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In PACA We Trust.rtf

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									                     In PACA We Trust:

             Commercial Protection of Suppliers
                         under the
        Perishable and Agricultural Commodities Act
                     [redacted version]




A paper submitted in satisfaction of the course requirement for

                     Food and Drug Law
                 Professor Peter Barton Hutt
                         Winter 2003
                    Harvard Law School

                          May 2003


                        Susan Chen
                        Class of 2003
Abstract


       This paper evaluates recent developments in judicial application of the Perishable and

Agricultural Commodities Act (―PACA‖). Enacted by Congress during the Great Depression,

PACA was originally designed to promote fair trade practices among buyers and sellers of

perishable agricultural commodities (―PACs,‖ e.g., produce). In 1984, in response to supplier

complaints that dealers were buying PACs but failing to pay or unreasonably delaying payment

for these products, Congress amended PACA to establish a trust for PAC proceeds in favor of

unpaid PAC suppliers. The idea was that a statutory trust would protect (typically) small

suppliers against unscrupulous conduct by (typically) larger merchants and dealers, and generally

minimize disruptions in the daily flow of these commodities. In the twenty years since, two

contradictory developments have emerged in courts’ application of the PACA trust provisions.

The first is an erosion of protection for suppliers through the use of traditional trust law

principles in deciding PACA disputes. The second is an expansion of protection for suppliers

through an increase in the range of commercial buyers to whom the PACA trust provisions are

held to apply. Ironically, though both trends appear to stem from courts’ desire to facilitate

commercial flow of PACs generally, the tension between the two may—at least temporarily—

generate uncertainty that hampers PAC commerce.




                                               2
                                     Table of Contents




Abstract


Introduction


Part I. The Perishable and Agricultural Commodities Act


   A. The Basic Act—History, Purpose, and Major Provisions

   B. The 1984 Trust Provisions


Part II. Judicial Application


   A. Some Interesting Case Law

   B. Eroding Protection for Suppliers—Lenders as Bona Fide Purchasers from the Trust

   C. Increasing Protection for Suppliers—Expanding the Identity of ―Dealers‖ Subject to the
      Trust


Part III. Reconciling Contradictory Trends and Conclusion




                                              3
Introduction


       ―I never lend on anything that grows.‖1 Such an austere policy hardly would seem to be a

formula for commercial success. But banks and other lenders who follow this rule are referring

not to businesses with profits that grow (which are often a good bet, after all), but rather to

businesses whose inventory physically grows (e.g., businesses that hold large quantities of fruits,

vegetables, or derivatives thereof).

       Lenders’ reluctance to rely on collateral ―that grows‖ is due in large part to the trust

provisions of the Perishable and Agricultural Commodities Act (―PACA‖), which effectively

give the suppliers of perishable and agricultural commodities (―PACs‖) priority over secured

lenders in the event of a purchaser’s financial distress or bankruptcy. The priority bestowed on

PAC suppliers stands in sharp contrast to the unsecured creditor status held by most other trade

suppliers. Congress created the special priority with the objective of facilitating PAC commerce

by protecting suppliers against potential exploitation by buyers and merchants.

       This paper examines recent judicial applications of the PACA trust provisions and

evaluates how the priority for PAC suppliers has operated in practice. The paper is organized in

three parts. Part I provides an overview of PACA and the 1984 amendments that created a

statutory trust in favor of unpaid suppliers. Part II discusses various aspects of the case law,

focusing in particular on two conflicting trends that have recently emerged. Part III explores

the tension between these trends and concludes.




1
 Vicky Balmot, Perishable Agricultural Commodies Act: Justice Doesn’t Grow on Trees, THE SECURED LENDER,
Jan./Feb. 2001.


                                                   4
Part I. The Perishable and Agricultural Commodities Act


A. The Basic Act—History, Purpose, and Major Provisions


        Congress enacted PACA in 1930 to promote fair trade practices among buyers and sellers

of PACs. Following World War I, agricultural prices had grown severely depressed as increased

capacity from wartime production turned into excess supply.2 Individual farmers and growers

were perceived to have very little bargaining power vis-à-vis their customers.3 To provide some

protection for farmers and other small produce suppliers, PACA required commission merchants,

dealers, and brokers to refrain from certain types of ―unfair conduct.‖4 The statute prohibits, for

example, the use of ―any unfair, unreasonable, discriminatory, or deceptive practice in

connection with . . . determining the quantity of any perishable agricultural commodity received,

bought, sold, shipped, or handled.‖ The statute also prohibits dealers from ―reject[ing] . . .

