus. L.J. 53 (1983), pp. 56
31 The abovementioned story of Chinese consumers is a good example. At the time when bankruptcies
of those bike-sharing companies were exposed, the bike-sharing market in China had become well saturated after years of wild growth.
32 A typical credit card transaction usually involves five entities: namely cardholder, retailer, card
issuer (e.g., banks), credit card association (e.g., Visa and Mastercard) and acquirer (e.g., banks). See
Consumer Protection on Prepayment and Retailer Insolvency Review of Chargeback and Beyond,
published by Consumer Council of Hong Kong, May 2017
33 Catherine Lee Wilson, Making Prepaid Safe for Consumers: A Framework for Providing Deposit
Insurance and Regulations E Protections, 17 U. Pa. J. Bus. L. 925 (2015), pp. 955. See also Office of
the Comptroller of the currency, U.S. Dep't of Treasury, Occ bull. No. 2011-27, prepaid access
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that.34 Evidence can be found in the highly consumer-favorable promotions for
prepayments. From the perspective of law and economics, a consumer who charged 200 euros for 100 euros free "loaned" the money to the retailer with a 50% interest rate. The surprisingly high-interest rate is consistent with commercial practices: the higher the borrower’s default risk is, the higher interest rates the loaner would lay down in the contract. However, as I would reveal in the next section, in case of retailer’s insolvency, consumers would find themselves on a position that most rational loaners would never put themselves on.
b. Consumers’ disadvantaged position on retailer’s insolvency
After buying, consumers turn into the retailer's creditors. The money they have spent on prepaid products becomes part of the assets of the company. Principally, in case of insolvency, all assets are available for distribution following the statutory hierarchy. Usually, the sequence of distribution goes as follows (here I take the UK Insolvency Act 1986 (amended in 2002) as an example, but note that the hierarchy of priority in most countries bears many similarities):
1. Any creditor holding a fixed charge over an asset; 2. Expenses of the administration;
3. Preferential debts (employees of an insolvent company have a degree of preference under the IA 1986);
4. Any creditor holding a ‘floating’ charge over an asset (less preferential debts and the ‘prescribed part’);
5. All unsecured creditors; and
6. Any surplus to shareholders per shareholder rights.
Consumers are classified in the category of "unsecured creditors," together with suppliers, landlords, other contractors35 as well as other creditors whose pledge is not
originated from a contract (e.g., the victims of tort). According to insolvency law of most countries, their claims are paid on a pari passu basis. If lucky enough, they would receive a dividend paid pro rata at the end of the distribution.
One can reasonably suppose that after paying expenses and secured creditors, there is a very limited amount of money left in the retailer's pool of assets.36 After all, one of
the main reasons an undertaking goes insolvent is that it does not possess sufficient
34 See, e.g. Marc L. Roark, Payment Systems, Consumer Tragedy, and Ineffective Remedies, 88 St.
John's L. Rev. 39 (2014), pp.51; V Finch, Security, Insolvency and Risk: Who Pays the Price? (1999) 62 MLR pp. 633-644; Kayode Akintola, The Proposed Preferential Priority of Prepaying Consumers:
A Fair Pack of Insolvency Recommendations? Journal of Business Law, 2018, pp.5
35 Note that contractual parties are not always unsecured creditors. In some countries (e.g., China), if
the administrator decides to continue the performance of contract after the commencement of
insolvency process, it is obligated to provide security according to the other party’s request. See Article 18 of the Insolvency Law of China.
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assets to pay its debts. Besides, the process of distribution can last for years,37 and the
chance of recovering the prepayments is very slim.38 In a word, it is unrealistic to
expect that in most insolvency cases prepaying consumers can have a bite at the cherry through the distribution.
Prepaying consumers in some Member States may see a ray of hope through the so-called "prescribed part." According to the UK Enterprise Act 2002, the prescribed part is the part of the proceeds from realizing the assets covered by a floating charge which must be set aside and made available to satisfy unsecured debts.39 The Finnish
insolvency law, following the amendment in 1993 which reflects similar concern with UN Insolvency Act, allows the floating-charge creditors’ priority covering at most 60% of the company assets.40 But a prescribed part saved for all unsecured creditors
may not be the right solution for anyone of them. Even where the prescribed part is distributed, the sums are so small that they are unlikely to make a difference to any particular creditor,41 and the process of distributing prescribed part has been criticized
for increasing the working burden of the already stressful administrator.42
Furthermore, most Member States would find prescribed-part-like program
unacceptable considering its impact on the hierarchy of distribution. Prescribed part directly injures secured creditors by taking away a significant part of available assets after the start of distribution, and therefore generates huge legal uncertainty.
