The Role of the Broker- Conflicting Paradigms TCA 2007 Annual Convention March 11-14, 2007 Bellagio Resort Las Vegas, Nevada The field of intermediaries extends from integrated supply chain management to transactional brokers matching one load at a time on the internet. While the scope is much more varied and complex, the principal role of the intermediary remains ill defined. As the NITL, the TIA and the ATA all promulgate lengthy contracts to address the issue, it is clear, “There is no consensus over the role of the intermediary.” Is an intermediary a “Broker/Arranger” or a “Principal/Provider”? What difference does it make? Is a freight intermediary like a stock broker or real estate agent who does his job by facilitating a transaction between two contracting principals – the shipper, a buyer of transportation services, and the carrier, a seller? Or … Is a freight intermediary just a different type of “transportation service provider” who by contract is liable to the shipper for safe delivery of cargo and liable to the carrier for freight charges regardless of whether it gets paid? LEGAL BASIS Broker / Arranger Principal / Provider Role established by common Established by contract contract law and statutes of waiving statutes and regulation under '14101(b) regulation; 49 CFR 371 Principal enters contracts to Broker arranges for contracts provide goods or services, between buyer and sellers assumes liability and hires subcontractors Professional intermediary is Frequently “broker” is like an insurance agent or real merely substituted for carrier estate broker in shipper contracts. GENERAL DUTIES Broker / Arranger Principal / Provider Duty of good faith and due Assumes by contract diligence carrier-like duties: Arranger of transportation (1) Payment of freight charges Brings together buyers and (2) Cargo claim liability sellers (3) Indemnity for BI & PD Bill of lading is contract of “arising out of ” haul (4) Purports to take “possession of cargo” Based on one’s answer to this Fundamental dichotomy, all of the vexatious issues affecting intermediaries and model contracts can be sorted out … Can or should an intermediary act like a carrier accepting responsibility for “providing” transportation? Can an intermediary accept primary responsibility for cargo claims? Should a broker have the right to offset cargo claims against freight charges? Should a broker accept ultimate liability for payment of freight charges? Does the carrier have recourse to the shipper for payment of freight charges? Can a broker pledge the gross amount of its freight invoices to its second lender or are only its commissions really its assets? Do motor carriers have special rights when brokers file bankruptcy or are they just unsecured creditors, subject to preference actions? To answer these seven questions, we must first examine the statutes and regulations to determine the prescribed duties of a broker on the agent/arranger versus principal/provider issue. BROKER - Means a person who for compensation arranges or offers to arrange the transportation of property by an authorized motor carrier. See 49 C.F.R. 371.1. CARRIER – On the other hand, is defined as a “person providing commercial vehicle transportation for compensation.” Although a carrier can “arrange” for transportation of shipments, it has accepted responsibility to “provider” the regulation governing brokers make clear that: Misrepresentation: Broker can’t represent itself as carrier.” (371.7) Broker is defined as an “arranger.” QUESTION: So, can a broker act like a carrier and accept responsibility for providing transportation as a carrier? ANSWER: No, it cannot and comply with broker regulations. VICARIOUS LIABILITY Broker / Arranger Principal / Provider Arranges for services provided Opens door to principal/ by licensed and authorized subcontractor claims carrier “Assumption of duty” in contract Eschews joint venture on can be used against in – Schramm v. prime/subcontractor claims Foster Broker not on bill of lading as Contractual indemnity language carrier and purchase of insurance raises settlement demands Contingent auto hard to find and too expensive Non-delegable duty of carriers in California Contemporary Horror Shows Guacamole and overdue freight charges. The stoplight is out, but who is the carrier? Conventional Wisdom Keep name of intermediary off bill of lading as the carrier If you have asset-based operations, use brokerage as contracting party Use different nomenclature to distinguish carrier and broker affiliates. QUESTION: Can a broker accept primary liability for cargo claims? ANSWER: Yes, but why would you want to?! As an arranger under the statute, a broker is not liable for cargo claims. The Carmack Amendment (14706) and the bill of lading make the carrier in possession and control