Eleventh Circuit Holds that PACA Trusts Do Not Give Rise to Nondischargeable Debts

Resolving a split among the lower courts in its jurisdiction, the Eleventh Circuit composed a definitive definition of a technical trust where a “defalcation” by the trustee would result in nondischargeability under Section 523(a)(4). Among other things, the appeals court held that an exception to discharge under that section “does not apply simply because the parties [to a contract] or a statute label the relationship as a trust.”

As a consequence of the rigid definition given a technical trust, the Atlanta-based appeals court held in an August 31 opinion that a claim against an individual arising from violation of a trust under the Perishable Agricultural Commodities Act, or PACA, 7 U.S.C. § 499a et seq., is not nondischargeable under Section 523(a)(4). The appeals court tells us that a PACA trust is more akin to a constructive or resulting trust.

The Breach of Trust

A company that purchased and resold produce was unable to pay its suppliers. A couple owned and controlled the business and therefore had personal liability to the sellers under PACA.

The business ran up a debt of more than $260,000 to a produce supplier that was not paid. To extricate themselves from personal liability, the couple filed chapter 7 petitions. The supplier filed a complaint to declare that the debt was incurred by “fraud or defalcation while acting in a fiduciary capacity” and thus was not dischargeable under Section 523(a)(4).

Bankruptcy Judge Roberta A. Colton of Tampa, Fla., granted summary judgment in favor of the debtors. She held that debts subject to PACA, a statutory trust, are dischargeable because PACA does not qualify as a technical trust. Spring Valley Produce v. Forrest (In re Forrest), 20-00447, 2021 BL 169248, 2021 WL 1784085 (Bankr. M.D. Fla. April 2, 2021). To read ABI’s report, click here.

The produce supplier appealed. The Eleventh Circuit accepted a direct appeal to resolve a split among the lower courts in the Eleventh Circuit. The appeals court upheld Judge Colton on August 31.

The History of PACA and the Law of Trusts

To protect farmers and dealers of fresh produce, Congress originally adopted PACA in 1930. Amended several times, the statute eventually created a floating trust on a purchaser’s inventory and proceeds. The floating trust gives rights in a debtor’s inventory and accounts receivable to beneficiaries of the PACA trust ahead of secured creditors. In other words, produce suppliers have priority over secured lenders in the event of the purchaser’s bankruptcy.

The opinion by Circuit Judge Charles R. Wilson is the most exhaustive exposition so far on the nature of PACA trusts and underlying case law distinguishing among the differing types of trusts. From the Supreme Court on down, he surveyed caselaw going back to the 1830s and treatises regarding various types of trusts.

Regarding debts arising from violation of PACA trusts, Judge Wilson found a split among lower courts in the Eleventh Circuit. They disagreed, for instance, on whether trust assets must be segregated before Section 523(a)(4) can render the debt nondischargeable.

The pivotal words of the statute are “defalcation” and “fiduciary capacity.” Quoting the Seventh Circuit, he said that “defalcation” is “a word that only lawyers and judges could love.” However, the appeal turned on “fiduciary capacity.”

Having surveyed wide-ranging authorities, Judge Wilson concluded that someone is acting in a “fiduciary capacity” if there is “an identifiable trustee, beneficiary, and trust res.” Those prerequisites were met in the case of a PACA trust.

In addition, Judge Wilson said that “a technical trust for purposes of § 523(a)(4) should also impose sufficient trust-like duties.”

To have “trust-like duties . . . sufficient to create a technical trust,” Judge Wilson said there must be “two duties: the duty to segregate trust assets and the duty to refrain from using trust-assets for non-trust purposes.”

Judge Wilson held that a “PACA does not impose sufficient trust-like duties to create a technical trust.” Two duties are lacking, he said. There is no duty to segregate and no prohibition against using trust assets for non-trust purposes. In fact, he said that the statute and its regulations “suggest” that comingling “is permitted.”

A PACA trust, Judge Wilson said, “bears closer resemblance to a constructive or resulting trust than a technical trust.” He added that constructive and resulting trusts do not qualify as technical trusts under Section 523(a)(4) “because they do not meet the third requirement that the debtor must be acting in a fiduciary capacity before the act of defalcation creating the debt.”

To soften the blow for creditors deprived of nondischargeable debts, Judge Wilson said that they are “entitled to the highest priority in bankruptcy.” He saw the decision as “strik[ing] a balance between” PACA’s deference to produce suppliers and the Bankruptcy Code’s design to promote a “fresh start.”

In case someone missed the holding in his 37-page opinion, Judge Wilson’s last paragraph summed up the reasons why the “debts incurred by a produce buyer acting as a PACA trustee are not excepted from discharge under § 523(a)(4)”:

While a PACA trust does identify a trustee, beneficiary, and trust res, thus satisfying the first step of our analysis, it does not impose sufficient trust-like duties to fit the narrow definition of a technical trust under § 523(a)(4). PACA does not impose the duties to segregate trust assets and refrain from using trust assets for a non-trust purpose, which are strong indicia of a technical trust. Instead, a PACA trust more closely resembles a constructive or resulting trust, which do not fall within § 523(a)(4)’s exception to discharge. Therefore, we affirm the bankruptcy court’s order dismissing [the creditor’s] complaint in this adversary proceeding.