PACA Claims: Watch Out or the Tail Will Wag the Dog

In re Cherry Growers, Inc., 576 B.R.. 569 (Bankr. W.D. Mich. 2017) –

A chapter 11 debtor that purchased agricultural produce but also earned income from non-Perishable Agricultural Act (PACA) sources sought court authorization to use cash collateral. A PACA claimant objected to using property included in the PACA trust to fund the case.

PACA creates a statutory trust to protect growers of perishable agricultural products along with their agents and others involved in supplying the products against the risk of non-payment. As described by the court: “Employing traditional trust principles, the producers and others closer to the crop-side of the transaction may enjoy the benefits of being the trust’s beneficiaries, while the produce buyers and others involved in the processing and marketing must shoulder the burdens of the fiduciary duties associated with a so-called ‘PACA trust.'” The statute is very broad:

Perishable agricultural commodities received by a commission merchant, dealer, or broker in all transactions, and all inventories of food or other products derived from perishable agricultural commodities, and any receivables or proceeds from the sale of such commodities or products, shall be held by such commission merchant, dealer, or broker in trust for the benefit of all unpaid suppliers or sellers of such commodities or agents involved in the transaction, until full payment of the sums owing in connection with such transactions has been received by such unpaid suppliers, sellers or agents.

The implementing regulations provide that trust assets “are to be preserved as a nonsegregated ‘floating trust'” and contemplate that trust assets will be commingled. A PACA trust claim trumps claims and liens of a buyer’s other creditors, whether secured, unsecured or priority.

A key issue is the scope of the res of the PACA trust. Although the debtor did derive income from perishable agricultural products, it also obtained income from non-PACA sources. The court noted that because many years had elapsed since the alleged PACA trust first arose and the PACA trust assets were commingled, it would be very difficult to trace the trust assets to determine whether particular property constituted proceeds included in the trust.

The PACA claimant contended that all of the debtor’s assets should be included in the trust unless the debtor could prove otherwise. It further contended that PACA trust property was excluded from the debtor’s bankruptcy estate. Thus, it could not be authorized to use any cash collateral.

The court noted that it would be more precise to say that the PACA claimant’s interests in the debtor’s property were excluded from the bankruptcy estate, rather than the property itself. It also noted that outside of bankruptcy the debtor would have the burden of proof.

If the debtor had dealt only in perishable agricultural products, the process would have been fairly simple: The supplier would file a complaint and prove the amount of unpaid produce, and then would be entitled to a portion of the produce related assets equal to what it was owed. However, since the debtor sold other commodities and commingled the proceeds from all of its activities, things became more complicated.

Reviewing the cases cited by the PACA claimant, the court concluded that its contention that the property in a PACA trust is excluded from the bankruptcy estate overstated the holdings of the cases. The language in the decisions relied on by the claimant was either more nuanced or was dicta.

The court considered that even outside of bankruptcy if, for example, a grower supplied a supermarket, the claimant’s status as a trust beneficiary would not give it the right to prevent the supermarket from using the produce in the trust or the proceeds or even its equipment. In the context of a Chapter 11 bankruptcy the argument is even stronger. The claimant’s position would cripple a reorganization. Its approach did not recognize the broad scope of the bankruptcy estate created by the Bankruptcy Code or the right of a trustee or debtor in possession to use estate property with court supervision.

In this case: on the one hand the PACA claim was ~$337,000, and on the other the debtor’s property was scheduled as likely to exceed $9 million in value. “Without some stronger showing beyond [the PACA claimant’s] mere status as a PACA beneficiary, the court will not permit the tail to wag the dog.”

The court concluded that the debtor and the PACA claimant had concurrent interests in the same thing at the same time, and the debtor should be allowed to use the “thing” (e.g. cash collateral) as long as it provided adequate protection. Given the relative value of the PACA claim and the debtor’s assets, the claimant did not contest the court’s finding of adequate protection.

Accordingly, the court granted the debtor’s motion and authorized the debtor to use its plant, property and equipment, and the funds generated through operations. The court viewed this result as consistent with Congressional intent as expressed in PACA and the Bankruptcy Code.

It can be easy to overlook PACA claims when perishable agricultural products are only a small portion of the debtor’s business. However, that would be a mistake since PACA claimants have significant leverage.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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