With the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, debtor's counsel are on the lookout for newly formed dangers, traps and pitfalls. However, many hurdles to reorganization are of an older vintage but remain just as difficult as their newly-minted counterparts.

A Brief Perusal of PACA

Congress enacted the Perishable Agricultural Commodities Act (PACA) (7 U.S.C. §§499a et seq.) in 1930 "to promote fair trading practices in the marketing of perishable agricultural commodities, largely fruits and vegetables." In re Magic Rest. Inc., 205 F.3d 108, 110 (3rd Cir. 2000) (citations omitted). PACA protects growers, producers, sellers and suppliers of "perishable agricultural commodities"¹ in the event such grower, producer, seller or supplier of such goods is not paid in full by a commission merchant, dealer or broker. In re Fleming Cos., 316 B.R. 809, 811 (D. Del. 2004). The aim of PACA, at the time of its enactment, was to curtail buyers and dealers from simply rejecting shipments from producers when the market price for ordered produce fell below the contract price between the parties. Leonard, Nicole, "The Unsuspecting Fiduciary, The Curious Case of PACA and Personal Liability," ABI Journal (May 2006).

One of PACA's mechanisms for protecting growers, producers, sellers and suppliers of perishable agricultural commodities is to impose a trust on (1) all perishable agricultural commodities received by the commission merchant, dealer or broker; (2) all inventories of food or products derived from such perishable agricultural commodities; and (3) any receivables or proceeds from the sale of such perishable agricultural commodities. 11 U.S.C. §499e(c)(2); In re Magic Rest. Inc., 205 F.3d at 111. PACA requires growers, producers, sellers and suppliers to "opt in" to the trust and its protections. 11 U.S.C. §449e(c)(3).

The easiest and most common method for opting in to the PACA trust is to place certain statutory language in a billing statement or invoice.² Another mechanism for protecting growers, producers, sellers and suppliers of perishable agricultural commodities employed by PACA is that wholesale commission merchants, dealers and brokers must be licensed by the Secretary of Agriculture to deal in perishable agricultural commodities, and that such license can be revoked or terminated by the Secretary for failure to comply with the provisions of PACA. 7 U.S.C. §§499c-d.³

PACA and Who?

PACA applies to commission merchants, dealers and brokers. See generally 7 U.S.C. §§499b, c and e and 7 C.F.R. §46.2. Generally speaking, a debtor's counsel knows whether or not his or her client is a commission merchant or a broker. The more difficult analysis is whether or not a debtor qualifies as a dealer under PACA. PACA defines a dealer 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...." 7 U.S.C. §499a(b)(6). Congress then proceeded to carve out three exceptions to a dealer under PACA: (1) no producer can be a dealer with respect to produce raised by the producer; (2) no buyer of produce purchased solely for sale at retail can be a dealer until the invoice cost of such purchases in any calendar year exceeds $230,000; and (3) no buyer of produce other than potatoes for canning and/or processing in the same state in which it is grown can be a dealer unless such product is frozen or packed in ice or consists of the omnipresent cherries in brine. Id.; see also 7 C.F.R. §46.2(m).

Much of the uneasiness surrounding PACA's definition of "dealer" arises from the Third Circuit's decision in In re Magic Restaurants Inc. in which it found, as a matter of first impression, that an owner of 13 restaurants that purchased more than $230,000 in perishable agricultural commodities qualified as a dealer under the plain language of PACA. See In re Magic Rest. Inc., 205 F.3d at 117; see also Royal Foods Co. v. RJR Holdings Inc., 252 F.3d 1102 (9th Cir. 2001) (restaurant qualifies as dealer under PACA), and In re Old Fashioned Enterprises Inc., 236 F.3d 422 (8th Cir. 2001) (same). The Third Circuit made this finding even though the congressional history behind PACA and its subsequent amendments, as well as the U.S. Department of Agriculture's (USDA) refusal to exercise jurisdiction over restaurants for nearly 70 years. In re Magic Rest. Inc., 205 F.3d at 117. Although no decision has expanded the reach of PACA past restaurants, it is not far-fetched to see the definition of dealer expanded to nursing homes, hospitals, prisons and other institutional entities that purchase large amounts of perishable agricultural commodities. See 3 Ruda, Howard, Asset Based Financing: A Transactional Guide, §30.07[2] (Matthew Bender Co. 2006).