c. The insolvency law fails to guarantee a consumer-favorable solution
However, that is not the end of the world. Insolvency law has provided consumers with other remedies. One solution is trading in administration. On insolvency, an insolvency practitioner would be appointed as administrator, who may decide to keep the business trading. If the business is sold, the subsequent purchaser can choose to honor the prepayments as well. According to the UK Law Commission's
investigation, most insolvent retailers chose to trade in administration.43
There are reasons for them to do so: it helps preserve the value of the brand.44 Those
who can prevent the consumers from loss can usually regain their fame more quickly
37 Government of the Netherlands, Minister Blok: bringing insolvency proceedings to a conclusion
more efficiently, https://www.government.nl/latest/news/2017/06/15/minister-blok-bringing-insolvency-proceedings-to-a-conclusion-more-efficiently
38. Where there are floating charge holders, it is relatively rare for any money to be
left over after the floating charge holders have been paid. SeeConsumer Prepayments on Retailer Insolvency, 8.28
39 Insolvency Act 1986, s 176A.
40 For detailed explanation see, e.g., Clas Bergström, On the Design of Efficient Priority Rules for
Secured Creditors: Empirical Evidence from A Change in Law, European Journal of Law and
Economics, 18: 273–297, 2004
41 Kayode Akintola, The prescribed part for unsecured creditors: a pithy review, Insolvency
Intelligence 2019, 32(2)
42 Ibid, pp. 67-70
43 Consumer Prepayments on Retailer Insolvency, 2.15 44 Consumer Prepayments on Retailer Insolvency, 2.17
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and therefore shorten the rebuilding period. To keep the business running also
promotes sales, since consumers often spend more than how much they have prepaid, and more customers, like the consumers’ friends and families, would be attracted to the retailer’s as well.45
But trade in administration is not a guaranteed solution. Administrators’ (as well as the subsequent business') decision on whether to reward the gift vouchers is not a consumer-oriented one. Instead, it is based on commercial concerns.46 For example,
they have to consider whether the balance of the purchase price exceeds the realization value of the goods and whether goods of that particular description are available.47 Only when trading in administration benefits creditors as a whole, will
they decide to keep the business running.48 Administrators are hired for managing the
insolvent company for the greatest interests of secured creditors, which means their discretion in decision-making is restrained. If the insolvency practitioner refuses to complete the sale, the prepaying buyer is left with an unsecured claim which may amount to very little.49
The process of decision-making lacks openness and transparency as well. Although consumers did lend money to retailers, in most cases they are excluded from the determination of further business strategies, and their appeals of interest under prepayment are often unheard.50 Outside the statutory process of decision-making in
administration, consumers fail to raise public’ attention as well. Unlike workers who are tightly connected through trade unions and other labor organizations, consumers are a loose group. Although there are consumer organizes who declare to represent consumers' interests, they often fail to impose strong influence on media or policy-maker due to their lack of leadership, consolidations and internal disciplines, which are precisely the common features for successful trade unions and labor campaigns.
d. Status quo of prepayment regulation at Union level: not that satisfying
Before discussing a legislation proposal of uniformed prepayment regulation, let me make a brief review of the current EU legislation on prepaying consumer protection. In 1990, the Council of European Communities adopted the Directive on package travel, package holidays and package tours (the old PTD). According to the old PTD, the providers of package travel shall ensure that the money consumers have paid is secured, and can be returned to them in full amount when the service provider is not
45 Sometimes the administrator would decide that vouchers can be redeemed only when the buyer
consumes more than the value of the voucher. See, e.g., ‘BHS vouchers can only be used for 50pc of purchases following firm's collapse’, https://www.telegraph.co.uk/money/consumer-affairs/bhs-vouchers-can-only-be-used-for-50pc-of-purchases-following-fi/.
46 Consumer Prepayments on Retailer Insolvency, 2.16 47 Consumer Prepayments on Retailer Insolvency, 2.19 48 Consumer Prepayments on Retailer Insolvency, 2.16 49 Consumer Prepayments on Retailer Insolvency, 8.2
50 Gert‐Jan Boon, Harmonizing European Insolvency Law: The Emerging Role of Stakeholders.
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able to perform its obligations under the contracts.51 Services providers are obligated
to present to the Member States the evidence of security. After the amended Directive was released in 2015, Member States’ obligation to ensure that organizers established in their territory provide security for the refund of all payments made by or on behalf of travelers insofar as the relevant services are not performed as a consequence of the organizer’s insolvency, was added (in Article 17).