without reasonable cause‖ any PACs that have been purchased, sold, or consigned in interstate or

foreign commerce.5

        PACA further requires that any person ―carrying on the business of a commission

merchant, dealer, or broker‖ be duly licensed, subject to a penalty of $1,000 per offense and

$250 per day.6 Parties determined to have violated the statute will be liable to injured parties for

damages; the liability can be enforced through a complaint to the Secretary of Agriculture or

through suit in any court with proper jurisdiction.7




2
  Sandra M. Ferrera, Perishable Agricultural Commodities Act Affecting Lender’s Secured Priority Interests, 7. U.
MIAMI BUS. L. REV. 353, 354 (1999).
3
  Id.
4
  7 U.S.C. § 499b.
5
  Id.
6
  7 U.S.C. § 499c.
7
  7 U.S.C. §499e(a)-(b).


                                                       5
        PACA applies to commission merchants, dealers, and brokers who buy and sell

perishable agricultural commodities. These commodities are defined by the statute as

        any of the following, whether or not frozen or packed in ice: [f]resh fruits and fresh
        vegetables of every kind and character; and . . . [i]nclud[ing] cherries in brine as defined
        by the Secretary in accordance with trade usages.8

PACA defines ―commission merchant‖ as ―any person engaged in the business of receiving in

interstate or foreign commerce any perishable agricultural commodity for sale, on commission,

or for or on behalf of another.‖9 ―Dealer‖ is defined as

        any person engaged in the business of buying or selling in wholesale or jobbing
        quantities, as defined by the Secretary, any perishable agricultural commodity in
        interstate or foreign commerce, except that (A) no producer shall be considered as a
        ―dealer‖ in respect to sales of any such commodity of his own raising; (B) no person
        buying any such commodity solely for sale at retail shall be considered as a ―dealer‖ until
        the invoice cost of his purchases of perishable agricultural commodities in any calendar
        year are in excess of $230,000; and (C) no person buying any commodity other than
        potatoes for canning and/or processing within the State where grown shall be considered
        a ―dealer‖ whether or not the canned or processed product is to be shipped in interstate or
        foreign commerce, unless such product is frozen or packed in ice, or consists of cherries
        in brine, within the meaning of paragraph (4) of this section.10

In addition, any person not considered a ―dealer‖ under the above definition may secure a PACA

license and will be considered a ―dealer‖ while the license is in effect. 11 Finally, the statute

defines ―broker‖ as ―any person engaged in the business of negotiating sales and purchases of

any perishable agricultural commodity in interstate or foreign commerce for or on behalf of the

vendor or the purchaser.‖ 12 An independent agent, however, whose only sales are of frozen

fruits and vegetables with an invoice value less than or equal to $230,000 per calendar year, will

not be considered a ―broker.‖13



8
  7 U.S.C. § 499a(a)(4).
9
  7 U.S.C. § 499a(b)(5).
10
   7 U.S.C. § 499a(b)(6) (emphasis added).
11
   Id.
12
   7 U.S.C. § 499a(b)(7).
13
   Id.


                                                 6
B. The 1984 Trust Provisions


        In 1984, in response to supplier complaints that dealers were buying PACs but either

failing to pay or unreasonably delaying payment for these products, Congress amended PACA to

establish a trust for PAC proceeds in favor of unpaid PAC suppliers. 14 The idea was that a

statutory trust would protect (typically) small suppliers against unscrupulous conduct by

(typically) larger merchants and dealers, and generally minimize disruptions in the daily flow of

these commodities. 15 Included in the 1984 amendments was a clear statement of legislative

purpose:

        It is hereby found that a burden on commerce in perishable agricultural commodities is
        caused by financing arrangements under which commission merchants, dealers, or
        brokers, who have not made payment for perishable agricultural commodities purchased,
        contracted to be purchased, or otherwise handled by them on behalf of another person,
        encumber or give lenders a security interest in, such commodities, or on inventories of
        food or other products derived from such commodities, and any receivables or proceeds
        from the sale of such commodities or products, and that such arrangements are contrary
        to the public interest. This subsection is intended to remedy such burden on commerce in
        perishable agricultural commodities and to protect the public interest.16

Congress apparently believed that merchants were using certain increasingly common financing

devices, such as loans secured by working capital, to take advantage of unsophisticated suppliers.

