The Perishable Agricultural Commodities Act (“PACA”) provides federal statutory protection to vendors of fresh fruits and vegetables as the commodities pass through the “foodservice chain” from growers, to distributors and to retailers. PACA packs a real punch, and protects unpaid suppliers of produce by treating them as beneficiaries of a trust. Unpaid PACA vendors who “follow the rules” to maintain their status as trust beneficiaries, are given a first-priority, preemptive, floating trust interest in the commodities themselves, as well as the proceeds and receivables in the hands of those who have sold or disposed of them (“PACA Trust Benefits”).

“PACA” and “PACA Trust Benefits”

PACA requires purchasers of produce to hold produce-related assets “in trust” for prompt payment to sellers. Failure to segregate, preserve and pay PACA Trust Benefits is unlawful under federal law. An unpaid produce supplier is entitled to immediate payment of PACA Trust Benefits. If PACA Trust Benefits are commingled with the purchaser’s other assets, the trust extends to all inventory gained from a commingled account and to any other assets acquired in exchange for PACA Trust Benefits.

PACA Trust Benefits in Bankruptcy Court

When an entity files bankruptcy, all the legal and equitable interests of the entity become property of the bankruptcy estate – i.e. those interests become part of the body of assets available to satisfy the debts of the bankrupt entity. However, because of their trust status, PACA Trust Benefits are not considered to be property of the bankruptcy estate of PACA debtors. A debtor can not encumber property in which it does not have a legal or equitable interest. Consequently, PACA Trust Benefits are not available to pay the debtors creditors. They also cannot be pledged by a PACA debtor as collateral for loans made to the PACA debtor by third-party lenders.

Owing to the preemptive effect of PACA, it is often assumed that the “players” in a bankruptcy case (debtors, trustees, secured creditors, administrative claimants) would concede that PACA Trust Benefits should be segregated and preserved for the benefit of PACA-protected creditors. What is surprising, however, is the consistent manner in which PACA Trust Benefits – and the rights of PACA-protected creditors – are given short shrift in bankruptcy courts, particularly bankruptcy reorganizations. It’s also remarkable how quickly PACA Trust Benefits, if left unattended, can lose their separate identity and become ground up and lost in the welter of “Emergency Motions,” adequate protection hearings, and cash collateral orders that define (and often consume) the initial stages of a bankruptcy case.

PACA Trust Benefits in the Bashas’ Inc. Bankruptcy Case

Here’s an example of what can happen, taken from the bankruptcy of Bashas’ Inc., a chain of supermarkets whose Chapter 11 case is now pending in Phoenix, Arizona.

Bashas’, the debtor, negotiated the terms of a first-day order (“PACA Order”) to address payment of an estimated $6.8 million of PACA Trust Benefits. Bashas’ prepetition secured creditor group (who collectively claim to be owed more than $215,488,650) took part in the negotiation of the PACA Order, and the PACA Order was expressly made subject to the terms of another order addressing the debtor’s use of cash collateral (the “Cash Collateral Order.”) The Cash Collateral Order required Bashas’ to run its operations per the terms of a specific budget. Neither the Cash Collateral Order nor the budget made any mention of the PACA Order. Not only did the budget fail to contain a line item representing payment of the PACA Trust Benefits, the budget did not account for the $6.8 million of PACA Trust Benefits in any way.

Compounding matters, Bashas’ and its prepetition secured lenders apparently had a falling out. On the eve of bankruptcy, Bashas’ obtained a line of credit to fund its reorganization from a third party. That line of credit loan arrangement then was approved by the bankruptcy court in a “Post-Petition Financing Order.”

A Clash of Bankruptcy Court Orders; Has the Train Left the Station?

Although both Bashas’ and its prepetition secured lenders seemed to agree that the $6.8 million of PACA Trust Benefits needed to be paid promptly, they disagreed on where the money should come from.

Bashas’ wanted to fund the claims from a cushion of cash collateral in its post-petition operating accounts. Bashas’ prepetition secured lender group said the Cash Collateral Order and its attached budget did not mention PACA Trust Benefits, did not take them into account and did not permit such payments. The secured lenders pointed out that Bashas’ had not segregated PACA Trust Benefits from the operating accounts as required by PACA (Bashas’ admitted they had not) and concluded that Bashas’ should satisfy its obligation to pay PACA Trust Benefits by borrowing the necessary funds with draws under its new line of credit as approved by the Post-Petition Financing Order.

What Went Wrong?

PACA-protected creditors are protected by some of the most powerful federal laws imaginable. In Bashas’ the debtor included a PACA payment motion in its “First-Day Orders.” No one among the many parties having an interest in the Bashas’ bankruptcy case said the PACA-protected creditors were not entitled to every penny of PACA Trust Benefits. But when it actually came to paying the PACA claims, the debtor and the pre-petition secured lender group looked at each other and said – “Pay it out of your pot.”