PACA's Cash Use and DIP Financing Punch

At first blush one would wonder what impact PACA would have on a debtor's ability to reorganize. However, PACA packs quite a punch on a debtor's ability to use cash collateral or obtain debtor-in-possession (DIP) financing. First, PACA's rules and regulations are exempted from the automatic stay pursuant to 11 U.S.C. §362(b)(4). Therefore, a bankruptcy petition will not stay a proceeding by the Secretary under PACA.

More troublesome, however, are PACA's trust provisions. Section 541(d) of the Code exempts assets held in trust from property of the estate. In addition, the trust imposed by PACA is the equivalent of a super-priority lien on the corpus of the trust, priming even properly perfected, first-priority secured creditors. 7 U.S.C. §499e(c).

The effect of these provisions is that a cash-strapped debtor is deprived of a potentially large sum of accounts receivable, both pre-petition and post-petition, which are now held in trust for growers, producers, sellers and suppliers of perishable agricultural commodities. In addition, the debtor's lienable inventory, for all intents and purposes, no longer includes any food or other products derived from perishable products. This hit on a troubled debtor's available accounts receivable and inventory at a time when every dime is crucial to the reorganization effort, can have a crippling effect on debtor's counsel's ability to negotiate cash use with the debtor's existing lender or obtaining DIP financing.

The pain of PACA's trust provisions can be lessened somewhat if the debtor has hoarded sufficient cash prior to filing its petition. PACA's trust provisions contemplate a floating trust and the commingling of trust and nontrust assets. 7 C.F.R. §46.46(b). Therefore, the debtor may be able to satisfy PACA's trust requirements without affecting accounts receivable and inventory (1) if the debtor has sufficient cash on hand to cover its estimated PACA exposure, and (2) the USDA finds the amount set aside to be sufficient to cover what it believes to be the debtor's estimated PACA exposure. If the debtor has not hoarded sufficient cash, debtor's counsel must negotiate the trust monies into (or more accurately, out of) the debtor's budget.

PACA's Licensing Dilemma

The most perplexing and counterintuitive impact PACA has on a debtor's ability to reorganize are its archaic licensing requirements. When crafting a reorganization plan, debtor's counsel must appease a myriad of constituencies, obtaining the consent of each class or, under a cramdown plan, the consent of at least one impaired class. All of that effort, however, can be mooted as soon as the plan is confirmed, courtesy of PACA.

Section 499d(a) provides, in part, that the "license of any licensee shall terminate upon said licensee, or in the case the licensee is a partnership, any partner, being discharged as a bankrupt, unless the Secretary finds upon examination of the circumstances of such bankruptcy, which he shall examine if requested to do so by said licensee, that such circumstances do not warrant such termination." See also 7 C.F.R. §46.9(b). Therefore, a debtor's reorganization plan that contains any sort of discharge, once confirmed, also serves to terminate the debtor's PACA license absent the intervention of the Secretary. In the case of a restaurant, grocer or other debtor covered by PACA, this automatic termination has the effect of preventing the reorganized debtor from doing business on a go-forward basis. This discrimination against bankrupt entities runs afoul of 11 U.S.C. §525 and its prohibition against discriminatory treatment; however, Congress specifically exempted PACA from this anti-discrimination provision. As far as PACA is concerned, confirmation of a reorganization plan is only the first of two steps that a bankrupt commodities merchant, dealer or broker must take. The second step is obtaining a new license under PACA.

