Produce growers who sold to a debtor/distributor on credit sued a factoring agent that acquired accounts receivable from the debtor. They contended that the receivables were subject to a PACA (Perishable Agricultural Commodities Act) trust, and consequently as trust beneficiaries they were entitled to be paid by the factor out of the receivables proceeds. The district court ruled in favor of the factor, and the growers appealed to the Ninth Circuit.
The growers argued that (1) the factoring agreement was actually a secured lending arrangement, not a true sale, (2) thus the accounts receivable remained PACA trust property, (3) the distributor breached the trust by transferring the receivables and the factor was complicit, and (4) as PACA trust beneficiaries, the growers had an interest in the receivables superior to the interest of the factor with the result that the factor was liable to the growers.
The debtor argued that governing Ninth Circuit precedent held that a “commercially reasonable factoring agreement” was sufficient to remove accounts receivable from the PACA trust without a breach. While acknowledging that generally a trustee may sell trust assets on commercially reasonable terms, the growers argued that the court should not address the commercial reasonableness of the factoring agreement until it first determined that the transaction was a true sale (specifically focusing on whether there is a transfer of the risk of account debtor nonpayment) – relying on cases from other circuit courts.
While acknowledging the cases cited by the growers, the district court concluded that it was bound by a Ninth Circuit case finding in favor of the factor. The decision expressly relied on the commercial reasonableness of the factoring agreement and implicitly rejected imposing an additional transfer-of-risk test. Besides, even if it could be argued that the prior Ninth Circuit case adopted a transfer-of-risk test, the facts in the prior case involved even less transfer-of-risk than the Tanimura case. Thus, the district court felt compelled to rule in favor of the factor.
The Ninth Circuit began by noting that “under the doctrine of stare decisis a case is important only for what it decides – for the ‘what,” not for the ‘why,” and not for the ‘how.'” In other words it is the holding that is important, not the rationale.
However, the implicit rejection of the transfer-of-risk test in the prior case was still binding since it was necessary to the holding given that there was virtually no transfer-of-risk. The court also agreed that even if it was possible to read the risk test into the prior case, the Tinamura case involved more transfer-of-risk so that the court would be precluded from granting relief to the growers in any event. Finally, on the issue of commercial reasonableness, the court noted that a factoring discount of 20% was clearly reasonable. Thus, the Ninth Circuit affirmed the district court decision.
Notwithstanding this result, two of the three judges on the panel joined in a concurring opinion arguing that the prior case was incorrect and the Ninth Circuit sitting en banc should join the Second, Fourth and Fifth Circuits in applying a separate transfer-of-risk test.
Key to this position was the purpose and structure of PACA. Congress was clear that it intended to prevent secured creditors from defeating the rights of PACA trust beneficiaries (such as the growers in the Tinamura case). To remedy a perceived unfair burden on the fresh fruit and produce industry, Congress created a statutory trust that gives unpaid suppliers or sellers of perishable agricultural commodities superior rights. The trust is a “nonsegregated floating trust” on the perishable agricultural commodities and their derivatives that permits commingling of trust assets without defeating the trust.
Thus, if a factoring agreement is in substance a secured lending arrangement, the receivables should remain trust assets and the PACA beneficiaries should have superior rights. In that case the factor would be required to disgorge amounts collected on the receivables sufficient to pay the PACA claims. On the other hand, if a factoring arrangement is a true sale of receivables at a commercially reasonable discount from face value, there would be no dissipation of trust assets, no breach of trustee’s duties, and no liability of the factor.
The concurring opinion noted that the term sheet used mix terminology (such as “seller” and “lender”) that led to a conclusion that the factor viewed itself as providing collection services rather than being a true purchaser of accounts for itself. The opinion drew a distinction between primary or direct risk and derivative or secondary – meaning on the one hand the lender bears the risk of nonperformance by the account debtor, and on the other hand the borrower remains liable and bears the risk of non-payment by the account debtor so that the lender only bears the indirect risk that the account debtor’s non-payment will leave the borrower unable to pay the loan.
The factor argued that using the transfer-of-risk test would lead to “absurd results” since it would remain liable to growers even though its payments to the distributor were in theory sufficient to pay the growers in full. However, the decision views this as merely the result of a clear policy choice made by Congress. In further response, the opinion draws an analogy to construction liens and contractors, noting the due diligence burden placed on lenders to protect against priming liens.
In reviewing the details of the Tanimura transaction, the concurring opinion reached the conclusion that it was not a true sale and was instead a secured financing arrangement, with the result that the growers should have won.
So, the bottom line is that the court found in favor of the factor because it was bound by the opinion of a prior panel, but two of the three judges on the panel urged the Ninth Circuit to consider the issue en banc and adopt the approach taken by other circuits that would have led to the opposite result.
It is interesting to note constituencies, such as perishable agricultural commodities sellers and construction contractors, that effectively carved out special protections that have become embedded in the law. For those curious about why perishable commodities sellers receive special treatment, the Second Circuit suggested the following based on legislative history:
According to Congress, due to the need to sell perishable commodities quickly, sellers of perishable commodities are often placed in the position of being unsecured creditors of companies whose creditworthiness the seller is unable to verify. Due to a large number of defaults by the purchasers, and the sellers’ status as unsecured creditors, the sellers recovered, if at all, only after banks and other lenders who have obtained security interests in the defaulting purchaser’s inventories, proceeds, and receivables.
Vicki R Harding, Esq.