PACA Trust Enforcement
In 1984, Congress amended the PACA statute to add the statutory trust provisions. Prior to this amendment, if a produce buyer became insolvent, produce sellers had to stand in line behind secured creditors, such as banks, for payments. As last in line, produce sellers often received no money for their produce. Congress wanted to cure this problem because it was concerned that non-payment to produce suppliers was threatening the financial stability of the produce industry. Their goal was simply to ensure that produce buyers used the proceeds of produce to pay the sellers of that produce. Congress also sought to prevent produce buyers from using the proceeds of produce, for which the produce sellers had not received payment, to pay their non-produce related expenses.
Congress could have followed state imposed remedies and given the produce sellers a lien on the buyer’s inventory or required that buyers be bonded. Instead, Congress chose to impose a trust on the parties to a produce sales transaction. This unique choice creates a fiduciary relationship between produce sellers and produce buyers. It gives produce sellers the most potent collection tool afforded any industry – a trust which provides them with superior creditor rights over other creditors, and requires produce buyers to act as a trustee to hold its produce-related assets in trust for the benefit of its produce sellers.
A trust is an obligation imposed by agreement or law where one person holds and controls property for the benefit of another. A trust must have four elements: a purpose, a trustee, trust assets, and trust beneficiaries. The PACA trust’s terms are set up by law. Since a federal statute (PACA) set up the trust, it is called a statutory trust. The “purpose” is to protect unpaid produce sellers. The “trustee” is the produce company that buys the product. The “trust assets” are the buyer’s produce inventory, products made from produce and proceeds from their sale. The “trust beneficiaries” are all unpaid produce sellers, who have properly preserved their rights as PACA trust beneficiaries.
Preserving PACA Trust Rights-PACA Licensees
In order to “preserve” its PACA trust rights to become a PACA trust beneficiary, the produce seller must send a document entitled “Notice of Intent to Preserve Trust Benefits” to the buyer within thirty (30) days of expiration of the parties’ payment terms. If the seller has a valid PACA license, it can use its invoices (or other billing statement) as a means of providing this written notice if it includes the following exact language on the front of the document
The perishable agricultural commodities listed on this invoice are sold subject to the statutory trust authorized by Section 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 from the sale of these commodities until full payment is received.
The invoice containing this language must be sent to the buyer within 30 days after (a) expiration of the payment terms, or (b) notification that a check has been dishonored. If a Company’s payment terms are 10 days as required by PACA, the Company has 40 days after the buyer’s receipt and acceptance of the produce to mail the invoice. We suggest you have some method of tracking when your invoices are mailed. If your invoices list an invoice date, your employees could testify that the ordinary course of business is to mail the invoice on the day it is prepared which is the invoice date on the invoice. It is not uncommon for buyers to claim they never received the invoice.
Preserving PACA Trust Rights-Non-PACA Licensees
Produce sellers that do not have a PACA license can’t preserve their PACA trust rights by placing the required language on invoices. They must send the buyer a separate written Notice of Intent to Preserve Trust Benefits (Trust Notice) within 30 days after expiration of their payment terms. The Trust Notice must include the statement that it is a notice of intent to preserve trust benefits and must include information which establishes for each shipment: (1) The names and address of the seller and the buyer, (2) The date of the transaction, commodity, invoice price, and terms of payment, (3) The date of receipt of notice that a payment instrument has been dishonored, if any, and (4) The amount past due and unpaid. We suggest that Non-PACA Licensees set up a system to send a Trust Notice to the buyer 35 days after shipment. Under this system the seller will send a Trust Notice on those invoices that are not timely paid and protect their trust rights on those invoices at risk for non-payment. The Trust Notice will also serve as a past due reminder by placing a highly visible “PAST DUE” notice on it. This system could be programmed into a computer system so that no sales transactions are missed.
The seller’s invoices must include payment terms. PACA requires prompt payment terms of 10 days after acceptance, however the statute also permits the parties to alter these terms provided that (a) they do so in writing and (b) the terms do not exceed 30 days. The seller will lose its PACA trust protection if payment terms longer than 30 days are agreed upon. If the seller intends to use terms other than the 10-day prompt payment terms, the seller must obtain the buyer’s signature on a written agreement which states the payment terms. This agreement must be entered into by the buyer prior to the first transaction. Both parties are to keep a copy of this agreement in their files. This is known as a “written payment term agreement.”
The seller must include the payment term contained in the written payment term agreement on its invoices, accountings and other documents related to the transaction. “Other documents related to the transaction” refers to any documents in which the seller expects to receive payment. The written payment terms must be consistent with the terms listed on the invoices, accountings and other documents related to the transaction. If the terms of these documents do not match, the Company risks losing its PACA trust protection.
