Fifth Circuit Rules for PACA Claimants, and Weakens PACA, All in One Curious Ruling

February 15, 2017

by: Leah Fiorenza McNeill

Set of colored vegetables for kids

Most restructuring practitioners are aware, either vaguely or through punishing experience, of the power of PACA creditors.  PACA (or the Perishable Agricultural Commodities Act, 7 U.S.C. § 499a et seq. for those who hate brevity) requires that buyers of produce hold such produce – and their proceeds – in trust for the benefit of produce sellers.  General creditors of the produce buyer receive nothing, even if they hold a lien on the buyer’s assets, until produce sellers are paid in full on any valid PACA claims (including their interest and attorneys’ fees in most instances).

But sometimes, or many times, the PACA trust assets needed to pay produce sellers are not present.  Accounts must be collected, by use of employees, lawyers, collection agents, or other parties.  Inventory must be preserved and then sold, incurring further costs.  In short, assets to pay PACA claims don’t magically appear, and if no one is paid to pound the pavement to sell that inventory and collect those funds, nothing will be collected, and nobody gets paid.

The Bankruptcy Code deals with the problem very simply.  If assets are being collected for the benefit of unsecured or priority creditors, the post-petition costs and expenses incurred to liquidate such assets are granted first priority of payment.  11 U.S.C. § 503(b)(1)(A).  Alternatively, if assets are being collected (or costs incurred) for the benefit of a secured creditor, the secured creditor’s collateral can (and should) be surcharged.  11 U.S.C. § 506(c).  If the secured creditor complains or balks, the trustee or DIP can (and should) abandon the collateral and force the secured creditor to pay its own costs to liquidate the collateral.

However, a recent Fifth Circuit opinion rejects this common sense approach when PACA is involved.  In Kingdom Fresh Produce, Inc. v. Stokes Law Office (In re Delta Produce), the Fifth Circuit held that the trust structure of PACA mandates that produce sellers be paid in full even prior to the costs of counsel which collected every single dollar needed to pay those very produce sellers’ claims.

The case has limited reasoning.  It borrows from cases holding that PACA creditors are ahead of secured creditors or other creditors, and expands that principal to cover everything.  A utility keeps the power on at the food warehouse so the inventory can be preserved and sold?  That is a foolish utility, unless it knows to a certainty the proceeds can pay PACA sellers in full, leaving funds left over to pay the utility bills.  Employees show up to make collection calls, or process payments?  Good luck getting paid for such efforts, if despite their work funds are insufficient to pay PACA claims in full.  In short, Kingdom Fresh turns a food business in wind-down into a charity for the benefit of PACA claimants, with everyone providing pro bono service to enhance the PACA trust.

Kingdom Fresh recognizes this “free rider problem“: why would anyone work even one iota for an insolvent produce buyer, if payment for their efforts comes behind all the PACA claimants?  But while the Kingdom Fresh Court notes this problem, its proposed solutions are, frankly, illusory.  The Court notes (remarkably, in the view of The Bankruptcy Cave) many professionals will be willing to work to collect assets for PACA creditors, and bear the risk of their fees being behind millions of dollars of such PACA creditors.[1]  Wow.  Second, the Fifth Circuit states that a court-appointed Special Master could do the collections work.  Yet this is not at all what Special Masters do under Federal Rule 53.  Third, the Kingdom Fresh Court notes that PACA allows recovery of attorneys’ fees – and so presumably attorneys working for the estate to collect A/R can get paid from the account debtors?  We guess so, but this is also speculative.  And who is to say the unpaid produce sellers cannot glom onto an attorneys’ fee award the same way they have a senior interest in an underlying claim or judgment owed by a third party to a debtor?  The opinion is silent.

Kingdom Fresh can be viewed as a victory for produce sellers and other beneficiaries of PACA – once again, such creditors are declared to be first among all other creditors.  But its slavish devotion to PACA renders every insolvency case involving the sale of produce much harder – things will grind to a halt until professionals employed to collect and liquidate assets negotiate with PACA creditors to be paid.  By depriving courts of the power to surcharge PACA trust assets, collection of those assets will be delayed or just won’t happen at all.  No one benefits, not even those which PACA is supposed to help.  Kingdom Fresh is, in fact, one of the most anti-PACA cases we at The Bankruptcy Cave have seen, despite its protestations to the contrary.

[1] This is an astounding and unsupported assumption. People taking on greater risk need greater compensation.  No one will take on risk of non-payment for free.