of the shipment. Case law is clear. Brokers are not liable. See Chubb Group of Insurance Companies v. H.A. Transportation Systems, Inc., 243 F. Supp. 2d 1064 (C.D.Cal. 2002); CGU International Insurance, PLC v. Keystone Lines Corp., 2004 U.S. Dist. LEXIS 8123 FREIGHT CLAIMS Broker / Arranger Principal / Provider No primary liability under Assumes cargo liability by statute contract provision or broad Typically warrants to shipper indemnity that carrier is financially Assumes risk of loss – allows responsible for paying cargo offset which may not be claims recoupable Gets contingent cargo Purports to take possession insurance to cover that and guarantees condition upon warranty arrival QUESTION: But shippers will not use brokers who don’t accept ultimate cargo liability. What is a broker to do? ANSWER: The problem of claims adjustment and cargo insurance loopholes drives the shipper commuting to insist on protection against improper claims adjustment by the carriers the broker selects. A broker by contract can insist on quick arbitration by the shipper and carrier, and can then warrant that claims for which the carrier is adjudged liable will be paid up to some agreed amount. Contingent cargo insurance can be purchased to cover the risk of negligent entrustment to carriers who are undercapitalized and improperly insured without accepting primary cargo responsibilities. QUESTION: Should the intermediary offset cargo claims against freight charges? ANSWER: Traditionally, he who has the gold rules in exempt where offset is the norm. Not so in regulated freight. It was precluded by Admin. Rules 128 and 65. Now shippers frequently insist on right or do it out of frustration. (1) Strong carrier objection (a) Broker is not impartial (b) Broker is only assignee by payment (c) The Spiral of Death (i) Insurers will not accept (ii) Factors can shut carrier for breach (2) If broker is “arranger” and not “provider” has no basis of offset. OFFSETS Broker / Arranger Principal / Provider Cargo claims filed against Shipper offsets against carrier intermediary Arbitration for economical Constructive trust concept determination violated Broker pays if no insurance Funds needed to pay non- and carrier insolvent negligent carriers is withheld by shipper 3PL’s cash flow interrupted QUESTION: Should a broker accept ultimate responsibility for payment of freight charges? ANSWER: There are two distinctly different views. FREIGHT CHARGES Broker / Arranger Principal / Provider Broker transmit payments TIA view – broker solely upon receipt responsible for payment to If advances payment, broker carrier becomes carrier’s assigner Shipper protected against Can guarantee payment if double payment by chooses broker/carrier contract but Does not guarantee rust belt Broker accepts entire risk of shipper payments shipper insolvency Position of major 3PLS Trumps bill of lading recourse Carrier extends credit to to shipper shipper or both, if broker Carrier must extend credit guarantees payment only to broker SO WHO SHOULD ULTIMATELY PAY FREIGHT CHARGES? THE SHIPPER, THE BROKER, BOTH OR NEITHER? QUESTION: Is it prudent to let the shipper think you are transporting a shipment when you are actually brokering it? ANSWER: No. It is possible to waive application of general principles of traditional brokerage in contracting but you are inviting lawsuits and vicarious liability issues when you become a “provider” of transportation. QUESTION: Does the carrier have recourse to the shipper if the broker does not pay? ANSWER: Unless expressly waived by contract or bill of lading agreement (e.g. Section 7), the carrier has recourse to the shipper in most Circuits. See Southern Pacific Transportation Co. v. Commercial Metals Co., 456 U.S. 336, 342 (1982); Strachan Shipping Co. v. Dresser Industries, Inc., 701 F.2d 483 (5th Cir. 1983); Contship Container Lines, Inc. v. Howard Industries, Inc., 309 F.3d 910 (6th Cir. 2002); Hawkspere Shipping Company, Ltd. v. Intamex, S.A., 300 F.3d 225 (4th Cir. 2003); National Shipping Co. Of Saudi Arabia v. Omni Lines, 106 F.3d 1544 (11th Cir. 1997) Exel Transp. Servs. v. CSX Lines L.L.C., 280 F. Supp. 2d 617 (D. Tex. 2003) The bedrock rule of carriage cases is that, absent malfeasance, the carrier gets paid. It is superficially unfair [consignors] must pay for shipments twice. However, allowing them the benefit of carriage without compensating the carrier would eventually cripple the shipping industry and the economy generally, as carriers devoted their time to investigating potential customers ...it is [the shipper’s] responsibility to choose a subcontractor that can forward money as well as freight ... Fear of double payment liability has led NITL to insist that a broker be the agent of carriers for collection or that carriers waive recourse in