Cherries Packed in Brine Pitfalls for Debtors Counsel under PACA

With the passage of the Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005, debtor's counsel are

on the lookout for newly formed dangers, traps and pitfalls.
However, many hurdles to reorganization are of an older vintage but
remain just as difficult as their newly-minted counterparts. </p>

<p><b>A Brief Perusal of PACA</b> </p> <p>Congress enacted the
Perishable Agricultural Commodities Act (PACA) (7 U.S.C.
§§499a <i>et seq.</i>) in 1930 "to promote fair trading
practices in the marketing of perishable agricultural commodities,
largely fruits and vegetables." <i>In re Magic Rest. Inc.</i>,
205 F.3d 108, 110 (3rd Cir. 2000) (citations omitted). PACA protects

growers, producers, sellers and suppliers of "perishable
agricultural commodities"¹ in the event such grower,

producer, seller or supplier of such goods is not paid in full by a
commission merchant, dealer or broker. <i>In re Fleming Cos.</i>, 316

B.R. 809, 811 (D. Del. 2004). The aim of PACA, at the time of its
enactment, was to curtail buyers and dealers from simply rejecting
shipments from producers when the market price for ordered produce
fell below the contract price between the parties. Leonard, Nicole,
"The Unsuspecting Fiduciary, The Curious Case of PACA and
Personal Liability," <i>ABI Journal</i> (May 2006). </p> <p>One
of PACA's mechanisms for protecting growers, producers, sellers and
suppliers of perishable agricultural commodities is to impose a
trust on (1) all perishable agricultural commodities received by the

commission merchant, dealer or broker; (2) all inventories of food
or products derived from such perishable agricultural commodities;
and (3) any receivables or proceeds from the sale of such perishable

agricultural commodities. 11 U.S.C. §499e(c)(2); <i>In re Magic
Rest. Inc.</i>, 205 F.3d at 111. PACA requires growers, producers,
sellers and suppliers to "opt in" to the trust and its
protections. 11 U.S.C. §449e(c)(3). </p> <p>The easiest and most

common method for opting in to the PACA trust is to place certain
statutory language in a billing statement or invoice.²

Another mechanism for protecting growers, producers, sellers and
suppliers of perishable agricultural commodities employed by PACA is

that wholesale commission merchants, dealers and brokers must be
licensed by the Secretary of Agriculture to deal in perishable
agricultural commodities, and that such license can be revoked or
terminated by the Secretary for failure to comply with the provisions of

PACA. 7 U.S.C. §§499c-d.³ </p> <p><b>PACA and
Who?</b></p> <p> PACA applies to commission merchants, dealers and
brokers. <i>See</i> <i>generally</i> 7 U.S.C. §§499b, c
and e and 7 C.F.R. §46.2. Generally speaking, a debtor's
counsel knows whether or not his or her client is a commission
merchant or a broker. The more difficult analysis is whether or not a
debtor qualifies as a dealer under PACA. PACA defines a dealer as
"any person engaged in the business of buying or selling in
wholesale or jobbing quantities, as defined by the Secretary, any
perishable agricultural commodity in interstate or foreign
commerce...." 7 U.S.C. §499a(b)(6). Congress then proceeded

to carve out three exceptions to a dealer under PACA: (1) no producer
can be a dealer with respect to produce raised by the producer; (2)
no buyer of produce purchased solely for sale at retail can be a
dealer until the invoice cost of such purchases in any calendar year

exceeds $230,000; and (3) no buyer of produce other than potatoes
for canning and/or processing in the same state in which it is grown

can be a dealer unless such product is frozen or packed in ice or
consists of the omnipresent cherries in brine. <i>Id</i>.; <i>see</i>

<i>also</i> 7 C.F.R. §46.2(m). </p> <p>Much of the uneasiness
surrounding PACA's definition of "dealer" arises from the
Third Circuit's decision in <i>In re Magic Restaurants Inc.</i> in
which it found, as a matter of first impression, that an owner of 13
restaurants that purchased more than $230,000 in perishable
agricultural commodities qualified as a dealer under the plain
language of PACA. <i>See In re Magic Rest. Inc.</i>, 205 F.3d at
117; <i>see also Royal Foods Co. v. RJR Holdings Inc.</i>, 252 F.3d
1102 (9th Cir. 2001) (restaurant qualifies as dealer under PACA), and

<i>In re Old Fashioned Enterprises Inc.</i>, 236 F.3d 422 (8th Cir.
2001) (same). The Third Circuit made this finding even though the
congressional history behind PACA and its subsequent amendments, as
well as the U.S. Department of Agriculture's (USDA) refusal to
exercise jurisdiction over restaurants for nearly 70 years. <i>In re

