Summary of a Recent
Judicial Development in
Perishable Commodities

Bank Required to Disgorge Certain
PACA Trust Funds

John D. Mead
National AgLaw Center Graduate Assistant

The United States District Court for the Southern District of New York has held that a lender that extended credit to a produce distributor was required to disgorge certain Perishable Agricultural Commodities Act ("PACA") trust funds that the lender received in violation of 7 U.S.C. § 499e(c). E. Armata, Inc. v. David Lee's Produce Service Corp., No. 99 Civ. 2042, 2002 WL 31834451 (S.D.N.Y. Dec. 17, 2002). However, the lender was not required to disgorge funds that were not derived from the sale of PACA-eligible goods. See id. At *5-6. Moreover, the court determined that the lender was a "bona fide purchaser" with respect to certain transactions because it took reasonable steps to inquire into the produce distributor's financial status, and thus the lender was not required to disgorge all of the trust monies that the plaintiffs sought under the PACA. See id. at *6.

E. Armata, Inc. ("Armata"), L&P Fruit Corporation ("L&P"), and Ven-Co Produce, Inc., ("Ven-Co"), plaintiffs, brought the instant lawsuit alleging violations of the PACA under 7 U.S.C. § 499e. See id. at *1. The plaintiffs asserted that Woori America Bank ("Bank"), a defendant, was liable to plaintiffs for monies deposited by David Lee's Produce Service Corporation ("DLPS"), also a defendant. See id. DLPS was a produce distributor which was in the business of selling and re-selling produce. See id.

The Bank was the successor to Korea Commercial Bank of New York ("KCB"). See id. KCB extended an overdraft line of credit to DLPS in the amount of $90,000.00 on September 11, 1997. See id. at *2. By establishing this line of credit, DLPS was able to write checks from its account even when the checking account had a negative balance of $90,000.00. See id. This line of credit essentially continued in modified forms until DLPS ceased operations in December, 1998. See id. at *4.

Prior to extending DLPS its line of credit, KCB's loan officers undertook a credit analysis of DLPS using nationally-recognized credit agencies and concluded that DLPS had no outstanding indebtedness. See id. at *2. KCB also determined that DLPS's payments to KCB would come from the company's business revenue. See id. In the litigation, the Bank conceded that nearly all of the deposits into the DLPS account came from the sale of PACA-eligible produce. See id.

In October, 1998, KCB and Hanvit Bank began merger discussions. See id. To facilitate the merger, DLPS's balance was converted into a fixed $85,000.00 term loan, and the loan was applied to the negative overdraft balance on DLPS's checking account. See id. at *4. However, at the time of the 1998 loan, the Bank was unaware that DLPS had any outstanding indebtedness because none of the plaintiffs had reported claims to any credit rating agencies. See id. DLPS's 1997 tax return showed that DLPS earned a gross profit of $80,000.00. See id.

When DLPS ceased operations in December, 1998, the company owed the plaintiffs a total of $650,451.95. See id. DLPS had not made any payments to plaintiffs or any other PACA merchant since August 14, 1998. See id.

Congress enacted the PACA in 1930 to prevent unfair business practices and promote financial responsibility in the fresh fruit and produce industry. See id. In 1984, Congress amended the PACA by creating a trust provision under 7 U.S.C. § 499e(c), wherein a trust res is created immediately upon the delivery of produce sold on credit to a PACA trustee, such as DLPS, and the provision confers upon produce sellers the right to look to a trust res for payment of the amounts owed. See id. at *5. 7 U.S.C. § 499e(c) provides:

Perishable agricultural commodities received by a commission merchant, dealer, or broker in all transactions, and all inventories of food or other products derived from perishable agricultural commodities, and any receivables or proceeds from the sale of such commodities or products, shall be held by such commission merchant, dealer, or broker in trust for the benefit of all unpaid suppliers or sellers of such commodities or agents involved in the transaction, until full payment of the sums owing in connection with such transactions has been received by such unpaid suppliers, sellers, or agents.

Id. at *4-5.

The court opined that although KCB did not have actual knowledge of the PACA and its trust provisions prior to this litigation, the Bank knew that DLPS was a produce distributor and therefore could be charged with having constructive knowledge of the statute. See id. at *5. However, the court noted that the plaintiffs were required to establish that KCB received trust assets from DLPS in breach of the PACA trust, and that the Bank's liability was predicated on there being a breach of trust by DLPS. See id. In reviewing the facts, the court determined that most of the funds that were deposited into DLPS's account at KCB were eventually paid to the PACA beneficiaries, and therefore no breach had occurred with respect to those funds. See id.

However, the court did find that of the $2 million of the PACA monies that were deposited into DLPS's account, $39,552.05 was distributed to non-PACA beneficiaries. See id. at *6. The court held that the Bank received those funds in violation of the PACA trust and that the maximum amount for which the Bank could be held liable was $39,552.05. See id.

The court then analyzed the Bank's defense that it was a "bona fide purchaser" ("BFP"). See id. In order to qualify as a BFP, the Bank had to have given value for the trust property it received and had to have had no actual or constructive knowledge of the breach of trust. See id. The court opined that it was undisputed that KCB gave value for the assets it received since money transferred to extinguish a pre-existing debt is considered to have been transferred for value. See id.

Moreover, the court opined that the burden is on a lender to establish that it did not have notice of a PACA trustee's breach of trust by showing that it made "the kind of inquiry as to debts owed by the trustee to PACA beneficiaries that a reasonably prudent lender would make as to debts owed by a similar borrower to a prior creditor who had rights superior to those sought by the lender." Id. In the instant case, the court determined that the Bank did make sufficient inquiries into DLPS's financial status by checking with national credit report agencies and reviewing DLPS's 1997 tax return. See id. The court determined that because of the plaintiffs' failures to take steps to make their claims known to the national credit report agencies, the Bank could be held liable only for payments made to non-PACA merchants after October 1, 1998, and that such payments totaled $4,510.35. See id. The court ordered the Bank to pay the $4,510.35 plus prejudgment interest to the plaintiffs according to their pro rata share set forth in their individual claims. See id.

The case was decided on December 17, 2002; this summary was posted February, 2003