A newly reorganized, and therefore PACA license-less, debtor must apply for a new license in order to deal in perishable commodities. The application process for a reorganized debtor is the same as it is for any PACA license applicant. However, the Secretary may refuse to issue a license to an applicant that was adjudicated or discharged as a bankrupt within three years of the application if such circumstances warrant the refusal "unless the applicant furnishes a bond of such nature and amount as may be determined by the Secretary or other assurance satisfactory to the Secretary that the business of the applicant will be conducted in accordance with this Act." 7 U.S.C. §499d(e).⁴ Debtor's counsel can anticipate that the Secretary will find that the circumstances of any debtor's case require the posting of a bond, whether or not all PACA claimants were paid in full prior to and during the debtor's bankruptcy proceeding. Therefore, a reorganized debtor will have to post a post-petition bond for the USDA in addition to making plan payments to its pre-petition and post-petition creditors.

PACA's regulations call for the reorganized debtor to post either a cash or surety bond in an amount not less than $10,000. 7 C.F.R. §46.5. A cash bond, if posted, is deposited in a special account with the U.S. Treasury, which cannot accrue or pay interest to the debtor. Id. A surety bond, if posted, must be with an underwriter holding a certificate from the Secretary of the Treasury indicating that such company is an acceptable surety on federal bonds. Id. The regulations indicate that the form and amount of the bond are left to the Secretary's discretion. Id. However, debtor's counsel may find that the Secretary's actual discretion may be limited to the term and amount of the bond.

Posting a cash bond with the U.S. Treasury to secure a post-confirmation PACA license requires debtor's counsel to be cognizant of the possible need to post a cash bond soon after confirmation and include the estimated amount of such bond in any exit-financing negotiation. If this is not possible, debtor's counsel must turn his or her attention to a surety bond.

When deciding whether to post a surety bond to secure a post-confirmation PACA license, debtors and their counsel need to be on the lookout for some significant issues with such a bond. First and foremost is what type of surety bond the Secretary provides to the debtor. It is possible that the Secretary will propose a surety bond that contains a clause that such bond is noncancelable for its duration. If a debtor receives this type of bond, debtor's counsel will face an uphill negotiation to obtain such a bond due to the large risk it would place on the underwriter. Debtor's counsel may need to assist the debtor in obtaining a letter of credit or other security being pledged to the underwriter in exchange for writing the surety bond. This will prove a difficult task for many debtor's counsel, however, as a reorganized debtor generally lacks significant unencumbered assets that it could pledge as security for the surety bond.

Conclusion

Although many of PACA's policies seem overly paternalistic and outdated, it is interesting to note that the last major revision to PACA, done in 1984, actually expanded the coverage of PACA to include sellers of perishable agricultural commodities. See In re Magic Rest. Inc., 205 F.2d at 112. Therefore, the archaic provisions of PACA appear to be firmly entrenched.

Debtor's counsel, therefore, must be keenly aware of PACA's provisions if his or her client purchases more than $230,000 of fruits and vegetables (or, for those rarest of cases, cherries packed in brine), be it frozen, unfrozen or packed in ice. Certainly, most grocers would meet this test and therefore be considered a dealer under PACA, and recent case law shows that restaurants may qualify as well. In addition, institutional clients such as hospitals, prisons, colleges, charter schools and other entities that serve food to numerous people as part of their operation run the risk of meeting PACA's dealer definition. In light of PACA's broadening scope and thorny issues, debtor's counsel would be wise to determine the applicability of PACA to his or her clients at the earliest stages of bankruptcy consultation.

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Footnotes

1 Perishable agricultural commodities encompass fresh fruits and vegetables of every kind and character, whether frozen, not frozen or packed in ice as well as cherries packed in brine. 7 U.S.C. §499a(b)(4). This definition is expanded upon by 7 C.F.R. §§46.2(u)-(w).

2 The statutory language is as follows: "The perishable agricultural commodities listed on this invoice are sold subject to the statutory trust authorized by §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 form the sale of these commodities until full payment is received." 7 U.S.C. §499e(c)(4).

3 Although not relevant to our discussion here, PACA utilizes a third mechanism for protecting growers, producers, sellers and suppliers in that it prohibits "unfair conduct" by any commission merchant, dealer or broker. 7 U.S.C. §499b.

4 PACA's discrimination is actually broader than bankrupt entities. Section 499d(e) also applies of a general partner of a partnership or an officer or holder of 10 percent or more of a corporation's stock is adjudicated or discharged as bankrupt. The same three-year time limit applies.