To protect those suppliers, the trust amendments provide in relevant part:

        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.
        Payment shall not be considered to have been made if the supplier, seller, or agent
        receives a payment instrument which is dishonored.17

14
   7 U.S.C. § 499e, et seq.
15
   See 7 U.S.C. § 499e(c)(1).
16
   Id. (emphasis added).
17
   7 U.S.C. § 499e(c)(2) (emphasis added).


                                                7
To preserve its trust rights, a PAC supplier must give written notice to the commission merchant,

dealer, or broker and file that notice within the time period prescribed by the statute. 18 The

statute also permits a PACA licensee to place certain language on ―ordinary and usual billing or

invoice statements‖ to give notice of its intent to preserve the trust.19

         Trade suppliers’ priority under the PACA trust provisions can create unfortunate

consequences for unwary lenders. The following example illustrates. 20 Suppose DealerCo

contracts to purchase 500,000 boxes of blueberries from ProduceCo at a fixed price of $10 per

box. Due to an unexpected glut of supply in the market, the market price falls to merely $5 per

box. DealerCo has a working capital loan agreement with a Bank, under which the Bank agreed

to advance DealerCo working capital funds up to eighty percent of inventory, valued at the lower

of cost or market. The maximum advance from Bank will therefore be $2,000,000 (i.e., 80% *

500,000 boxes * market price of $5 per box). ProduceCo will deliver the agreed-upon 500,000

boxes for a total price of $5,000,000; as payment, ProduceCo will accept $2,000,000 cash and

allow DealerCo to take the rest on credit. Suppose now that DealerCo was undercapitalized,

finds itself unable to pay the rest of ProduceCo’s invoice, and files for bankruptcy. ProduceCo


18
   An unpaid supplier, seller, or agent must provide written notice of its intent to preserve trust benefits ―within
thirty calendar days (i) after expiration of the time prescribed by which payment must be made, as set forth in
regulations issued by the Secretary, (ii) after expiration of such other time by which payment must be made, as the
parties have expressly agreed to in writing before entering into the transaction, or (iii) after the time the supplier,
seller, or agent has received notice that the payment instrument promptly presented for payment has been
dishonored.‖ The written notice must set forth information that is sufficiently detailed to identify the transaction
subject to the trust. If parties agree to a payment time period different from the time period established by the
Secretary of Agriculture, a copy of the agreement must be filed with each party, and such payment terms must be
disclosed on transaction documents. 7 U.S.C. § 499e(c)(3).
19
   The bill or invoice statement must contain certain information regarding the terms of payment, as well as the
following statement: ―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. 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.‖ 7
U.S.C. § 499e(c)(4).
20
   This example was created by the author. Understanding of the effect of the PACA trust on the relative positions
of various parties was developed by reviewing various scenarios described in Balmot, supra note 1.


                                                          8
(assuming it followed the appropriate notice requirements) will have a PACA trust claim for

$3,000,000 (i.e., the $5,000,000 total purchase price, less the $2,000,000 that DealerCo drew on

its line from Bank and used to pay ProduceCo). ProduceCo’s PACA trust claim will be superior

to the Bank’s $2,000,000 senior debt claim. Despite its conservative 80% advance rate, the Bank

will end up not with a 20% inventory cushion, but rather overadvanced by $3,000,000.

       Moreover, ProduceCo ends up much better off than an unpaid trade supplier who does

not enjoy the protections of PACA—for example, a hypothetical supplier of cellophane wrap to

DealerCo. Suppose DealerCo, in addition to entering the above transactions, had contracted to

purchase $500,000 of cellophane from WrapCo. WrapCo’s entire claim would come after both

ProduceCo’s claim and the Bank’s claim.

       The following tables depict DealerCo’s financial condition and ProduceCo’s priority

claim on DealerCo’s assets in this example:

       [table redacted]

The direct benefits of PACA trust priority are further highlighted when one examines how the

relative positions of the Bank and ProduceCo would change if ProduceCo’s PACA trust

protection were removed. As the senior debt holder, the Bank would be able to recover 100% of

its claim. ProduceCo would be reduced to receiving distributions—on a pari passu basis with

WrapCo—of the assets remaining after satisfaction of the Bank’s entire claim.




                                               9
       [table redacted]

Losing PACA trust protection thus dramatically changes ProduceCo’s position from recovering

fully on its claim to recovering only 43%. Conversely, the existence of PACA trust protection

means the Bank is able to recover only 25% of its claim rather than the full amount it would

recover as a senior secured lender to dealers or merchants in other industries.