But the success of PTD does not necessarily mean it is feasible to expand PTD to all industries and all undertakings. As I would analyze in next part, bigger undertakings they can easily obtain funds from consumers and stakeholders, but in return, they have to raise the price of their products. For SMEs who are less competitive on the market, higher price could be fatal.
Another critical legislation is a series of Directives constituted of Directive 2000/46EC, 2000/48EC, 2005/60EC, and 2009/110EC (hereinafter "EMDs", the abbreviation of "Electronic Money Directives"), under which the Member States shall lay down in their national law the card issuers' obligations of safeguarding money they have received from the consumers. If the retailer fails to perform its contractual obligation or is no longer able to perform due to liquidation or insolvency, the consumer can request the issuer to annul the payment and return the money. In this way, EMDs effectively ensure that the card issuers shelter consumers' money. It shall be noted, however, that the Directives are only applicable to the so-called "open loop" electronic cards, i.e. cards which may be used in a wide range of retailers for a variety of purposes.52 Paper vouchers as well as prepaid cards that may be
redeemed only at particular sellers (like your Starbucks gift card), which take a significant proportion of gift cards on the market, fall outside the scope of regulation.53
Part III: What are in the Toolbox of the Proposed Framework? A Comparative Research between Different Mechanisms for Providing Protection
If the Union determines to take action in the harmonization of prepaying consumer protection, it needs to deliberate: which legal mechanism is most suitable for achieving the goal? This part is to analyze the feasibility of some possible options through a detailed comparison between them. There are already safeguarding measures adopted within and outside EU while much more has been put forward in academic works and discussions, but many of those mechanisms bear many
similarities, and I find it wordy and superfluous to examine them one by one. For this paper, I would classify all legal mechanisms into three categories: securities,
51 Article 4(6)b of the Directive.
52 Consumer Prepayments on Retailer Insolvency, 4.45
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segregations, and transfer rules and evaluate them separately. The purpose of my research is not to find out the “prime” mechanism but to reveal how each of them can find its own place in our proposed framework.54 But before starting my comparative
research, the benchmarks of evaluation shall be determined.
A. Benchmarks: what defines a “suitable” mechanism?
Every EU act must strike a balance between conflicting interests, although they are often designed to favor one particular group of people.55 Indeed, the proposed EU
common framework we discuss in this paper is supposed to benefit consumers, but the Union has to take into account its negative impact on other stakeholders as well. The most directly-affected party is the business. The regulation would inevitably constitute a restriction on their freedom of providing goods and services. This is particularly the case for business in small and medium size, who are already in a disadvantaged position in competition with big enterprises. Having regard to that, I decide the benchmarks of evaluation as follows.
Firstly, the chosen mechanism shall be capable of effectively preventing prepaying consumers from financial loss in retailers’ insolvency. In particular, the mechanism shall enable consumers to shelter their money from secured creditors’ pledges.
Secondly, a suitable safeguard mechanism shall not impose an excessive burden on undertakings. This benchmark focuses on the restrictive effects of legal mechanisms from the business’ perspective. My assessment mainly focuses on their potential inconsistency with the freedom of providing services and EU Competition Rules, as these are the two vital aspects for the freedom of business. Since securities and
segregations bear similar restrictive effects, I would combine the analysis of these two categories.
Freedom of providing services is assumed to be absolute.56 It demands the removal of
all restriction that may prevent or burden the provision of services by a person who is established in another Member State. In other words, restriction, even when it is equally imposed on domestic and foreign undertakings and individuals, nevertheless constitutes an infringement of Article 56.57 This has been made clear by the Court
in case like Ladbrokes Betting58 and Säger59.
54 Scholars like Peter de Cruz argued that the comparatist is not seeking to be judgmental in the sense
of whether he believes them to be “better” or “worse”, but it is acceptable to evaluate the efficacy of a given solution for approach to a legal problem”. See Peter de Cruz, Comparative Law in a Changing
World (third edition), Routledge Cavendish 2007, pp. 224
55 Supra note 17, pp.440 56 Supra note 54, pp.324
57 Catherine Barnard, The Substantive Law of the EU: The Four Freedoms (fifth edition), Oxford
University Press, Part III 7.D.4.1
58 C-258/08 Ladbrokes Betting & Gaming and Ladbrokes International, [2010] ECR I-4757, para.15;
Case 203/08 Sporting Exchange Ltd [2010] ECR I-4695 para. 23; Joined cases 447/08 and C-448/08 Sjöberg and Gerdin [2010] ECR I-6921 para. 32
13
Once an infringement has been established, we need to consider if there is a
justification for such a restrictive measure. According to Article 62 TFEU, grounds of justification listed under Article 52 (public policy, public security, and public health) are applicable to restriction on the freedom to provide services as well. Consumer protection would be a vital public interest. But to survive the condemn based on Article 56, the contested measure shall be tested in the light of the principle of
proportionality60 which has been concluded by the Court inPhilip Morris61 as a
four-step test: finality test (is the measure suitable to achieve a legitimate aim), necessity test (is the measure necessary to achieve that aim), suitability test (did the measure impose excessively burdensome) and the least restrictive alternative test (are there less restrictive means capable of producing the same result).
