PACA Trust Does Not Prevent Chapter 11 DIP’s Use Of Cash Collateral

Overview

In 1930, the Congress enacted the Perishable Agricultural Commodities Act (PACA) to address unfair and fraudulent practices in the marketing of perishable agricultural commodities in interstate and foreign commerce.  7 U.S.C. §§ 499a et seq.  A provision in the PACA requires a covered “dealer” to “promptly pay” for the purchase of perishable agricultural commodities.  One way that the PACA ensures prompt payment is via the creation of a PACA trust to hold the proceeds of the sale of perishable commodities for the for the benefit of the unpaid seller until full payment is made. 7 U.S.C. § 499e(c)(2).   

This PACA trust provision was added in 1984 to address the problem of buyers filing bankruptcy after purchasing perishable commodities, but before full payment was made.  Basically, once an unpaid seller learns that a buyer has become insolvent, a PACA trust is created and the PACA trust funds (amounts owed to the seller) are escrowed for pro rata distribution to the PACA trust beneficiary or beneficiaries.  The point is that the assets in a PACA trust are excluded from the bankruptcy estate of a bankrupt buyer.

A recent case involved an interesting question - whether the PACA trust bars a bankruptcy debtor-in-possession (DIP), from using the cash collateral of the PACA trust in the continued operation of the DIP’s business.  Is the status of the perishable commodity seller as a PACA trust beneficiary sufficient, by itself, to bar the DIP’s use of the cash collateral?

The rights of a DIP to use cash collateral of a PACA trust, that’s the topic of today’s post.

Chapter 11 and the DIP

A DIP is a party (individual or corporation) that has filed a Chapter 11 (reorganization) bankruptcy petition.  While creditors of the DIP have liens in the DIP’s property, the DIP remains in control of the property and continues to operate the underlying business.  The DIP essentially continues to operate the business in a fiduciary capacity for the creditors’ best interest.  Thus, ordinary business operations are permissible, but the DIP has to get court approval for actions that are beyond the scope of normal business practices.    

Recent Bankruptcy Case

In a recent Chapter 11 bankruptcy case, In re Cherry Growers, Inc., No. 17-04127-swd, 2017 Bankr. LEXIS 3838 (W.D. Mich. Nov. 1, 2017), the debtor, as a Chapter 11 DIP, filed a motion for an order authorizing its use of cash collateral.  A bank, the DIP’s principal secured creditor, supported the motion.  However, a claimant asserting PACA rights opposed the motion because, in its view, such an order would violate the claimant’s PACA trust rights as well as the rights of others as beneficiaries of the PACA trust.

As mentioned above, the PACA creates a statutory trust to protect growers of perishable agricultural products against the risk of non-payment by buyers and others.  A PACA claimant, as a seller of eligible produce, has a trust claim against the qualifying inventory and proceeds that is superior to the claims and liens of the buyer’s creditors with no regard to whether the creditors are secured or unsecured and without regard to the priority level of the claim.  Under the facts of the case, the claimant held an equitable interest in the bankruptcy estate with respect to its $337,159.18 PACA claim, and the question before the court was whether that equitable interest was sufficient to deny the debtor’s requested (and otherwise consensual) use of its secured lender’s cash collateral, especially where a sufficient equity cushion existed to adequately protect the PACA claimant’s claim.

The court held an interim hearing on the motion at which it took testimony, granted interim relief and scheduled a final hearing. At the final hearing PACA claimant argued that its PACA claim reached all of the DIP’s property, at least if the DIP could not prove otherwise.  The claimant asserted that its status as PACA trust beneficiary was sufficient to bar a debtor from utilizing the cash collateral.  The claimant also argued that in the absence of proof the contrary from the DIP, all income derived during the case from any of the property in the DIP’s possession, would constitute proceeds of the PACA trust, and that the DIP could not use any of the property because it belonged to the PACA claimant and not the bankruptcy estate.

The court did note the power of the PACA trust.  Specifically, the court pointed out that, under PACA, growers and suppliers of perishable agricultural products who have properly preserved their rights under the statute are entitled to the benefit of a broad and powerful “floating trust” in their buyer’s qualifying inventory and proceeds thereof. These trust claims are to be paid first from trust assets, even prior to any claims or interests of secured creditors in such property. Furthermore, the court noted that the commingling of trust assets is specifically contemplated under the federal regulations implementing PACA. As the court recognized, PACA is “designed to promote priority payment to the PACA claimant.” 

However, the court held that to conclude that the subject matter of the PACA trust is excluded from the bankruptcy estate overstated the case holdings that the PACA claimant cited.  Instead, the court determined that the PACA expressly contemplates the commingling of trust and non-trust property, the creation of a “floating trust,” and the continued operation of the PACA trustee. Thus, within the context of a Chapter 11 bankruptcy, the DIP presumptively continues operating its business in accord with applicable non-bankruptcy law.  In turn, the court reasoned, this meant that it made sense to think in terms of permitting the DIP to use its buildings and equipment to conduct its business as it had done for years, along with the cash and cash equivalents derived from that use, even though they may be impressed to some extent with a statutory trust, as long as the DIP provides adequate protection of the PACA claimant’s interest in the estate property. In addition, because the value of the property of the estate that the PACA claimant believed to be impressed with the PACA trust far exceeded the claimant’s claim, the court concluded that the DIP had met its burden of showing that the claimant would be adequately protected. Therefore, the court granted the DIP’s motion authorizing the use of the cash collateral in the property in which the PACA claimant had an equitable interest, in accordance with 11 U.S.C. §363 “as long as the DIP provides adequate protection of [the PACA claimant’s] interests in the estate property.”  Because the DIP’s property that the PACA claimant alleged was subject to the PACA trust was much greater than the PACA claimant’s $337,159.18 claim, the court found that the PACA claimant’s interests were adequately protected.

The court also disagreed with the PACA claimant’s assertion that the DIP bore the burden of proof that the property that the DIP wanted to utilize in its business operations were not property of the PACA trust.  Instead, the court determined that the PACA claimant had to first prove that the claimant had an interest in the DIP’s property.  After that, the DIP had to establish that adequate protection was provided to the PACA claimant.  In so holding, the court distinguished a contested matter under 11 U.S.C. §363 from that involving a battle of competing property interests. 

Conclusion

What’s the “take-home” from the court’s decision?  Certainly, PACA claimants have substantial rights.  But, there are limits on those rights.  In addition, according to the court, a PACA claimant’s equitable interests in the PACA trust are not bankruptcy estate property, but the assets themselves are under 11 U.S.C. §541.  The case could also indicate that DIPs may have more leverage with creditors in getting authority to use cash collateral to conduct continuing business operations.