Part II. Judicial Application


       As outlined in Part I, a PACA trust in favor of unpaid produce suppliers, sellers, and

agents arises when all three of the following statutory requirements are met:

       (i) the commodities sold or supplied are PACs;

       (ii) the purchaser is a commission merchant, dealer, or broker engaging in interstate

       commerce; and

       (iii) the suppliers, sellers, or agents have not yet received full payment and have

       preserved their trust rights via the statute’s notice requirements.

Because the availability of PACA trust protection can have such a dramatic impact on suppliers’

and lenders’ fortunes, it is not surprising that interested parties have fought numerous court

battles over issues such as the types of products that will be considered subject to the statute, and

which party bears the burden of proving that PACA trust assets were dissipated or improperly

transferred to parties other than the intended trust beneficiaries. Part II.A reviews some of the

case law that has developed with respect to these issues. Parts II.B and II.C discuss two

particular areas of PACA case law in which there have been substantial recent developments,

and notes the existence of an interesting doctrinal tension between these areas. This tension is

further explored in Part III.



                                                 10
A. Some Interesting Case Law


1. What is a PAC?


        Courts have held that ―unprocessed or very minimally processed fruits and vegetables‖

are PACs as long as the processing has not changed the items’ ―essential nature.‖21 For example,

courts have held that drying, slicing, pitting, or adding sweetening agents to products does not

alter them such that they are no longer PACs.22 It is not always clear, however, when certain

types of processing will be deemed to have changed an item’s ―essential nature‖ or to have

created ―articles of food of a different kind or character.‖23 A review of some of the case law

and regulations relating to the humble potato illustrates the difficulty—and often absurdity—of

differentiating among various types of processing.

        Raw French fries to which oil has been added as a preparatory step for cooking have been

held to fall outside PACA.24 However, potatoes that have been blanched with oil (i.e., oil has

been added to prepare them for freezing or preservation) have been held to fall within PACA.25

Processing steps that include other substances further complicate the issue. In re Long John

Silver's Restaurants Inc.26 was a 1999 case involving the estate of a bankrupt restaurant chain.

The court faced the question of whether raw French fries that had been coated with a special

batter in preparation for cooking retained the ―essential nature‖ of raw potatoes.27 If they did,

they would fall within the PACA trust and outside the bankruptcy debtor’s estate; the potatoes

21
   A&J Produce Corp. v. CIT Group/Factoring, Inc., 829 F. Supp. 651, 658 (S.D.N.Y. 1993).
22
   7 C.F.R. § 46.2(u).
23
   Id.
24
   See A&J Produce at 658.
25
   See Endico Potatoes, Inc. v. CIT Group/Factoring, Inc., 67 F.3d 1063, 1067 (2nd Cir. 1995).
26
   230 B.R. 29 (Bankr. D. Del. 1999).
27
   The batter supposedly enabled the fries to remain crispy while they rested under heat lamps for long periods of
time. Thomas J. Salerno, Last in Line: “You Want Fries with That?” Or, How to Batter Yourself out of PACA
Protections. 1999 ABI JNL LEXIS 64, 3.


                                                       11
and any proceeds derived from their sale would then be available solely for the benefit of unpaid

suppliers. If the ―specially engineered‖ batter coating changed the potatoes into ―food of a

different . . . character,‖ however, the battered fries would fall outside the PACA trust; and the

fries and their proceeds would then be available for distribution to all unsecured creditors. The

Long John Silver’s court decided that adding batter to potatoes falls in the middle of the

spectrum between oil blanching (which does not change the potatoes’ ―essential nature‖) and

breading (which does change the ―essential nature‖ of products28)—but, alas, on the side that

excludes the suppliers of those potatoes from PACA protection.29


2. Tracing Proceeds and the Burden of Proving Trust Dissipation


         The Fifth, Sixth and Eighth Circuits have held that the defendant of a PACA claim bears

the burden of proving that disputed assets were not acquired using proceeds from the sale of

PACs.30 This is a difficult burden for a defendant to meet, because tracing the origin of disputed

assets may not be possible. However, courts have justified placing this burden on defendants by

pointing to legislative history, noting that Congress ―enacted the 1984 Amendments to protect

what it determined to be an especially vulnerable class.‖31 In contrast, under ordinary trust law

principles, the plaintiff bringing a claim would bear the burden of proving that disputed assets

had been purchased with trust assets or the proceeds of trust assets.32




28
    See Endico Potatoes at 1071.
29
    See Salerno at 3.
30
   See Sanzone-Palmisano Co. v. M. Seaman Enterprises, 986 F.2d 1010, 1014 (6th Cir. 1993); Six L's Packing Co.
v. West Des Moines State Bank, 967 F.2d 256, 258 (8th Cir. 1992); In re Gotham Provision Co. Inc., 669 F.2d 1000,
1011 (5th Cir. 1982).
31
    Sanzone-Palmisano at 1013.
32
    See Restatement (Second) of Trusts § 202 (―Where the trustee by the wrongful disposition of trust property
acquires other property, the beneficiary is entitled . . . to enforce a constructive trust of the property so acquired . . .
as long as the product of the trust property is held by the trustee and can be traced.‖) (emphasis added).