As for Competition Rules, the two most essential provisions are Article 101(1) and 102 TFEU (former Article 81 and 82 TEC). Article 101(1) provides that all
agreements, collective decisions and concerted practices which have as their object or effect the prevention, restriction or distortion of competition within the internal market shall be prohibited,62 while according to Article 102, any abuse by one or
more undertakings of a dominant position within the internal market or in a
substantial part of it shall be prohibited while no justification is allowed. Sometimes Article 106 TFEU would be taken under consideration as well, which usually happens when state authorities enter into the market through state-funded undertaking or strengthen the position of existing dominant undertakings. Although the Union would not be directly involved in the infringement of Article 106, it nevertheless may
facilitate a violation of Competition Rule through problematic legislation, which is an undesirable outcome for EU policy-makers. Competition Rules, therefore, impose significant restraints on EU's legislative power as well.63
Thirdly, I have to take into account the technical difficulties of their operation, which would be observed from the perspective of parties whose cooperation is needed. One of them is the insolvency administrator, whose duties are quite broad, time-sensitive and intensive.64 A technically complicated program of distribution would lead to
economic inefficiency of the process of administration, which would easily outweigh the welfare it generates for consumers.
60 Supra note 64, Part II 6.D
61 Case C-547/14 Philip Morris, para. 165. See also Case C-368/95 Familiapress [1997] ECR I-3689 62 The Commission and most textbooks make the distinction between horizontal and vertical
agreements. The discussion on cooperation between retailers and security companies in this paper follow the same approach as most textbooks adopted in the discussion of vertical agreements, although the relationship between them is not the same as the one between upstream and downstream
undertakings.
63 According to Article 263 TFEU, the Court of Justice of the European Union shall review the legality
of legislative Acts which have binding effect. EU institutions, Member States and individuals whose interests are directly affected by the EU legislative Act may institute proceeding against that Act before the Court as well.
14 B. Securities
Security has been widely adopted within and outside EU, but mostly as a voluntary choice rather than a legal duty. In this paper, security is defined as a compulsory promise. Under the promise, the retailer bears the obligation of refunding buyers what they have paid when the retailer has failed or is legally impossible (e.g., when it goes bankrupt) to perform its obligation under the contracts. Security provides the
prepaying buyers with a preferential priority and therefore “lifts” the consumers from the bottom of the creditor hierarchy.
It remains questionable whether a security is capable of ensuring the consumers' priority position against other secured creditors, especially floating charge creditors. In most countries, "first come first served" remains the essential rule in deciding the priority of security interests. In the absence of any agreements regarding the sequence of priority, those who first set up security interest on the property (and register first) would get paid first in distribution. If consumers obtain the security interest later than other secured creditors and are not able to reach an agreement with creditors ranking before them to switch their priority (no secured creditors would agree so), those secured creditors still get paid prior to consumers, and very likely the consumers would have to go home with empty hands again.
To deal with the disadvantage of regular security, the purchased money security interest (PMSI) adopted in countries like the USA and Australia, may be taken into account. According to Article 9 of the American UCC, a security interest in goods is a purchase-money security interest:
(1) to the extent that the goods are purchase-money collateral with respect to that security interest;
(2) if the security interest is in inventory that is or was purchase-money collateral, also to the extent that the security interest secures a purchase- money obligation incurred with respect to other inventory in which the secured party holds or held a purchase-money security interest; and
(3) also, to the extent that the security interest secures a purchase-money obligation incurred with respect to software in which the secured party holds or held a purchase-money security interest.
PMSI provides the creditor with a super-priority, which means in a priority contest with an earlier registered or perfected non-PMSI security interest it will take
priority.65 However, PMSI factually draw an exception for the “first come first serve”
rule and therefore distinctly conflicts with the security interest of other secured
65 Rasiah Gengatharen, Protecting the prepaying buyer of goods from the seller’s insolvency, UWA
15
creditors.66 It also generates legal uncertainty that potentially affects secured
creditors’ confidence.67 After all, if the assets they have set up security interest on
could be made unavailable in the future by another unknown creditor, they have to think twice before providing loans, or carrying out more investigation on where did the retailer obtain the assets.