Magic Rest. Inc.</i>, 205 F.3d at 117. Although no decision has
expanded the reach of PACA past restaurants, it is not far-fetched
to see the definition of dealer expanded to nursing homes, hospitals,
prisons and other institutional entities that purchase large amounts

of perishable agricultural commodities. <i>See</i> 3 Ruda, Howard,

<i>Asset Based Financing: A Transactional Guide</i>, §30.07[2]
(Matthew Bender Co. 2006). </p> <p><b>PACA's Cash Use and DIP Financing

Punch </b></p> <p>At first blush one would wonder what impact PACA
would have on a debtor's ability to reorganize. However, PACA packs
quite a punch on a debtor's ability to use cash collateral or obtain

debtor-in-possession (DIP) financing. First, PACA's rules and
regulations are exempted from the automatic stay pursuant to 11
U.S.C. §362(b)(4). Therefore, a bankruptcy petition will not stay

a proceeding by the Secretary under PACA. </p> <p>More troublesome,
however, are PACA's trust provisions. Section 541(d) of the Code
exempts assets held in trust from property of the estate. In addition,

the trust imposed by PACA is the equivalent of a super-priority lien
on the corpus of the trust, priming even properly perfected,
first-priority secured creditors. 7 U.S.C. §499e(c). </p>
<p>The effect of these provisions is that a cash-strapped debtor is
deprived of a potentially large sum of accounts receivable, both
pre-petition and post-petition, which are now held in trust for
growers, producers, sellers and suppliers of perishable agricultural

commodities. In addition, the debtor's lienable inventory, for all
intents and purposes, no longer includes any food or other products
derived from perishable products. This hit on a troubled debtor's
available accounts receivable and inventory at a time when every dime is

crucial to the reorganization effort, can have a crippling effect on

debtor's counsel's ability to negotiate cash use with the debtor's
existing lender or obtaining DIP financing. </p> <p>The pain of
PACA's trust provisions can be lessened somewhat if the debtor has
hoarded sufficient cash prior to filing its petition. PACA's trust
provisions contemplate a floating trust and the commingling of trust

and nontrust assets. 7 C.F.R. §46.46(b). Therefore, the debtor
may be able to satisfy PACA's trust requirements without affecting
accounts receivable and inventory (1) if the debtor has sufficient
cash on hand to cover its estimated PACA exposure, and (2) the USDA
finds the amount set aside to be sufficient to cover what it
believes to be the debtor's estimated PACA exposure. If the debtor has

not hoarded sufficient cash, debtor's counsel must negotiate the trust

monies into (or more accurately, out of) the debtor's budget. </p>
<p><b>PACA's Licensing Dilemma</b> </p> <p>The most perplexing and
counterintuitive impact PACA has on a debtor's ability to reorganize

are its archaic licensing requirements. When crafting a reorganization

plan, debtor's counsel must appease a myriad of constituencies,
obtaining the consent of each class or, under a cramdown plan, the
consent of at least one impaired class. All of that effort, however,

can be mooted as soon as the plan is confirmed, courtesy of PACA.

</p> <p>Section 499d(a) provides, in part, that the "license of
any licensee shall terminate upon said licensee, or in the case the
licensee is a partnership, any partner, being discharged as a
bankrupt, unless the Secretary finds upon examination of the
circumstances of such bankruptcy, which he shall examine if
requested to do so by said licensee, that such circumstances do not
warrant such termination." <i>See also</i> 7 C.F.R.
§46.9(b). Therefore, a debtor's reorganization plan that
contains any sort of discharge, once confirmed, also serves to
terminate the debtor's PACA license absent the intervention of the
Secretary. In the case of a restaurant, grocer or other debtor covered

by PACA, this automatic termination has the effect of preventing the
reorganized debtor from doing business on a go-forward basis. This
discrimination against bankrupt entities runs afoul of 11 U.S.C.
§525 and its prohibition against discriminatory treatment;
however, Congress specifically exempted PACA from this
anti-discrimination provision. As far as PACA is concerned, confirmation

of a reorganization plan is only the first of two steps that a
bankrupt commodities merchant, dealer or broker must take. The
second step is obtaining a new license under PACA. </p> <p>A newly
reorganized, and therefore PACA license-less, debtor must apply for
a new license in order to deal in perishable commodities. The
application process for a reorganized debtor is the same as it is
for any PACA license applicant. However, the Secretary may refuse to

issue a license to an applicant that was adjudicated or discharged
as a bankrupt within three years of the application if such
circumstances warrant the refusal "unless the applicant
furnishes a bond of such nature and amount as may be determined by the
Secretary or other assurance satisfactory to the Secretary that the
business of the applicant will be conducted in accordance with this
Act." 7 U.S.C. §499d(e).⁴ Debtor's counsel can
anticipate that the Secretary will find that the circumstances of
any debtor's case require the posting of a bond, whether or not all PACA