                                                            12
        Going even further, the Second Circuit has held that assets acquired by a defendant prior

to the time that a specific PACA claim arises can still be subject to a PACA trust, because PACA

creates a non-segregated, floating trust that exists for the benefit of all PACA creditors until

those creditors are paid in full. 33 The Second Circuit suggested that a defendant could

successfully argue that certain previously acquired assets should not be subject to PACA only by

showing one of the following: (i) no PACA trust existed at the time the assets were acquired; or

(ii) although a PACA trust existed when the assets were acquired, (a) the assets were not

acquired with PACA trust assets, or (b) the PACA trust was terminated prior to the time that the

plaintiff’s claim arose because unpaid suppliers, sellers, and agents were paid in full prior to the

transaction involving the plaintiff. 34


3. Preserving PACA Trust Rights


        According to current regulations, full payment for PACs is generally due no later than ten

days after the products are accepted by the commission merchant, broker, or dealer. 35 Therefore,

to preserve the benefits of a PACA trust, a seller, supplier, or agent generally must file written

notice within forty days—the ten-day payment period plus the thirty-day notice period set forth

in the statute—after the PACs are accepted by the purchaser.

        Courts have adhered fairly strictly to the time guidelines set forth by the PACA statute

and regulations, a position that favors unpaid suppliers. Courts have held, for example, that

neither parties’ oral agreement to extend the time period for payment nor a course of dealing that




33
   See In re Kornblum & Co., 81 F.3d 280, 286 (2nd Cir. 1996).
34
   Id.
35
   7 C.F.R. § 46.2(aa).


                                                       13
involves such an extension waives PACA trust protection for creditors. 36 Any agreement to

extend the time period must be in writing and properly recorded as specified in the statute. Most

recently, the First Circuit held that partial compliance with the statute’s time guidelines will

result in partial PACA trust protection. In Hiller Cranberry Products v. Koplovsky,37 the court

considered a written agreement that provided that 75 percent of the purchase price would be paid

within ten days of the invoice, with the remainder to be paid over sixty days. The court held that

the 75 percent for which payment was due in ten days fell within the protection of the PACA

trust provisions.38


B. Eroding Protection for Suppliers—Lenders as Bona Fide Purchasers from the Trust


         Because the PACA trust provisions require that PACs and their proceeds be held in trust

for the benefit of unpaid suppliers, unpaid suppliers typically can recover from a lender who has

received payments from trust assets ahead of its turn. In the numerical example given in Part

I.B, if the Bank had recovered 100% on its claim ahead of ProduceCo, ProduceCo could have

brought an action against the Bank to recover the remaining 57% of its unpaid claim.

         An interesting and still developing area of case law deals with whether and when a lender

can claim that it was a bona fide purchaser from a PACA trust. Under ordinary trust law

principles, a bona fide purchaser of trust assets—i.e., one who takes the property for value,

without notice of the breach, and without knowingly taking part in an illegal transaction—takes

those assets free from any claim by trust beneficiaries. 39 The bona fide purchaser doctrine



36
   See, e.g., Hull Co. v. Hauser’s Foods, Inc., 924 F.2d 777, 782 (8th Cir. 1991); Continental Fruit Co. v. Thomas J.
Gatziolis & Co., Inc., 774 F. Supp. 449, 452 (N.D. Ill. 1991).
37
   165 F.3d 1, 11-12 (1st Cir. 1999).
38
   Id.
39
   Restatement (Second) of Trusts § 284.


                                                         14
facilitates commerce by encouraging parties to engage in good faith transactions without

conducting expensive and time-consuming research into the detailed history of each transaction.

