Trust in the PACA Trust: A Bankruptcy Practitioner's Primer on the Perishable Agricultural Commodities Act

Creditors share bankruptcy estate assets according to the amount and priority of their claims. The estate is comprised of the debtor’s legal and equitable interests in property as of the filing date. Property that the debtor holds in trust for another is not an asset of the bankruptcy estate, [1] and accordingly, the beneficiary of that trust is entitled to collect the entire amount it is owed before other creditors of the estate are entitled to their distribution. The Perishable Agricultural Commodities Act (PACA) creates a trust (the “PACA trust”) for the benefit of suppliers (the “PACA suppliers”) of perishable agricultural commodities (PACs). [2] The benefits provided by a PACA trust are numerous: Not only is a PACA supplier able to collect the debt it is owed ahead of other creditors, it is relieved from the difficult process of tracing funds owed to it because PACA creates a floating trust that attaches to all of the debtor’s assets. [3] In certain circumstances, PACA suppliers may also recover directly from a debtor’s officers and directors. The advantages of being a PACA trust beneficiary are clear. However, PACA suppliers must satisfy numerous requirements to be eligible for PACA protection. Further, a PACA supplier must be wary of unintentionally waiving its PACA rights.  

The recent A&P bankruptcy [4] and general recessionary pressures on the grocery industry highlight the importance, for both PACA suppliers and their purchasers, of complying with PACA. This article focuses on the intersection of PACA and bankruptcy by discussing PACA’s impact on parties in bankruptcy proceedings and highlights compliance procedures for suppliers and debtors and their principals and officers.

History
In 1930, PACA was enacted to “regulate the sale of produce in interstate commerce” [5] by “encourage[ing] fair trading practices in the marketing of perishable commodities by suppressing unfair and fraudulent business practices in marketing of fresh and frozen fruits and vegetables...and providing for collecting damages from any buyer or seller who fails to live up to his [or her] contractual obligations.” [6] Though not part of the original statute, the PACA trust was added after Congress re-examined PACA in 1983 due to an increase in defaults among buyers. [7] It ultimately determined that these defaults necessitated greater protection for sellers. [8] Suppliers in the perishable-commodities business faced inordinate risk because they were “typically required to sell their produce quickly and frequently found themselves in the position of unsecured creditors of buyers whose creditworthiness could not be verified.” [9] If buyers defaulted, PACA suppliers’ recourse was to either repossess the perishable commodities (which would have perished) or recover their proceeds. [10] The right to recover proceeds did not offer enough protection to unpaid PACA suppliers as they had to “st[and] in line behind banks and other lenders who had obtained security interests in the defaulting purchasers’ inventories, proceeds and receivables.” [11] Congress determined that this inequity was a “burden on commerce and contrary to the public interest.” [12] It was particularly concerned with problems faced by “small farmers whose survival depends on prompt payment by purchasers.” [13] As a remedy, Congress created the PACA trust in 1984, which, inter alia, makes PACA suppliers’ interest in a debtor’s assets superior to those of other creditors, including secured creditors. [14]

PACA Requirements
PACA imposes numerous requirements on PACA suppliers. First, the supplier must have sold a “perishable agricultural commodity,” [15] which is defined as “fresh fruits and vegetables of every kind and character...whether or not frozen or packed in ice.” [16] However, fruits or vegetables that are manufactured into a food of different character are not considered perishable agricultural commodities. [17] Furthermore, the purchaser of the PAC must have been either a “dealer,” “commission merchant” or “broker.” [18] Generally, a dealer is a person who buys or sell PACs, [19] a commission merchant is an entity that receives and sells another’s PACs on commission [20] and a broker is a person who negotiates the sales and purchases of PACs on a supplier’s or purchaser’s behalf. [21] Additionally, the transaction must have occurred within interstate or foreign commerce. Finally, the PACA supplier must have provided adequate notice to the purchaser that it intends to preserve its PACA trust rights. [22] A PACA supplier can establish this intent by either providing written notice or including specific language in its agreement with the purchaser or in a sale invoice. To provide notice in writing, a PACA supplier must give the purchaser adequate written notice (and file such notice with the Secretary of Agriculture) within 30 days after expiration of (1) the time payment is due, (2) any other time negotiated by the parties or (3) the time that the PACA supplier receives “notice that payment instrument that was presented was dishonored.” [23] Additionally, a PACA supplier can preserve its rights by including boilerplate language in its sale agreement and/or the billing or invoice statement that provides notice of the intent to preserve its rights in the PACA trust. [24]

PACA Waivers
PACA suppliers must tread carefully when seeking payment from a purchaser struggling to fulfill its payment obligations. Suppliers might be tempted to make concessions, grant extensions or agree to payment plans, but they risk waiving the benefits of the PACA trust.

