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by Allison E. Batts
When you hear the words "Perishable Agricultural Commodities Act" (PACA), you may not automatically associate it with insolvency. But, this seemingly discreet statute can have sweeping effects on a creditor's recovery when a business such as a grocer or restaurant is in financial distress. PACA gives sellers of produce super-priority status over other creditors and can substantially decrease the recovery of unsecured creditors. It may also impose liability on principals of the debtor and even on creditors of the debtor who have a role in depleting the trust fund PACA creates.
If your client is involved with the produce business, even as a lender or supplier of other goods and services, then you need to know the basics of PACA - what products are covered, what written notice is required, the payment terms, liability under PACA, and PACA's effect in bankruptcy. As the price of produce spikes due to fuel costs and flooding along the Mississippi River, this industry may be one of the next to experience a wave of financial instability.
I. What is PACA?
PACA (7 U.S.C. § 499) was first codified in 1930. It was designed to protect sellers of perishable agricultural products who often have capital tied up in land and machinery and depend on timely payment. These sellers typically supply their products to distant merchants, and Congress felt that they were especially vulnerable and deserved enhanced protection from the effects of late payment. By protecting produce sellers, Congress hoped to ensure stability for the entire produce industry.
PACA creates a floating, non-segregated trust for the benefit of PACA claimants. The trust arises automatically upon delivery and continues until the claim is paid in full. Trust funds include accounts receivable, cash, noncash proceeds of the sale of all PACA products, and assets purchased with money from produce sales. PACA gives produce sellers a right to payment before all other creditors, even those with a security interest in inventory. PACA does not require tracing of proceeds. The trust attaches to all PACA inventory and proceeds, and the buyer or other creditors have the burden of proving which assets are not part of the trust. Generally, those who buy or sell more than 2,000 pounds of fruits and vegetables daily must be licensed under PACA. Brokers or agents typically must be licensed as well.
II. What is required to establish a PACA trust?
In order to gain the protections of PACA, the act requires that sellers comply with specific requirements. PACA only covers fruits and vegetables that have not been altered from their fresh state. If the produce is processed by the seller, it is likely not covered by PACA. PACA also requires that written notice be provided to the buyer that the products are sold subject to the PACA trust.
A. Type of products covered.
PACA covers sellers of fresh fruits and vegetables, whether frozen or on ice and includes cherries in brine. PACA only includes items that have not been processed and are still in "their natural form." Endico Potatoes, Inc. v. CIT Group/Factoring, Inc., 67 F.3d 1063, 1070-1 (2d Cir. 1995). In Endico, the Second Circuit determined that products containing less than 90% fresh ingredients are not afforded PACA protection. For example, PACA covers onions, but not onion rings. Cucumbers, but not pickles. Cranberries, but not cranberry sauce. Okra, but not once it is breaded. Potatoes, but not if they are instant mashed potatoes.
B. Written notice of intent to preserve trust benefits.
To take advantage of PACA's protections, a seller must comply with strict requirements. PACA licensees may use their invoice as notice that their sales are subject to the PACA trust if the invoice contains the following language verbatim:
The perishable agricultural commodities listed on this invoice
are sold subject to the statutory trust authorized by Section
5(c) of the PACA, 1930. (7 U.S.C. § 499e(c)). The seller of
these commodities retains a trust claim over these commodities,
all inventories of or other products derived from these commodities,
and any receivables or proceeds from the sale of these commodities
until full payment is received.
The language must prominently appear on the front of the invoice.
If a seller is not licensed under PACA or is licensed but does not place the above language on its invoices, it must provide a "Notice of Intent to Preserve PACA Trust Benefits" to buyers in order to preserve the seller's right to trust funds. This notice must contain sufficient detail to allow the buyer to identify the transactions subject to the trust.
Regardless of the form of the notice, it must be given within thirty days from the date payment was due or the date the seller received notice of a dishonored check.
C. Payment terms.
PACA requires full payment promptly. What constitutes prompt payment varies between 10 and 30 days depending on the circumstances set forth in 7 C.F.R. §§ 46.2 (z) and (a)(a). Parties can agree to different terms prior to the subject transactions and should list the different terms on all invoices and accountings. Although 7 C.F.R. § 46.46(e)(1) appears to require written agreements in order to use different payment terms, some courts have held that an oral agreement to extend terms will not disqualify a PACA claimant from sharing in trust funds. Idahoan Fresh v. Advantage Produce, Inc., 157 F.3d 197, 205 (3d Cir. 1998); Hull Co. v. Hauser's Foods, Inc., 924 F.2d 777, 781-82 (8th Cir. 1991). In Hull, the Eighth Circuit allowed a PACA claim even though the oral agreement extended terms to 45 days. The Hull Court interpreted the regulation as allowing terms beyond 30 days if agreed to orally, but not if reduced to writing.
