PACA: If It Looks Like a Duck and Walks Like a Duck, It Still Needs to Be a True Sale to Avoid Liability

The strong arm effect of The Perishable Agricultural Commodities Act (PACA) continues to strike at lenders who refuse to take “no” for an answer.

In March 2018, we dedicated two Wurst Case Scenario posts to a significant PACA decision (Tanimura) from the Ninth Circuit Court of Appeals where the Court reversed its prior position and joined the Second, Fourth and Fifth Circuits in protecting true sale factors from exposure when a PACA beneficiary goes unpaid. In that case, the Ninth Circuit said:

…. a PACA trustee’s true sale of accounts receivable for a commercially reasonable discount from the accounts’ face value is not a dissipation of trust assets and, therefore, is not a breach of the PACA trustee’s duties. … (“The assets of the trust would thus have been converted into cash and the receivables would no longer have been trust assets.”)… “([A] ‘bonafide purchaser’ of trust assets receives the assets free of claims by trust beneficiaries” and noting that the determinative issue on appeal is whether the “factoring agreement” was a loan secured by accounts receivable or a true sale of accounts receivable); … (“[N]othing in PACA or the regulations prohibits PACA trustees from attempting to turn receivables into cash by factoring. To the contrary a commercially reasonable sale of accounts for fair value is entirely consistent with the trustee’s primary duty.”)…

In January 2020, we focused on a case affecting Produce Pay, Inc., a “multi-service finance company,” that asserted a PACA claim against a bankrupt distributor, claiming it was a purchaser that was entitled to assert PACA trust claims against a nonpaying/bankrupt purchaser of produce. The bankruptcy court in that case determined that Produce Pay purchased produce from growers but with full recourse. Thus, it was not entitled to the protection of the PACA trust.

On Oct. 13, 2020, the United States District Court for the Central District of California issued a decision – again concerning Produce Pay. This time Produce Pay claimed not to be a factor but instead a consignor and that the risk of nonpayment fell on Produce Pay’s consignment agent (Izguerra), who assumed the risk of nonpayment. The Court noted:

While it is true that the opinion in Tanimura focuses on whether a factoring agreement is a sale in order to determine whether the proceeds remained in the trust, this Court must decide whether a transaction is a sale to determine whether Plaintiff is entitled to PACA protection. Therefore, this Court applies the transfer-of-risk test adopted by the Ninth Circuit in Tanimura.

The transfer-of-risk test established in Tanimura provides:

Where the lender has purchased the accounts receivable, the borrower’s debt is extinguished and the lender’s risk with regard to the performance of the accounts is direct, that is, the lender and not the borrower bears the risk of non-performance by the account debtor. If the lender holds only a security interest, however, the lender’s risk is derivative or secondary, that is, the borrower remains liable for the debt and bears the risk of non-payment by the account debtor, while the lender only bears the risk that the account debtor’s non-payment will leave the borrower unable to satisfy the loan.

In considering whether to apply the transfer-of-risk test, the Court, looking to the Second Circuit’s seminal decision on the subject, considered: (a) whether Produce Pay has a right to recover any deficiency from Izguerra if the assets assigned do not satisfy the debt; (b) whether Produce Pay’s right to the assets assigned is affected should Izguerra pay the debt from independent funds; (c) whether Izguerra has a right to any funds recovered from the sale of assets above that necessary to satisfy the debt; and (d) whether the debt is reduced by the assignment itself.

The Court noted that according to the agreement, Izguerra bears all the risk should its purchaser fail to pay. Accordingly, the Court held that:

the transaction is a secured loan and not a true sale, contradicting the Complaint and making Produce Pay ineligible for protection under PACA.

Produce Pay loses again. These are expensive lessons. Notwithstanding, there are reasonable opportunities to provide financing to the PACA industry. But be warned not to be cavalier in extending financing, and be sure to make and rely upon sound business and legal practices or run the risk of sustaining losses.

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