PACA applies only if PACs are sold pursuant to short-term credit arrangements. [25] The arrangement must require that payment be due within 30 days after delivery of the PACs. [26] As a result of this time-sensitive requirement, PACA suppliers must be wary of waiving their PACA rights by either initially providing PACs on long-term credit, or by subsequently granting extensions to make payments after the produce was delivered. Post-default extensions beyond 30 days result in waiver of PACA rights since it “could actually encourage long-term credit arrangements, because sellers could offer long-term forbearance to delinquent buyers with the knowledge that the seller would still be protected by the PACA trust.” [27] Of course, extending PACA rights to suppliers that provide long-term credit is contrary to PACA’s stated goal of protecting suppliers that sell produce on short-term credit. [28]

Like contractual disputes in any context, disagreements often arise over whether the parties agreed to an extension. A majority of courts that have addressed this issue hold that oral agreements to extend the due date of payments are not sufficient to waive PACA rights. [29] Therefore, in most jurisdictions, an agreement to extend the due date must be memorialized in writing in order to waive PACA protections. [30] However, the agreement need not be memorialized in a formal contract; it need only be a writing that would satisfy the statute of frauds. [31] Courts have reasoned that since PACA trusts can be created with informal writings (invoices or letters), then they can be waived with informal writings. [32]

Suppliers that want to establish their PACA rights should not extend payment due dates beyond 30 days. However, another frequent issue is whether a PACA supplier waives PACA rights by historically accepting payments made after 30 days. [33] Routinely, debtors pay creditors after the date payment is due, and such practice can be so common between a debtor and creditor that such a course of dealing is classified as the “ordinary course of business” between them. [34] However, the majority of courts hold that such a course of dealing is not sufficient to waive a supplier’s PACA rights. [35]

Fees Connected to PACA Transactions
A PACA supplier’s attorneys’ fees earned in connection with the collection of a PACA debt may be recoverable from a PACA trust, as they may qualify as “sums owing in connection with such transactions.” [36] However, not all fees incurred by a supplier are covered under PACA. [37] Courts have held that the cost of transporting PACs was not a “contemplated expense” under PACA, as transportation service charges are not within PACA’s purpose of creating a trust for the benefit of sellers and suppliers of produce. [38]

Strict Compliance
As a result of the tremendous protections offered by PACA, courts construe PACA’s eligibility requirements and waivers strictly. For example, courts will not excuse a supplier for failing to provide exact credit terms on the invoices where the statute mandates that “the terms of payment shall be disclosed on invoices.” [39] PACA suppliers must be mindful of waivers that can occur by failing to prosecute their rights in bankruptcy proceedings (i.e., filing timely proofs of claims). [40]

Principals’ and Officers’ Personal Liability
An additional protection offered by a PACA trust is that PACA suppliers may seek damages from the individuals tasked with preserving the PACA trust for their benefit, usually the debtor’s officers and/or directors (the “PACA trustees”). [41] The right to pursue an individual stems from “basic trust principles,” which imposed a fiduciary duty on a trustee to “exercise such care and skill as a man of ordinary prudence.” [42] Since a PACA trust beneficiary has superior rights over other claimants (including secured creditors), a PACA trustee’s fiduciary duties are such that it may not allow trust assets to be depleted to the extent that the PACA supplier is not ensured payment in full. [43] A depletion of assets due to payments made to secured or unsecured creditors is not a sufficient excuse. [44] As a result, a PACA supplier may be able to seek recourse against the PACA trustees.
Additionally, principals and officers may be barred from employment by any PACA licensee for one year if the individual “is or has been responsibly connected’ to flagrant or repeated PACA violations.” [45] Furthermore, a PACA trustee who individually files for bankruptcy may find itself unable to discharge any liability based on breached fiduciary duty because defalcation of fiduciary duties renders the underlying debt as nondischargeable under § 523(a)(4) of the Bankruptcy Code. [46] Due to these extreme remedies, courts limit officers’ and directors’ personal liability to instances in which they were in a position to actually control the PACA trust assets, as “formal title alone is insufficient” to prove actual control. [47] Similarly, some courts require that the debtor had actual knowledge of his or her fiduciary duties under PACA in order to impute liability to its officers and directors. [48]

PACA Procedures
Bankrupt debtors often propose procedures to address the issues raised by PACA (the “PACA procedures”) as part of the debtor’s first-day motions. The PACA procedures established in A&P’s bankruptcy represent a comprehensive mechanism to notify potential PACA claimants, provide a mechanism to address disputes and make distributions on their claims. In part, that procedure provides for (1) notice to potential PACA claimants that they must file a claim against the debtor; (2) a method for the debtor to pay PACA claims that it deems “allowed” and a concomitant release from the claimant on account of such payment; (3) separate reports containing “allowed” and “disputed” PACA claims; (4) a mechanism to dispute the classification of the claims; and (5) retention of the court’s jurisdiction to determine the validity of disputed PACA claims. [49] Moreover, the debtor must provide for full payment to all valid PACA claims. In the A&P bankruptcy, the debtor sought authorization to pay its PACA suppliers $3.4 million in outstanding debts. The cash outlay required by a debtor at the early stages of its bankruptcy case can be significant.

Conclusion
Both PACA suppliers and purchasers should ensure that they fully and properly comply with PACA and any case-specific procedures and mechanisms established in a bankruptcy proceeding. In failing to comply, a PACA supplier risks potentially diminishing or eliminating a distribution on account of the debt owed to it in a bankruptcy proceeding. Debtors must account for the priority status of PACA claims. Finally, directors and officers of purchasers of PACs should pay particular attention to their duties under PACA, as they may be held individually liable for PACA claims.