Accordingly, the PMSI priority is restricted in two ways. First, there must be a nexus between the acquisition of collateral and the secured obligation.68 A delay in time
between the acquisition of the collateral and the securing of the related indebtedness will prevent a finding of a close nexus. This requirement causes great difficulty for buyers claiming for a PMSI in the goods he has prepaid for, as he has to present evidence suggesting that his prepayment is used to acquire the seller’s newly-added asset.69 Secondly, the PMSI priority applies only to the extent that the credit is
actually used to acquire the asset.70 The buyer may not claim for the super-priority
outside this scope. Thus, intangible input like knowledge, design, and administration, which take a big proportion of the cost in goods (especially customized goods), would not count.71
Besides the restriction imposed on its utility, PMSI fails to provide a suitable solution to prepaying consumer protection due to the technical difficulties of operation as well. To introduce PMSI in safeguarding a massive number of prepayments at the EU level, a cross-broader tracing system recording how the retailers make use of each sum of money they received from the consumers, shall be established. One can suppose that a system like that would be expensive and technically challenging to build up. The obligation of reporting the management of money also gives rise to commercial privacy concerns.
C. Segregation: guarantee fund, trust and more
We now turn to segregation, another type of safeguard measures. The commonality of mechanism in this category is that they all require the company to put a certain amount of money in a separate account. Segregation has a strong preventive characteristic since the account is designed solely to refund consumers. To achieve that goal, the fund in this account does not form a part of the company's pool of assets in insolvency, which means the money is unavailable for secured creditors. For example, under the abovementioned EMDs, before the company provides the consumers with the goods or services, consumers’ money remains under the card
66 Cuming RCC and Wood RJ, Compatibility of Federal and Provincial Personal Property Law (1986)
65 Can Bar R 267 pp. 285
67
Supra note 73, pp. 10
68 Ibid, pp.10 See also Jackson TH and T Kronman A, “A Plea for the Financing Buyer” (1975) 85
Yale L J 1, pp. 28
69 Ibid, pp.10 70 Ibid, pp.10 71 Ibid, pp.11
16
issuer’s control. If the company goes bankrupt, those money is certainly unavailable for distribution.
A guarantee fund can be financed through various sources. The retailer can provide the money by itself, but it would be excessively burdensome to do so. Consumers can be another source. For example, in every transaction, the consumer may be required to put an extra amount of money (like 5 euro) into the guarantee fund account. For bigger companies, it would also be feasible to obtain the fund from their
shareholders.72 As for the management of the fund, some Member States (like
Denmark), obligate the retailers to store the money in a bank account (as one of the mandatory requirements of running a business in which prepayment is used).73 In
other Member States (like the Netherlands), a big proportion of retailers choose to join in the private company managing guarantee funds.74 As I would present later, the
form of the management of funds makes a difference in the assessment of restrictive effects.
Compared with security, a big advantage of segregation is that the money saved in the separated account is immune from secured creditors’ claims. Thus, the discussion on the priority of consumers and other creditors’ claims would be evaded. Certainly, the immunity is not absolute: other creditors (and sometimes the insolvency administrator as well) can nevertheless attack the segregation on the ground of debt evasion. Should that be the case, the court would have to take into account both the objective and effects of the retailer’s behaviors in light of its national insolvency rules. A guarantee fund set up when the retailer is already in a difficult situation or a huge amount of money deposited into the account at that moment would be considered particularly suspicious. To prevent the potential conflicts with secured creditors, EU regulation shall lay down detailed requirements regarding the establishment and management of the fund.
Trust is a special tool for segregation which has been adopted in some countries.75
There are two main types of trust frameworks. In a self-benefit trust, the retailer acts as both the trustor and beneficiary. It is obligated to put the prepayment he received from consumers into a trust account managed by the trustee.76 Unless the retailer has
duly performed the obligation of providing goods or services to customers, it may not request the trustee to transfer the money into its account of assets. Consumers benefit
72 Supra note 55, pp. 318
73 Ibid, pp. 322 74 Ibid, pp. 321-322.
75 Trust has become a popular security measure for safeguarding distance shopping, although usually it
is not managed in the name of “trust”, but other names like “third-party platform”. A well-known example of third-party platform is Alipay (‘Zhifubao’) in China. Where Alipay is adopted in transfer of money, consumer’s payment would be temporarily stored in Alipay. After goods is delivered and accepted by the consumer, Alipay would transfer the equal amount of money to the seller.