Also, in instances where the invoice states a payment term other than 10 days, and there is no written payment term agreement, the seller may risk losing its PACA trust protection. In order to avoid this problem, all documents must be consistent. We strongly recommend using PACA’s prompt payment terms of 10 days.
PACA law mandates that the produce buying company/trustee must maintain PACA trust assets to pay PACA trust claims. If non-PACA trust assets are commingled with PACA trust assets, under trust law, all of the assets are impressed with the PACA trust. The buyer/trustee has the burden of proving which assets are not subject to PACA. The produce company must maintain its assets subject to the trust in such a manner as to make these assets “freely available” to satisfy outstanding obligations to produce sellers as their invoices become due. However, Congress failed to provide an administrative or enforcement mechanism should the produce company fail to meet its obligations to pay its produce suppliers.
Steps to Enforce the PACA Trust
Since PACA is a trust, PACA attorneys have borrowed general trust law and agency law to develop a body of court made law, known as “federal common law,” to fill the gaps in the PACA statute in order to provide administrative or enforcement mechanisms to unpaid produce suppliers. The federal common law remedies available to unpaid sellers include: (1) asking a court to grant an injunction in the form of a Temporary Restraining Order (TRO) that orders the produce company to maintain the trust, freezes the company’s assets and prevents it from transferring assets; (2) asking a court to institute a PACA claims procedure, which is like a mini bankruptcy procedure, whereby the produce company is liquidated, its assets deposited into a trust account, and PACA trust beneficiaries are invited to bring claims against those assets; (3) if the produce company has insufficient assets to cover its trust claims, the unpaid suppliers can look to the individual officers, directors and shareholders of the company for payment, this is called “personal liability;” (4) if the individual officers, directors and shareholders of the company file for personal bankruptcy protection in an attempt to discharge the “personal liability” debt owed to the produce suppliers, the produce suppliers can seek to have the debt exempted from the bankruptcy discharge since the personal debt arose due to their failure to perform their fiduciary trust duties; and (5) if the produce company transferred trust assets to any non-PACA party, the produce sellers can trace these assets into the hands of third parties and sue for recovery of these monies.
In an ordinary lawsuit to recover money, the creditor files a complaint seeking payment of money, and the lawsuit is served on the debtor who then has twenty days to file an answer. This is followed by discovery, motion practice, and ultimately the lawsuit is decided by either a Motion for Summary Judgment or a trial. It may take a year or more for the case to wind through the legal proceeding, and in the end, the creditor is simply awarded a judgment stating that the debtor owes it money. If the debtor does not voluntarily pay somewhere along the line, in order to obtain payment, the creditor then needs to enforce that judgment by executing upon the debtor’s assets.
Temporary Restraining Order
Under the PACA Trust, the produce buyer is a trustee of its produce assets, and as trustee, must maintain its PACA trust assets so they are freely available to pay the outstanding claims of produce suppliers as they become due. The PACA trust creates a fiduciary relationship between the produce buyer and the seller. Because of this fiduciary relationship, a court can enter an injunction, in the form of a Temporary Restraining Order (TRO), against a produce buyer, as trustee. An injunction is a court order requiring a party to whom it is directed to do or refrain from doing a particular thing. A TRO is a temporary injunction, which can last no more than 10 days, issued at the beginning of a lawsuit without notice to the party to whom the injunction is directed.
A TRO stands the normal lawsuit procedure on its head. Instead of waiting until the end of the case to seize assets, a supplier that can prove that the produce buyer is not maintaining sufficient assets to pay its PACA Trust claim, or is dissipating PACA Trust assets, can ask the court to freeze the assets of the produce buyer at the beginning of the case, and without notice to the buyer. Once the assets are frozen through a TRO, within ten days, the judge must set the matter for a preliminary injunction (“PI”) hearing, to turn the temporary injunction into a permanent injunction. The assets of the produce company are then held up front pending going through the entire litigation process to determine who is entitled to those assets.
If the produce company does, in fact, have the money to pay the PACA beneficiary that filed the complaint, it will pay the claim and settle the lawsuit. If it does not have the money to pay, the sellers usually ask the court to institute a PACA Claims Procedure.
Since the TRO is temporary and can only last a maximum of ten days, the court must set a hearing within this time to look at the evidence and determine whether the Temporary Restraining Order should be turned into what is known as a Preliminary Injunction (“PI”).
Between the period of time in which the TRO is entered and the PI Hearing is scheduled, if the buyer has sufficient assets to pay its PACA Trust beneficiaries, an agreement can often be reached and the case settled. This settlement may include obtaining a judgment against the produce buyer and paying that judgment off over a series of payments. Since the seller has obtained a judgment stating it has a valid PACA Trust claim, these payments do not void PACA Trust protection.
If the produce buyer does not have sufficient assets to pay its produce suppliers, the seller is entitled to a PI. In its basic form, a PI is the same as a TRO. It provides that the produce buyer cannot transfer any assets subject to the PACA Trust without further court order. Over the years, however, we have found that this is not sufficient to protect the interests of the PACA Trust beneficiaries.