claimants were paid in full prior to and during the debtor's
bankruptcy proceeding. Therefore, a reorganized debtor will have to
post a post-petition bond for the USDA in addition to making plan
payments to its pre-petition and post-petition creditors. </p>
<p>PACA's regulations call for the reorganized debtor to post either a
cash or surety bond in an amount not less than $10,000. 7 C.F.R.
§46.5. A cash bond, if posted, is deposited in a special
account with the U.S. Treasury, which cannot accrue or pay interest
to the debtor. <i>Id</i>. A surety bond, if posted, must be with an
underwriter holding a certificate from the Secretary of the Treasury

indicating that such company is an acceptable surety on federal
bonds. <i>Id</i>. The regulations indicate that the form and amount of
the bond are left to the Secretary's discretion. <i>Id</i>. However,

debtor's counsel may find that the Secretary's actual discretion may

be limited to the term and amount of the bond. </p> <p>Posting a
cash bond with the U.S. Treasury to secure a post-confirmation PACA
license requires debtor's counsel to be cognizant of the possible need

to post a cash bond soon after confirmation and include the estimated
amount of such bond in any exit-financing negotiation. If this is
not possible, debtor's counsel must turn his or her attention to a
surety bond. </p> <p>When deciding whether to post a surety bond to
secure a post-confirmation PACA license, debtors and their counsel
need to be on the lookout for some significant issues with such a
bond. First and foremost is what type of surety bond the Secretary
provides to the debtor. It is possible that the Secretary will
propose a surety bond that contains a clause that such bond is
noncancelable for its duration. If a debtor receives this type of
bond, debtor's counsel will face an uphill negotiation to obtain
such a bond due to the large risk it would place on the underwriter.

Debtor's counsel may need to assist the debtor in obtaining a letter

of credit or other security being pledged to the underwriter in
exchange for writing the surety bond. This will prove a difficult
task for many debtor's counsel, however, as a reorganized debtor
generally lacks significant unencumbered assets that it could pledge as
security for the surety bond. </p> <p><b>Conclusion</b> </p>

<p>Although many of PACA's policies seem overly paternalistic and
outdated, it is interesting to note that the last major revision to
PACA, done in 1984, actually expanded the coverage of PACA to
include sellers of perishable agricultural commodities. <i>See In re

Magic Rest. Inc.</i>, 205 F.2d at 112. Therefore, the archaic
provisions of PACA appear to be firmly entrenched. </p> <p>Debtor's
counsel, therefore, must be keenly aware of PACA's provisions if his

or her client purchases more than $230,000 of fruits and vegetables (or,

for those rarest of cases, cherries packed in brine), be it frozen,
unfrozen or packed in ice. Certainly, most grocers would meet this
test and therefore be considered a dealer under PACA, and recent
case law shows that restaurants may qualify as well. In addition,
institutional clients such as hospitals, prisons, colleges, charter
schools and other entities that serve food to numerous people as
part of their operation run the risk of meeting PACA's dealer
definition. In light of PACA's broadening scope and thorny issues,
debtor's counsel would be wise to determine the applicability of
PACA to his or her clients at the earliest stages of bankruptcy
consultation. </p>
<hr><h3>Footnotes </h3><p> 1 Perishable agricultural commodities
encompass fresh fruits and vegetables of every kind and character,
whether frozen, not frozen or packed in ice as well as cherries packed

in brine. 7 U.S.C. §499a(b)(4). This definition is expanded upon
by 7 C.F.R. §§46.2(u)-(w). </p><p>2 The statutory language is
as follows: "The perishable agricultural commodities listed on
this invoice are sold subject to the statutory trust authorized by
§5(c) of the Perishable Agricultural Commodities Act, 1930 (7
U.S.C. 499e(c)). The seller of these commodities retains a trust claim

over these commodities, all inventories of food or other products
derived from these commodities, and any receivables or proceeds form
the sale of these commodities until full payment is received." 7
U.S.C. §499e(c)(4). </p><p>3 Although not relevant to our
discussion here, PACA utilizes a third mechanism for protecting
growers, producers, sellers and suppliers in that it prohibits
"unfair conduct" by any commission merchant, dealer or broker.

7 U.S.C. §499b. </p><p>4 PACA's discrimination is actually
broader than bankrupt entities. Section 499d(e) also applies of a
general partner of a partnership or an officer or holder of 10 percent

or more of a corporation's stock is adjudicated or discharged as
bankrupt. The same three-year time limit applies.</p>