76 See, e.g., Act Governing Issuance of Electronic Stored Value Cards of Republic of China (Taiwan),
Article 18, 19. Also, see Chih-Cheng Wang, Law of Trust (in Chinese), published by Wu-nan Book Inc. pp. 52-53
17
from the mandatory terms that must be included in the trust agreement, which provides that in case of insolvency or deregistration when the retailer’s performance becomes impossible, consumers whose prepayments have not been honored are entitled to the benefits of the trust. In other words, the consumer now becomes the beneficiary.77
A second trust framework is a third-party-benefit one, in which the consumer is appointed as the beneficiary ab initio. Compared with self-benefit trust, a third-party-benefit trust may be a more consumer-favorable approach, as for the former, the provider of goods or services acts as both trustor and beneficiary, it can decide the management of money together with the trustee without consumer’s consensus. Unless the retailer goes bankrupt, consumers cannot claim for any rights since they are precluded from the three-corner relationship of trust. In third-party-benefit trust, If the trustee fails to manage the property properly, consumers, as beneficiary may request the court to annul such a dispose. In addition, since the consumer is entitled to the benefits of trust ab initio, they are now sheltered from creditors’ claims on the trusted property or the benefits on it. But third-party-benefit trust can be difficult to operate. The number of customers as beneficiary is big, and the holder of prepaid cards and vouchers frequently change, especially when those products are
anonymous78. Similar to the case of PMSI, the insolvency administrator would be
unpleasant facing a massive number of claims from the beneficiaries.
Akin to guarantee fund, a trust is exposed to the creditors’ attack, for it has the effect of putting assets beyond the reach of the creditors as well. UK law has established the so-called “sham trust” criteria. In Midland Bank plc v Wyatt79, the defendant set up a
trust for the purpose of “protecting his family from long-term commercial risk”. The court rejected the defense, saying that the risk is too vague and uncertain. The trust was defined as a sham set up in order to “screen or protect (the defendant’s families) against the unknown risks of the new adventure” and was therefore a nullity
according to Section 423(2) of the UK Insolvency Act.80
The Midland case rings the alarm to the proposed EU harmonization on prepayment regulations. Certainly, prepaying consumers’ risks of suffering loss in case of the retailer’s insolvency is not a mirage. However, if the retailer has already joined in a
77 Mandatory and Prohibitory Provisions of Trust Agreement for the Entrustment of Stored Fund in
Electronic Stored Value Cards of Republic of China (Taiwan), Annex 1, para. 3(2)
78 A Brief Analysis of the relationship in prepayment trust: use voucher trust as an example, published
by Trust Association of Republic of China (Taiwan) (in Chinese), 19 October 1995, pp. 6
79
High Court of Justice 10 June 1994, [1995] 1 FLR 697
80 This section provides as follows: (2) Where a person has entered into such a transaction, the court
may, if satisfied under the next subsection, make such order as it thinks fit for—
(a)restoring the position to what it would have been if the transaction had not been entered into (3) In the case of a person entering into such a transaction, an order shall only be made if the court is satisfied that it was entered into by him for the purpose—
(a)of putting assets beyond the reach of a person who is making, or may at some time make, a claim against him
18
voluntary safeguard program, would the soundness of a new trust set up under EU regulation remain unquestionable? Therefore, the mechanism of recognition of
existing protective measures shall be incorporated in the proposed EU framework.
* The restrictive effects of securities and segregations: a combined assessment
Freedom to provide services: Among all legal instruments, compulsory trusts and guarantee funds seem to be the most problematic ones, for they have the effect of increasing the threshold of entrance and preventing the retailers from making full use of their working capitals. Such a deterrent effect may seriously undermine one of the biggest advantages of prepayment: the flexibility it brings to the retailers’ business strategies. Prepayment enables small business to make use of the money they received prior to the performance of contracts, and thusimprove their competitiveness vis-à-vis big companies.
Forced segregation can be blamed for narrowing the source of financing of small
businesses as well. As has been pointed out by many, a big proportion of small businesses struggle to get sufficient funds.81 Financial institutions usually show less willingness to
provide a loan to small businesses, since their financial status is less stable and once their business strategies fail, they can get into trouble quickly. Each mean of financing,
therefore, can make a big difference for small businesses. If financing through
prepayments becomes technically impossible, retailers would be forced to turn to other options: usury, subprime lending, or even underground banks. The potential consequence that they have to bear more burdensome debts while a significant part of the money they received from consumers is unavailable for making profits would be, as one can imagine, open to law and economic criticisms.