III. What liability exists for breach of PACA trust?
In addition to knowing what goods are covered, it is important to understand who can be held liable under PACA for breaches of the trust and the potential exposure for damages. If PACA sellers contract for attorney fees and interest, these amounts are often recoverable from trust funds. In addition to the business responsible for holding the funds in trust, principals of the business and creditors of the business may also be liable for breach of trust if PACA funds are improperly distributed.
A. Attorney fees and interest.
In addition to payment of the trust funds to satisfy the amounts owed for the produce, businesses who buy products subject to PACA may also be liable for attorney fees and interest owed to the sellers. Although PACA does not explicitly provide for recovery of attorney fees or interest, it does provide for recovery "of sums owing in connection with" PACA transactions. Although courts have reached various conclusions as to whether attorney fees and interest should be included in PACA trusts, recent U.S. Circuit Court opinions suggest that a consensus may be forming to allow these amounts to be included in a PACA trust if the parties contracted for them. However, courts seem reluctant to allow recovery of these amounts from the trust when there are insufficient funds to pay all claims in full.
Several courts have included attorney fees and interest in PACA claims when these remedies are contractually provided. See, e.g., Coosemans Specialties, Inc. v. Gargiulo, 485 F.3d 701, 709 (2d. Cir. 2007); Country Best v. Christopher Ranch, LLC, 361 F.3d 629, 633 (11th Cir. 2004). The Ninth Circuit has allowed fees and interest to PACA claimants that contracted for them even when there were insufficient trust funds and pro rata distributions were to be made to PACA claimants. Middle Mountain Land and Produce, Inc. v. Sound Commodities Inc., 307 F.3d 1220, 1224-5 (9th Cir. 2002). The Middle Mountain Court also ruled that interest could be awarded on a discretionary basis even if the claimants had not contracted for it "if such an award is necessary to protect the interests of PACA claimants." Id. at 1226. Another court determined that interest and attorney fees may be included in the trust, but they should not be awarded unless the underlying PACA claims can be paid in full from the trust first. Nobles-Collier, Inc. v. Hunts Point Tomato Co., Inc., 2004 WL 102756, *2 (S.D.N.Y. Jan. 22, 2004).
Although most courts agree that attorney fees and interest may be included in PACA trusts, a few courts have declined to include attorney fees and interest in the PACA trust at all, finding that PACA does not authorize including these costs as "owing in connection with" PACA sales. Crown Foodservice Group, Inc. v. Hughes, 1999 WL 33117269, *14 (S.D. Ohio July 12, 1999); Hereford Haven, Inc. v. Stevens, 1999 WL 155707, *4 (Tex. Mar. 12, 1999); Valley Chip Sales, Inc. v. New Arts Tater Chip Co., 1996 WL 707028, *6 (D. Kan. Oct. 10, 1996). If attorney fees and interest are not paid from the trust, the PACA claimant is a general unsecured creditor with respect to that portion of its claim.
A PACA claimant that recovers funds for the benefit of the other trust claimants may be entitled to reimbursement of the attorney fees incurred in recovering the funds. Fresh Kist Produce v. Choi Corp., 362 F.Supp.2d 118, 131 (D.D.C. 2005). This may include recovering funds in actions against principals of the business and lenders.
B. Personal liability.
The buyer's principals may also be personally liable for dissipation of trust assets. The individuals must have had a role in causing the corporate trustee to breach the trust or have had the ability to control trust assets. This means a sole shareholder who also operates the company may likely be responsible for the loss of trust funds, but a minority owner who does not participate in the day-to-day activities of the business may not be. Golman-Hayden Co., Inc. v. Fresh Source Produce, Inc., 217 F.3d 348, 351 (5th Cir. 2000); Sunkist Growers v. Fisher, 104 F.3d 280, 283 (9th Cir. 1997). Principals, either acting individually or as trustees, may also be sued for misrepresentation. Hiller Cranberry Products, Inc. v. Koplovsky, 165 F.3d 1, 10 (1st Cir. 1999). If a principal knowingly makes false statements that trust funds can be used for purposes other than to pay PACA claimants and other parties rely on those statements, then a cause of action for misrepresentation may arise. Id.
