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Court ruling strengthens PACA Trust

In what is being called an “important decision” for the produce industry, on Feb. 22, the U.S. Court of Appeals for the Ninth Circuit issued an en banc opinion strengthening the rights of growers and suppliers under the PACA Trust, by reversing a prior ruling that the court made in 2001. En banc review, which is in front of all of the judges in a particular circuit, is necessary to overturn or reverse a prior case determined by just three judges.

Lou-DiessLou DiessLouis W. Diess III of McCarron & Diess, who argued the winning side of the case in front of 11 judges, told The Produce News that, in essence, factoring firms will now typically be treated in the same manner as secured lenders when the PACA Trust provisions are invoked because of bankruptcy proceedings. He explained that Congress intended PACA to prevent secured lenders from defeating the rights of PACA beneficiaries. However, there have been cases in which growers and suppliers have lost trust rights based on alleged sales of PACA Trust assets through factoring arrangements.

The Trust provision of the Perishable Agricultural Commodities Act was added in the mid-1980s to basically make sure that when a bankruptcy occurred upstream in the supply chain, the farmer would be first in line — before secured lenders — to receive the proceeds from the sale of his goods. There are many nuances, rules and regulations that have emerged after 30 years of interpretations, case law and regulatory changes.

In 2001, the Ninth Circuit Court ruled, in a case involving Boulder Fruit, that a factoring deal was essentially a sale and was not subject to the PACA rules that govern secure loans. Secured lenders have long sought unsuccessfully to overturn a grower’s priority position in the event of a bankruptcy by the buyer of the goods.

In the 2001 decision, Diess relayed that the court did not consider whether the factoring agreement was a loan or a sale. He successfully argued before the en banc Appeals Court that a “true sale” test was necessary to determine if a factoring agreement was actually a financing arrangement that violated the rights of PACA trust creditors. The court agreed and held there must be a threshold inquiry to determine if the transaction is a loan, which is governed by PACA, or a true sale of the accounts receivable, which is not.

Factoring agreements are typically used for cash flow reasons by some supply chain distributors. For a percentage of the receivables in question, a factoring company will advance the distributor the money to be collected.

In this case, growers sold their produce to a produce dealer, a PACA trustee. The dealer then sold the produce on credit to third parties and generated accounts receivable. The dealer then allegedly transferred the accounts receivable to a “factor,” pursuant to a document called a “Factoring Agreement.”

The court held that, “Although described as a sale of accounts, the Factoring Agreement involved hallmarks of a secured lending arrangement.” These included the “factor” referring to itself as a lender, and stating the agreement was a Security Agreement. The “factor” also had security interests in the accounts receivable, and filed UCC (Uniform Commercial Code) finance statements, which indicated the transaction was nothing more than a loan secured by the accounts receivable and not a true sale of the accounts receivable.

The court sent the case back down to the district court for a determination of whether the financing arrangement was a loan or a true sale. If the district court finds that the arrangement was a loan disguised as a sale, the “factor” may be liable for the funds it received from the accounts receivable.

With this opinion, the 9th Circuit joined other circuits in the U.S. (2nd, 4th and 5th), which had adopted the “true test” determination. Diess said it is an important decision because it reverses a bad case precedent and creates consistency on a pivotal issue involving the PACA trust. Though the lower court will still have the opportunity in this case to determine whether it was a loan or sale, Diess said the victory is in basically making that determination mandatory.

Diess added that a factoring company can “buy” accounts receivables, which would mean that they would not fall under the purview of the PACA Trust. However, in those cases, he said the sale must be “commercially reasonable” which serves as a check against a sale designed to avoid the provisions of the trust.

Diess argued the case with colleague Mary Jean Fassett on the brief. The court ruled 8-3 in his favor.