Competition Rules: For a retailer who decides to provide security to prepayments, it can manage the security by itself, but that would usually be economically inefficient since the retailer would have to employ experts for the management of security instruments. As an alternative choice, it can conclude an agreement with another undertaking expertized in this field. From the perspective of security companies, it would be necessary to filter undertakings who seek for cooperation with some financial thresholds.
Competition Rules are, however, susceptible to thresholds artificially set up for cooperation. Thresholds which are potentially problematic in light of Article 101(1) TFEU include requirements of minimum capitalization or criteria for assessing the insolvency risk a given undertaking poses.82 These standards, however necessary, are
81 See, for example, Philip McCallum, William J. Casey, Rene A. Wormser, James Thornburg and
Dennis Maduro, Small Business Financing, The Business Lawyer Vol. 20, No. 1 (November 1964), pp. 185-219
19
considered to be unfriendly to small undertakings.83 Those undertakings, due to their
limited assets or financial instability, may find it difficult to join in such cooperation. Thus, criterions for entrance, though neutral per se, would be capable of precluding a big proportion of undertakings from competing with rivals who are financially stronger.84 Even when small undertakings manage to meet the requirements and are
approved to participate in the security program, they may nevertheless be subject to more disciplines and monitors on their commercial behaviors,85 which are considered
to be necessary for their "risk control."
Similar anti-competitive concern can be raised based on Article 102 TFEU as well. When one security company enjoys the dominant position on the market, it can abuse its dominance either by imposing an unreasonably high threshold for retailers who seek to cooperate with it, or imposing unfair purchase or selling prices or other unfair trading conditions on different contractual parties.86 It can also obtain
supra-competitive profits through bundling other products with the securities it provides or offering rebates to retailers as a reward of establishing long-term exclusive
membership.87
Besides, cooperation between security companies and retailers (especially a long-term relationship with a retailer possessing a considerable proportion of market share) are likely to soften the competition between the formers.88 This restrictive effect would
become particularly obvious when several oligopolies collectively dominate the security market.89 Long-term cooperation with dominant undertakings is capable of
precluding new-coming security companies as well.90 Assume that 95 percent of the
security services are controlled by four security companies, who have respectively established twenty-year-long exclusive cooperation with some retailers, who collectively take 95 percent of share on their relevant market. Competition on the market of security products would be significantly undermined in two ways: first, the dynamics of the security market would see an obvious decline. A direct consequence is that oligopolies, within a considerably long period, no longer need to compete with each other. Second, these existing cooperative relationships would make the entrance of other security companies rather tricky and therefore shelter the oligopolies from new rivals’ challenges.
83 European Commission, Guidelines on Vertical Restraints, 2010/C 130/01, para.97. Note that,
however, vertical agreements involving only SMEs are considered to be not capable of affecting free competition, see para. 8-11 of that Guidelines.
84 Ibid, para.100
85 Increased transparency between undertakings may give rise to concern on collusive outcomes. See,
e.g., European Commission, Guidelines on the applicability of Article 101 of the Treaty on the
Functioning of the European Union to horizontal co-operation agreements, para.58, 60
86 Article 102 (a)-(c) TFEU
87. It did take place in real life. See, e.g., Case C-322/81, Nederlandsche Banden- Industrie-Michelin v
Commission [1983] ECR 3461 (‘Michelin I’); Case C-23/14 Post Danmark A/S v Konkurrencerådet
88 Supra note 89, para. 151-167 89 Ibid, para. 110
20
If State authority makes security for prepayment legally compulsory, it can be involved in the infringement of EU Competition Rules. The responsibility of state authorities has been confirmed in INNO v ATAB, where the Court found that State authority may not maintain in force legislation which could deprive the competition rules of their effectiveness.91 According to the Court, this obligation generates
together from the Competition Rules and Article 4(3) TEU (the “Sincere
Cooperation” Clause).92 But would Union act be found guilty on the same ground as
well? By far no case law has suggested so. In fact, neither Article 101(1) nor Article 102 TFEU has included the Union as an obligor. However, a Union Act facilitating restriction of competition or abuse of dominant position would certainly put EU on a rather sticky position, and conflicts with its long-standing position on safeguarding cross-broader transactions and creating and maintaining good commercial
environment for SMEs.