A body of federal common law has developed whereby these preliminary injunctions are used as a quasi-bankruptcy proceeding to marshal the assets of the company, determine the valid PACA Trust beneficiaries, and distribute the money. These orders are commonly referred to as PACA Claims Procedures.
PACA Claims Procedure
The PACA Claims Procedure Orders first provide the preliminary injunction relief that states that the produce buyer and any parties working with it cannot transfer or dissipate PACA Trust assets. Second, the Orders provide for the liquidation of the buyer’s PACA Trust assets. Usually a third party is chosen to handle the task of collecting the assets and depositing them into an escrow account. An attorney from a firm is usually chosen, and we like to hire a former employee of the company who is familiar with the books and records to maintain the books and records and assist with the collection efforts. If this is one of the owners of the company, we do not compensate them, but if it is a bookkeeper or other administrative person, that party is usually paid to provide these services. We then set up a Court-supervised escrow account in which to deposit all the recovered proceeds.
Next, since the PACA Trust is a trust, if there are insufficient monies to pay all PACA Trust beneficiaries in full, the monies recovered must be paid to the PACA Trust beneficiaries on a pro-rata basis. As a result, even though one or a handful of PACA Trust beneficiaries may have commenced the lawsuit to recover their money, they cannot receive their money unless they share it with all other potential PACA Trust beneficiaries. Therefore, it is necessary to determine all of the valid PACA Trust beneficiaries. In the PACA Procedures Order, we provide for a separate PACA Claims Procedure. Under this claims procedure, the original parties who filed the lawsuit must send a notice to all potential creditors of the buyer informing them that if they are potential PACA Trust beneficiaries, they are required to intervene in the lawsuit by filing a Complaint and PACA Proof of Claim setting forth the requirement that they are a valid PACA Trust beneficiary. Both these actions must be completed by a certain date which is referred to as a “Bar Date.” The Bar Date is usually set about 60 days after the Order is entered. Usually within 30 days after the Bar Date, another deadline is set which requires all parties to file any objections to the PACA Trust claims. Any party, including PACA Trust beneficiaries or the buyer, can file objections to the amount or validity of the PACA Trust claims. The sellers then have a period of time in which to respond to any objections. This response is usually 20 days after the objections are filed.
Then, within approximately 30 days after the response to any objections, the original parties file what is called a PACA Distribution Chart. This Chart lists all the claims that were filed in the case, the claims that are disputed and those that are undisputed. From the amount of money that has been recovered in the case to date, a distribution is made to those with undisputed claims. The remaining portion of recovered funds is held in the escrow account for those with disputed claims, pending a resolution of those claims. The parties then work to resolve the claims, and if they cannot be resolved, they must be presented to the Court for determination. This process usually takes four to six months after the PACA Claims Procedure Order is entered.
Our firm developed these PACA Claims Procedures. They have been adopted as the model for the industry and are used in nearly all PACA Trust cases. As many of you know, some of these move very quickly and operate according to plan. Other times, they do not work as well. The problems usually occur in one of two manners. First, the produce buyer does not have the assets it anticipated, and there are very few assets to distribute to creditors. The second major problem occurs when the buyer, its owners, or lenders decide to aggressively defend the matter and try to determine every conceivable way to object to the PACA claims, and the process of determining the validity of these claims drags on. All in all, these procedures have worked well, and we are continuing to work to move these procedures along and refine the procedures.
The PACA trust statute and the “federal common law” have been developed to fill the gaps left by the statute’s omission of administrative or enforcement mechanisms in order to assist unpaid produce suppliers.
Normally an unpaid creditor can only look to the corporate debtor for payment of a debt. The existence of a business entity (common examples are corporations or limited liability companies) shield the individual owners from personal liability for the business debt. However, under the PACA statute, the business that buys produce is also the trustee of that produce, the money received from the sale of that produce, and any assets bought using produce money. As trustee, the buyer has fiduciary duties to the produce seller, and is charged with maintaining its inventory of produce and receivables from the sale of produce in such a manner that these assets are freely available to satisfy outstanding obligations to unpaid sellers.
If the buyer does not maintain sufficient assets to cover its PACA trust claims, it has breached its fiduciary duty to the unpaid valid PACA trust beneficiaries. The legal classification for a breach of a fiduciary duty is a tort, which is a breach of any duty imposed by law (except for breaches of contract). The most common types of torts are personal injury and medical malpractice, but also include a trustee’s breach of fiduciary duty. Since business entities have no real existence besides the people in the company who are reasonable for its operations, those individual employees who commit torts are personally liable for the damages caused, even when the employee was acting within the scope of his or her employment. For example, if a FedEx truck is involved in a wreck, the driver of the truck is personally liable (in addition to FedEx) for the damages he caused.