writing. The carrier’s position is that the shipper selected the 3PL. If the shipper will not guarantee the broker will transmit the payment in good faith, why should the carrier take the risk? QUESTION: What is the effect of the TIA approach on intermediaries? ANSWER: It leads to a commingling of payments: FIFO accounting Receivables from one customer used to pay delinquent payables of another When delinquent customer defaults, must have cash reserves to pay Broker is only as creditworthy as its worst customers Big 3PLs will not guarantee Ford or GM. Can a small broker afford to? The Conduit Theory versus FIFO Accounting Under the “Broker/Arranger” model as set forth in the regulations, the broker must set up special accounting which benefits the shipper and broker, and if followed, assures both that money paid to the broker for the carrier’s freight charges is transmitted upon receipt. Under the broker regulations, it can be inferred that the broker should receive the payment of freight charges in trust and transmit payments as a conduit to the performing carrier to the extent the carrier has not already been paid. The Conduit Theory versus FIFO Accounting The broker regulations require separate accounting of brokerage services and payments due to carriers and provides that both shippers and carriers have the right to see the accounting of when the shipper was billed, when it paid the broker and when the broker paid the carrier. 49 C.F.R. Sec. 371.13 Accounting: Each broker who engages in any other business shall maintain accounts so that the revenues and expenses relating to the brokerage portion of its business are segregated from its other activities. Expenses that are common shall be allocated on an equitable basis; however, the broker must be prepared to explain the basis for the allocation. Thus, under the regulations, it would seem improper for a broker to accept carrier cargo claim liability and then commingle freight charge receivables intended for the carrier into a common pot for the purpose of offset. Carriers find it is like robbing Peter to pay Paul. QUESTION: Can a broker borrow money, pledging as collateral that portion of its gross receivables owed to carriers? ANSWER: This significant legal question is not resolved… Experienced transportation factors will not purchase broker freight bills without proof that carrier has been paid, because upon default, shipper will pay carriers: Factors stand in shoes of brokers and acquire no greater collection rights than brokers. Carriers can trump broker’s lender when seeking unpaid freight charges from shippers. Yet bankruptcy involving intermediaries have produced mixed results: WORLDPOINT (WA) Intermodal (IMC) Bank got to keep its collected amount, but lost receivables unpaid to Worldpoint at time of bankruptcy which were traceable to carrier services – Coupon Clearing Case Followed AIR CARGO, INC. (MD) Air freight forwarder/agent for airlines Borrow against gross receivables from bank When filed bankruptcy, bank claimed security in all receivables Special motor carrier committee sued airlines – bank settled out and motor carriers acquired all estate rights in plan to sue airlines for double payments JAMCO (VA) Exempt broker and newspaper insert Motor carrier creditors got rights to pursue receivables QUESTION: Do motor carriers have special rights in the bankruptcy of intermediaries, or are they merely general unsecured creditors who typically take nothing? ANSWER: Unless carriers waive their rights to recourse and agree the broker regulations and arranger model are trumped, carriers have important rights in broker bankruptcy. Parker Motor Freight, Inc. v. Fifth Third Bank, 116 F.3d 1137 (6th Cir. 1997) (Motor carriers interest trumps the bank) Yet in constructive trust not generally found in bankruptcy unless debtor actually segregated Does this suggest that brokers, through malfeasance or misfeasance, can fail to segregate payments and thereby get to freely borrow against monies intended by shipper for carrier? BLUE THUNDER (GA) may resolve this: Pure broker Owed $42M to bank/commingled all carrier/broker accounts Bank swept receivables No broker regulations compliance/carriers have recourse to shippers in 11th Circuit Broker violates regulations/ξ14704 gives “any person” private right of action QUESTION: If constructive accounting is implicit in the regulations and would insure the shipper’s payment is forwarded to the carrier upon receipt, why don’t all the parties agree and insist on it as the best way to avoid the possible double payment issue? QUESTION: Wouldn’t brokers be better protected against customer insolvency by the constructive trust/conduit principles of the arranger model then by accepting noncontingent payment obligations to the carrier under the TIA model contract?