Now, more than a month after the bankruptcy filing, the issue of “who pays” the PACA claims has been the subject of at least three motions; the first penny of PACA claims has yet to be paid; and finally, the PACA-protected creditors finally have decided to engage lawyers to appear on their behalf in the Bashas’ bankruptcy case.

How could the payment of funds held “in trust” be subject to this type of confusion? The answer is that all of the parties having an interest in Bashas’ bankruptcy case had an advocate and a procedure on their side at the get-go; all of them, that is, except the PACA-protected creditors. Bashas’ had its lawyers and a welter of bankruptcy laws (like the automatic stay) on its side. The prepetition secured lenders had their lawyers, liens, rights to adequate protection and the Cash Collateral Order (complete with budget) on their side. Even the unsecured creditors, at the bottom of the bankruptcy food chain, had the U.S. Trustee, an unsecured creditors’ committee, two sets of lawyers, and a consultant, all on their side.

The PACA-protected creditors, who were sitting at the very top of the bankruptcy food chain — in the cat-bird’s seat in terms of payment priority — had no voice amidst this plethora of advocates. There was an acknowledged place for the PACA claimants at the table, but nobody reserved it and nobody took a seat. Nobody insisted on the debtor taking the relatively simple step of setting aside the PACA Trust Benefits. So, more than a month into Bashas’ reorganization proceedings, the PACA Trust Benefits were packed up with the cash collateral, and put on the next train out. The PACA-protected creditors were left at the station with an expensive, uphill battle on their hands.

PACA Trust Claims Should Trump Cash Collateral in Bashas’ Case

After it became apparent that the secured lender group was not willing to release PACA Trust Benefits from its claim on cash collateral, Bashas’ sought the bankruptcy court’s intervention. Bashas’ said it had not escrowed or segregated the PACA Trust Benefits, but it said the necessary funds had continuously been on deposit in Bashas’ operating accounts since the date its bankruptcy petition was filed on July 12th. Moreover, Bashas’ noted, its actual operating expenses as projected in the budget, had been less than the budgeted amounts, leaving a surplus of a cash cushion that was more than sufficient to: (1) pay all PACA Trust Claims and (2) stay within budget.

Bashas’ saved its best argument for last, arguing that the preemptive nature of PACA prevented any lien from attaching to PACA Trust Benefits in the first place; PACA Trust Benefits, Bashas’ said, should not have been included in the secured lenders’ “pot” of cash collateral in the first place, and, technically at least, should not have been included as “property of the estate” subject to the bankruptcy court’s jurisdiction.

Bashas’ arguments went full circle, and the paradox of PACA claims in bankruptcy became apparent. None of the several competing bankruptcy court orders should be controlling, Bashas’ said. Rather, the bankruptcy court, exercising its general equitable powers over Bashas’ bankruptcy case, should rule that the rights of PACA-protected creditors preempt the security interest claims of Bashas’ secured lender group. Bashas’ claimed that the bankruptcy court has inherent equitable power to enter an order segregating PACA Trust Benefits from the cash cushion in its operating accounts so that they could be paid to PACA-protected creditors. (The matter was scheduled for hearing on Wednesday, August 19th but as of Friday, August 21st no order or notes of the proceedings had yet been entered.)

Lessons for PACA-Protected Creditors

For PACA-protected Creditors, the lesson is simple. Don’t assume that your interests are going to be protected and preserved In a customer’s bankruptcy. Take a few simple steps:

• Mark all of your invoices and take the necessary steps to establish and maintain your statutory PACA rights in the first place.
• If your purchaser goes into bankruptcy, be ready with a predetermined plan, or find a professional to help you – quickly.
• You don’t necessarily need to hire a bankruptcy law firm where the bankruptcy case is filed, but you do need to get a professional working on your side quickly and efficiently.
• Round up other PACA-protected creditors who are owed by the bankrupt. A formal or informal alliance among PACA-protected creditors is likely to gain three things for its member/participants: (a) the “clout” that comes through strength in numbers; (b) significant reduction of costs shared by participants, as opposed to “going it on your own;” and, due to the preemptive nature of PACA, (c) a relatively low likelihood that participants’ recoveries will be diluted by the group effort.

Remember, it shouldn’t take much to protect your PACA rights if your customer files for bankruptcy protection; as a PACA-protected creditor, you are entitled to protection, too. But if you wait around on the assumption that you’ll be protected by the bankruptcy laws, think again: you may find that somebody put your PACA Trust Benefits on the last train out, leaving you at the station!