D. Rules of transfer (or rules of appropriation): make them more consumer-favorable?
In some cases, consumers have paid for the goods, and the goods have been produced and are ready for delivery before the seller goes bankrupt. In the absence of any agreements between parties on the transfer of ownership, the question arises whether the consumers may claim that they have already owned those goods, even though the retailers still possess the goods. The answer to that question varies between different legal systems.93 But would it be a good idea to harmonize the rules regarding the
ownership of prepaying goods in a consumer-favorable way?94
The effectiveness of this rule of transfer in consumer protection is evident. If the transfer of ownership takes place prior to the delivery of goods, consumers can, in case of retailer’s insolvency, claim before their national court that they have already become the owner of those goods, and therefore effectively tackle secured creditors from declaring their security interests on them. From the retailers' perspective, unlike securities and segregations, a new rule on transfer of ownership would not impose
91 Case C-13/77 GB-INNO-BM NV v Vereinging van de Kleinhandelaars in Tabak [1977] ECR 2115;
[1978] 1 CMLR 283
92 Ibid. For a detailed explanation of the application of sincere cooperation clause in Competition Rule
cases, see, e.g., Richard Whish and David Bailey, Competition Law (eighth edition), Oxford University Press, Chapter 6.2 ‘Article 4(3) TEU: Duty of Sincere Cooperation.'
93 In a consensual system (adopted in countries like France), the contract itself transfers ownership of
the object to the buyer. In a tradition system (adopted in countries like Germany where it is called
Trennungsprinzip), a distinction is made between the contract and the legal act aimed specially at
transferring ownership.
94 A good attempt on to extend the efforts in the harmonization of European Private Law to the field of
Property Law is the Draft Common Frame of Reference (DCFR) VIII.2:101 rules to transfer
ownership: a) by concluding an agreement as to the time ownership is to pass and the conditions of this
agreement are met; or b) in the absence of such agreement, delivery or an equivalent to delivery. For
comment on this mixed approach, see, e.g. Celia Martinez-Escribano, Possession in the Transfer of
Goods: Reflections on the DCFR, EPLJ 2017; 6(1): 53–86; A. Salomons, ‘Fifteen Questions on the Rules Regarding the Acquisition of Movables in Book VIII Draft Common Frame of Reference’, ERPL, no. 4 (2009), p.714–715.
21
extra burden on them: it only changes the person to whom the retailer shall transfer the goods, but it does not expand their responsibilities, nor does it restrict the way they make full use of their working capitals. However, some technical difficulties shall be overcome for the operation of this transfer rule. A crucial problem is how to accurately define the moment when the prepaying buyers are entitled to the ownership of goods.
In general, goods must become specific or ascertained before the buyer can claim his ownership on them. In countries where the consensual system is adopted, some criterions have been established for the definition of ascertained goods. In France, the Cour de cassation has found that in sales of generic goods, the ownership may not pass to the buyer unless the objects have been individualized.95
In UK law, Part 16 of the 1979 sales act provides that where there is a contract for the sale of unascertained goods no property in the goods is transferred to the buyer unless and until the goods are ascertained. Part 18 of that Act sets out that where there is a contract for the sale of unascertained or future goods by description, and goods of that description and in a deliverable stat-e are unconditionally appropriated to the contract, the property in the goods then passes to the buyer.96
British courts have given several interpretations on the definition of "ascertained goods." In Healey v Howlett Sons the court found that delivery of a quantity of goods to a carrier without identifying a subset of those goods for a specific buyer will not amount to unconditional appropriation.97 Carlos Federspiel & Co v Charles
Twigg & Co is another remarking case regarding the appropriation of goods.98 In that
case, some bicycles for sale had been packaged in boxes with the buyer's name on them before the seller went bankrupt. The court found that even the seller has labeled the goods with the buyer's name, those goods had not been ascertained at the moment of insolvency since the court failed to see the seller's intention to attach the contract accurately to these goods.
The Irish court has presented a similar position on this issue. In Flynn v Mackin and Mahon,99 the second defendant agreed to supply the first defendant with a new car.
On the way to the appointed place of delivery, the car was involved in a traffic accident. The plaintiff, as the victim, requested the first defendant to compensate for his loss. The Irish Supreme Court rejected the claim on the ground that the ownership
95 Cour de Cassation, com 12 April 2005 Reza Gem v Lafont (administrator for Chaumet et cie). For
English translation, See Cases, Materials and Text on Property Law, edited by Sjef van Erp and Bram Akkermans, Hart Publishing, pp.799-800.
96 Note that under UK sales law, the passing of ownership and the passing of risk are distinguished.
See Consumer Prepayments on Retailer Insolvency, 9.6-9.9
97 Healey v Howlett[1917] 1 KB 337.
98 Carlos Federspiel & Co v Charles Twigg & Co [1957] 1 Lloyd’s List Rep 240. This judgment is
followed in case law like re Goldcorp Exchange Ltd [1995] 1 AC 74 at 90; [1994] 2 All ER 806 at 814 (PC).