Since individual employees are liable for the torts committed in the context of their employment, when the produce buyer does not have sufficient money to pay its suppliers in full we try to recover the balance from the individual employees whose tort – the breach of the fiduciary duty – resulted in nonpayment. We have been successful in making new federal common law whereby federal courts have found shareholders, officers, or directors of a produce buyer personally liable for a corporation’s breach of trust. This is called “personal liability.” Courts have extended PACA liability to the individuals because it is reasonable and necessary in order to carry out Congress’ intention when it enacted the PACA legislation, which is to protect consumers and sellers of produce from nonpayment by the buyer.
The question then becomes who is personally liable? Courts have developed a two part test that states that those shareholders, officers, or directors who were in a position to control PACA trust assets and did not preserve the corporation’s PACA Trust assets for the beneficiaries are personally liable. The first inquiry is whether the individual had the legal right to control and the ability to direct the management and policies of the company. So far, courts have found sole proprietors or sole shareholders as individuals with the right and obligation to control the company. Since these individuals had absolute control of the company, their failure to exercise any oversight of the company’s management has rendered them personally liable for the company’s breach.
Third Party Liability
Normally an unpaid creditor can only look to the corporate debtor for payment of a debt. However, under the PACA statute, if the buyer does not maintain sufficient assets to cover its PACA trust claims, it has breached its fiduciary duty to the unpaid valid PACA trust beneficiaries. If the produce company transfers PACA trust assets to any non-PACA trust creditors, and the unpaid produce sellers can trace these assets into the hands of third parties, they can file suit seeking recovery of these monies, this is called “Third Party Liability.”
The most common example of Third Party Liability is a bank or other financial institutions obtaining payment of their loans just prior to the produce buyer going out of business. These financial institutions usually have more timely information than the produce suppliers about when and how a produce buyer experiences financial problems. When the financial institution learns of the poor financial condition, it will often place the account into “work out” status and try to pay down its loan as soon as possible. As the loan is being paid down, the produce buyer usually slows in paying its produce suppliers. Once the payments stop, the produce supplier must enforce its PACA trust rights by suing the produce buyer for payment. The supplier will soon find out that the company has no assets because they have all been paid to the bank.
The only recourse for the supplier in this example to obtain payment of its claim is to sue the bank for recovery of the transferred monies. The suit can be against the bank or any other party that received the produce buyer’s assets. In order to prevent lawsuits against any party that may have received assets from the produce buyer, a complex set of legal rules has been developed by the courts as to what needs to be proven in order for the produce suppliers to recover the monies. These rules apply no matter whether the third party is a bank, relative or other supplier who received assets.
If the produce supplier can prove the following three elements, it has a valid case against the third party, unless the third party is able to rebut the facts. This is called a “Prima Facie Case.” First, the supplier must have a valid PACA trust claim. Second, the monies transferred to the third party must be PACA trust assets, which include inventories of perishable agricultural commodities (“Produce”), food or products derived from Produce (“Products”), accounts receivable and other proceeds of the sale of Produce or Products, and assets commingled or purchased or otherwise acquired with proceeds of such Produce or Products. Third, the monies must have been transferred to the third party in breach of the PACA trust. In other words, the transfer must have been to the detriment of the PACA trust beneficiaries. This issue was the subject of a recent court decision wherein the court held that transfers of invoices to a factoring company for 80% of face value were not in breach of the PACA trust. This test also protects regular vendors such as utilities, landlords and non-produce trade creditors from facing this type of lawsuit.
Once the produce supplier proves its Prima Facie Case, the third party is liable to the PACA trust beneficiaries unless it can rebut these facts by proving that if was a bona fide purchaser for value of the PACA trust assets. A bona fide purchaser for value is commonly referred to as a BFP. In order to prove it was a BFP, the third party must prove both: (1) that it received the transfer for value; and (2) it received the transfer without knowledge that it was in breach of the PACA trust.
In order for the transfer to be for value, it has to be a contemporaneous exchange and in the ordinary course of business. For example, the payment of a normal monthly loan payment is for value because it is in the ordinary course of business. A bank setting monies off from a bank account is not for value. This part of the test is usually easy to prove.
Proving that the transfer was made without knowledge that it was in breach of the PACA trust is very fact intensive. The third party is charged with knowledge of the PACA trust. They needed to know that the produce buyer was unable to pay both the third party and the PACA trust beneficiaries. Thus, the third party must have had some knowledge of the produce buyer’s poor financial condition.
If both of these parts of the BFP test are not met by the third-party, it is liable to disgorge the money received to the PACA trust beneficiaries.
Congress was kind to the produce industry by giving sellers trust protection when buyers do not pay. When these rights are used properly, produce sellers have an unprecedented array of options to recover monies when their buyers go out of business.