           Under ordinary trust law principles, trust assets transferred in satisfaction of a previous

debt are not considered transferred ―for value‖ unless the property is money. The rationale

behind the money exception is that ―the payee of money in due course of business [should] not

be put upon inquiry at his peril as to the title of the payor.‖ 40 Since money is, after all, the

common currency of business transactions, placing such a burden on a recipient of mere money

would add considerable time and delay to most business dealings. A lender who receives money

from a PACA trust is therefore able to retain that money—regardless of outstanding claims by

unpaid suppliers—as long as the lender qualifies as a bona fide purchaser.

           Courts have been mixed, however, in their willingness to grant bona fide purchaser status

to lenders that occupy seemingly similar situations. The Second Circuit and its district courts

have been among the most strict, imposing on lenders a duty of inquiry as to whether the trust

has been breached, and suggesting that a lender will not be able to take trust assets free of unpaid

suppliers’ claims if the lender has constructive knowledge of a trust breach. A lender might be

deemed to have had constructive knowledge of a breach if, for example, the lender regularly

reviewed the borrower’s financial statements and thus arguably should have noticed that a

borrower was experiencing cash flow problems and potentially using PACA trust assets to make

loan payments. Recently, in Albee Tomato Co. Inc., et al. v. Korea Commercial Bank of New

York,41 the U.S. District Court for the Southern District of New York held that a bank that had

accepted a produce merchant’s financial statements and lists of accounts, without inquiring

whether the merchant could satisfy its debts to prior creditors, could not have been a bona fide


40
     Austin W. Scott & William F. Fratcher, THE LAW OF TRUSTS, 304 (4th ed. 1989).
41
     2003 U.S. Dist. LEXIS 1616 (S.D.N.Y. Feb. 4, 2003).


                                                        15
purchaser because the bank had ―ignored important signals that [the merchant] faced financial

difficulties.‖42

        Courts in the Second Circuit have also been reluctant to grant bona fide purchaser status

to lenders who take a security interest in working capital rather than purchasing the accounts

outright. Ten years ago, in A&J Produce v. CIT Group/Factoring, Inc.,43 the U.S. District Court

for the Southern District of New York held that a lender that had exercised its rights to take

collateral under a security agreement was not a bona fide purchaser because the foreclosure

amounted to ―forc[ing] the transfer of trust property in satisfaction of an antecedent debt,‖ and

any such transfer—even of money—could not qualify as a transfer for value. 44 The Second

Circuit subsequently held in Endico Potatoes v. CIT Group Factoring, Inc. that lenders that

receive PACA trust assets as loan payments do not receive those assets free of unpaid suppliers’

claims, if the lender did not actually purchase the accounts receivable but only received

payments pursuant to a security interest in those accounts.45

        Fortunately for lenders, but unfortunately for produce suppliers, the Second Circuit’s

view appears to be the minority one among circuit courts. The Third and Eleventh Circuits have

exhibited considerable willingness to protect secured lenders from having their loans ―primed‖

by unpaid suppliers, holding that a lender who receives loan payments out of PACA trust assets

takes those assets free of unpaid suppliers, so as long as the lender does not have actual notice of

the breach of trust. In the landmark case C.H. Robinson Co. v. Trust Co. Bank, N.A.,46 unpaid

sellers of PACs attempted to recover, after the purchaser’s bankruptcy filing, loan payments that

had been made to two of the purchaser’s banks. The Eleventh Circuit held that although a

42
   Id. at 24.
43
   829 F. Supp. 651, 658 (S.D.N.Y. 1993).
44
   Id. at 656 – 57.
45
   Endico Potatoes v. CIT Group Factoring, Inc., 67 F.3d 1063 (2nd Cir. 1995).
46
   952 F.2d 1311 (11th Cir. 1992).


                                                        16
transfer of the actual inventory to the banks would have been subject to the PACA trust, a

transfer of money in satisfaction of the purchaser’s outstanding debts was not.47 The court also

held that knowledge of the existence of the trust was not sufficient to destroy the banks’ status as

bona fide purchasers. Instead, the banks could take loan payments ―free and clear of the trust

although [they] had notice of the existence of the trust, unless [they] had notice that the trustee

[had] committed a breach of trust in making the transfer.‖48 The C.H. Robinson court attempted

to distinguish the banks’ position in that case from the position of lenders in cases such as

Endico Potatoes, noting that the banks in C.H. Robinson had received payments on outstanding

term loans rather than payments on revolving inventory or accounts receivable lines which might

be considered more directly tied to trust assets.49

        Similarly, in a subsequent case, Sheppard v. KB Fruit & Vegetable, Inc., 50 the U.S.