C. Creditor liability.
Some courts have cited the "knew or should have known" standard for liability found in the Restatement (Second) of Trusts § 297(a) as the proper standard for holding a creditor liable to PACA claimants when the creditor receives payment from PACA funds. Consumers Produce Co., Inc. v. Volante Wholesale Produce, Inc., 16 F.3d 1374, 1382 (3d Cir. 1994); Battle v. Fresh Preps Distribution, Inc., 873 F.Supp. 1062, 1067 (E.D. Mich. 1995).
Such creditors may be forced to return trust property unless it is established that they are a bona fide purchaser for value who did not know and should not have known payment was made with trust assets. See, e.g., Albee Tomato, Inc. v. A.B. Shalom Produce Corp., 155 F.3d 612, 616 (2d Cir. 1998); Consumers Produce Co., Inc. v. Volante Wholesale Produce, Inc., 16 F.3d 1374, 1382 (3d Cir. 1994); C.H. Robinson Co. v. Trust Co. Bank, N.A., 952 F.2d 1311, 1315 (11th Cir. 1992).
IV. What's the effect of PACA in a bankruptcy case?
The Bankruptcy Code does not limit liability for depletion of a PACA trust, and valid PACA claims in bankruptcy are granted the same super-priority status that they enjoy outside of bankruptcy. Additional benefits of PACA claims in bankruptcy are that they are not subject to avoidance in preference actions and adequate protection payments may be available.
A. Preference claims.
Regarding preference actions, funds held in PACA trusts do not become part of the bankruptcy estate, since the debtor is holding the funds for the PACA claimants. When paid in full from available trust funds, PACA claims are also excluded from a calculation of any new value defense to a preference claim under 11 U.S.C. § 547(c)(4). In re Arizona Fast Foods, 299 B.R. 589, (Bankr. D. Ariz. 2003).
Just as a trustee cannot avoid these payments, the creditor cannot use the payment as a defense to a preference action for payments that were not made from the PACA trust. For example, if the supplier sold the debtor both cucumbers and pickles, there may be preference liability for payments made for the pickles in the 90 days prior to the petition date. Therefore, PACA claims may not be part of a preference analysis to determine a preference liability or defense. In re Arizona Fast Foods, LLC, 299 B.R. at 596 (Bankr. D. Ariz. 2003).
B. PACA claimants may be entitled to adequate protection.
PACA claimants can request adequate protection that trust assets will not be dissipated and can ask for prompt payment outside of the terms of a plan of reorganization. Additionally, injunctive relief may be available to keep trust assets from being dissipated. One court allowed injunctive relief to force a buyer in bankruptcy to replace misappropriated and dissipated trust funds. Six L's Packing Co. v. Arter, 1991 WL 4400 (E.D. Pa. Jan. 6, 1991). Six L's Packing was granted relief from the automatic stay to pursue its PACA claim against Arter, the principal of the company who was responsible for holding the funds in trust. However, while Six L's Packing was pursuing Arter in U.S. District Court for payment of its PACA claim, it failed to object to Arter's assertion that the PACA debt be discharged in his bankruptcy case. Id. at *6. As a result, the debt was discharged and Six L's Packing was barred from further collection action against Arter. Id. Therefore, a PACA claimant should be wary of dealing with PACA claims outside of an ongoing bankruptcy and ensure that its rights are preserved in both forums.
C. Other creditors need to be aware of PACA claims.
Counsel for a party in a bankruptcy proceeding needs to be aware of PACA claims at issue in the case. Because of the potential creditor liability and PACA claims' super-priority status, these claims can have a substantial effect on the amount of money available for unsecured creditors. Therefore, counsel for unsecured creditor committees or individual unsecured creditors owed significant amounts in a bankruptcy need to be sufficiently knowledgeable of PACA in order to spot deficiencies in a seller's preservation of its trust. These potential deficiencies include whether the products are covered under PACA, whether written notice was sufficient, whether the payment terms were prompt, and whether claimants are entitled to attorney fees and interest from the trust funds.
V. Conclusion.
Attorneys who practice in the area of insolvency gain an edge when they know the impact of PACA on their client's interests. This knowledge may become increasingly important as the produce industry faces challenges associated with rapidly increasing costs. Since PACA can significantly affect how the available pool of money is distributed to creditors, attorneys who understand the basics of this statute will be able to advise their clients how to structure business transactions to preserve or account for a PACA trust and will have an advantage when advocating for their client's share of the assets.
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