District Court for the Eastern District of Pennsylvania held that lenders who received PACA trust

funds in repayment of outstanding loans could qualify as bona fide purchasers unless they were

actually aware that they were receiving funds in breach of the trust. The court pointed to the

Restatement (Second) of Trusts § 297, comment (c), which suggests that notice of a trust breach

encompasses three elements: knowledge of the trust’s existence, knowledge of the nature of the

trust, and knowledge that a trustee is improperly deviating from trust terms.51 Of course, it is far

easier for a lender to disavow notice of a breach of trust under this test than under the doctrine of

constructive breach endorsed by the Second Circuit.

        The requirement that lenders possess actual knowledge that specific payments have been

made in breach of the PACA trust, before those lenders will be disqualified as bona fide

47
   Id. at 1312.
48
   Id. at 1314 (emphasis added).
49
   Id. at 1316.
50
   1993 U.S. Dist. LEXIS 1933 (Jan. 12, 1993).
51
   Id.at 9-11.


                                                  17
purchasers, constitutes a significant erosion of PACA trust protection for suppliers. The C.H.

Robinson court justified its imposition of the actual knowledge requirement by arguing that

―absent specific instructions to the contrary, Congress must have intended for [the PACA] trust

to operate according to settled principles of trust law.‖52 However, both the lessened protection

for PAC suppliers and this quick judicial explanation raise certain questions.           First, the

assumption that Congress intended PACA trusts to operate under ordinary trust law principles in

this context may not be appropriate. Courts have recognized in other contexts—such as the

tracing of proceeds discussed in Part II.A—that PACA trusts do not always operate in the same

fashion as do ordinary trusts. PACA trusts are unique in that they are non-segregable and

floating—i.e., the trust continues in existence until all unpaid suppliers are paid in full. Thus a

PACA claimant whose transaction with a purchaser took place before the purchaser acquired

certain trust assets still has a claim on after-acquired assets. If courts do not regularly apply

ordinary trust law principles to trace PACA trust proceeds, is it fair for courts to quickly assume

that Congress would have intended doctrines such as constructive breach to be used in

determining whether parties have taken free of a PACA trust? Courts have applied general trust

principles despite recognizing that a mandate to do so is not ―expressly stated in PACA.‖53

           In addition, one can make an argument of the type commonly raised in disputes over

statutory interpretation—i.e., that Congress knew how to indicate that ordinary trust principles

should be used in applying PACA and would have put this language in the statute if it meant to

do so.


C. Increasing Protection for Suppliers—Expanding the Identity of “Dealers” Subject to
the Trust


52
     Id.
53
     Endico Potatoes, 67 F.3d at 1067.


                                                18
        Courts’ recent narrowing of protection for PAC suppliers, through application of ordinary

trust law principles and loose interpretation of the bona fide purchaser doctrine, stands in

contrast to another recent trend in PACA jurisprudence: an expansion in the identity of parties

that may qualify as ―dealers‖ under the statute. In March 2000, the Third Circuit held in In re

Magic Restaurants that restaurants that purchase annually more than $230,000 of PACs in

―wholesale or jobbing‖ quantities qualify as ―dealers‖ under the plain language of the statute.54

The Eighth and Ninth Circuits soon followed the reasoning of the Magic Restaurants court. 55

        Prior to Magic Restaurants, only the ―buying arms‖ of restaurants—separate legal entities

that buy and resell PACs to a restaurant—had been considered subject to PACA.56 Expanding

the definition of ―dealers‖ to include restaurants appreciably increased the number of entities

potentially subject to the statute. Interestingly, despite a broader judicial definition of ―dealers,‖

the Department of Agriculture, the federal agency charged with administering PACA, does not

itself consider restaurants ―dealers.‖ 57 The Magic Restaurants court justified its contrary

position by reasoning that restaurants clearly meet the plain meaning of ―dealer‖ under the

statute and noting that ―a reviewing court should not defer to an agency position which is

contrary to an intent of Congress expressed in unambiguous terms.‖58 The court also argued that

a more expansive definition for ―dealers‖ is beneficial from a public policy perspective. The

court noted that ―the 1984 amendments, including the trust provision, were enacted for the

protection of all produce sellers and suppliers,‖ and contended that ―[h]olding restaurant-

54
   205 F.3d 108, 115 (3rd Cir. 2000).
55
   See In re Old Fashioned Enterprises, Inc., 236 F.3d 422, 427 (8th Cir. 2001); Royal Foods Co., Inc. v. RJR
Holdings, Inc., 252 F.3d 1102, 1109 (9th Cir. 2001).
56
   H. Bruce Bernstein, Restaurant Chain is a “Dealer” Subject to PACA Trust Provisions, THE SECURED LENDER,
Jan./Feb. 2001.
57
   The Magic Restaurants court acknowledged that ―[the DOA’s] consistent practice for seven decades since
PACA's enactment has been to deny that the statute gives it jurisdiction over restaurants.‖ Magic Restaurants at
114.
58
   Id. at 114-15 (quoting Estate of Cowart v. Nicklos Drilling Co., 505 U.S. 469, 476 (1992)).


                                                      19
purchasers responsible to produce sellers . . . provides protection of produce suppliers up through

the distribution chain and therefore furthers the purposes of the trust provision.‖59


Part III. Reconciling Contradictory Trends and Conclusion


         Just as not all courts have followed the Third and Eleventh Circuits’ generous application

of the bona fide purchaser doctrine to PACA, not all courts have followed the Magic Restaurant
                                                                         60
court’s lead in classifying ―restaurants‖ as ―dealers.‖                        However, both jurisprudential

movements have gathered sufficient force that the trends—and the seeming contradiction

between them—are worth exploring. On one hand, employing ordinary trust law principles to

make it harder for unpaid suppliers to ―prime‖ secured lenders significantly curtails protection

for produce suppliers under the PACA. On the other hand, a broader definition of ―dealer‖

greatly expands supplier protection by vastly increasing the statute’s reach. Why—and how—

have both of these trends emerged?

         The reasoning employed in the individual cases that embody these movements offers

some clues. Although the effects of the two judicial movements conflict with one another, they

still may be viewed as complementary. Both are motivated by courts’ desire to fulfill the

original Congressional intent behind PACA: facilitating the commercial flow of PACs. Courts

that interpret the bona fide purchaser doctrine to exclude lenders with constructive—but not

actual—notice of a breach of trust state do so to encourage more lenders to offer capital to PAC

merchants and dealers.61 Likewise, courts that liberally interpret ―dealer‖ to include restaurants




59
   Id. at 116.
60
   See, e.g., In re Old Fashioned Enterprises, Inc., 245 B.R. 639, 643-44 (D. Neb. 2000).
61
   See, e.g., C.H. Robinson at 14 (―[I]mposition of strict liability has the ironic effect of placing . . . the secured
lender, in a worse position than [another party] whose loans were unsecured. We decline to endorse such a rule.‖).


                                                          20
do so with the hope of encouraging PAC commerce by better protecting PAC suppliers.62 One

can reconcile these two trends in PACA jurisprudence, then, by recognizing that courts that reach

―pro-supplier‖ decisions and courts that reach ―pro-lender‖ decisions share the common goal of

creating PACA case law that is pro-system. ―PACA was not intended to protect those in debtor's

shoes, but rather to prevent the chaos and disruption in the flow of perishable agricultural

commodities sure to result from an industry-wide proliferation of unpaid obligations."63

        Of course, the fact that these two jurisprudential trends stem from a common objective

does not make the results any less incongruous. It is likely that these movements continue in

opposite directions because courts remain uncertain about the extent to which PACA ought to be

applied to facilitate commerce in situations where the statute arguably conflicts with other

laws—such as general fiduciary trust principles and the federal Bankruptcy Code—that are

designed to achieve similar goals in a broader, non-PAC context.

        One concern with the current jurisprudence is that although the doctrinal tension appears

to have arisen from disagreement over how best to facilitate PAC commerce, inconsistent

judicial application of the statute is likely in fact to stifle commerce—hence the vow by some

lenders to ―never lend on anything that grows.‖64 Law and economics scholars comment that

―[h]ow readily laws may change or evolve will affect their predictability and, relatedly, the costs

incurred when seeking legal advice.‖65 Courts have drawn on different bodies of law while in

pursuit of the same goal—but in doing so, risk losing the goal altogether. Courts presiding over

future PACA disputes might therefore wish to consider how to configure their holdings and/or

dicta in a way to create a more coherent body of case law.
62
   See, e.g. Magic Restaurants at 114.
63
   In re Country Club Market Inc., 175 B.R. 1005, 1008 (D. Minn. 1994), citing In re Fresh Approach Inc., 51 B.R.
412, 420 (Bankr. N.D. Texas 1985).
64
   See supra text accompanying note 1.
65
   Louis Kaplow, Rules versus Standards: An Economic Analysis, 42 DUKE L.J. 557, 617 (1992); see also id. at 611-
20.


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