Summary of a Recent
Judicial
Development in
Perishable Commodities
Ninth Circuit Rules That Factoring
Agreements Do Not Per Se
Breach PACA Trust
Jeffrey A. FeirickNational AgLaw Center Graduate Fellow
The Ninth Circuit Court of Appeals has ruled that factoring agreements do not per se breach the trust created by the Perishable Agricultural Commodities Act (PACA). Boulder Fruit Express & Heger Organic Farm Sales v. Transportation Factoring, Inc., 251 F.3d 1268, 1271-72 (9th Cir. 2001), cert. denied, 122 S. Ct. 1077 (2002). In rejecting the trust beneficiaries’ claim that factoring agreements per se breach the PACA trust because they contemplate a discounted sale of trust receivables, the court opined that “a commercially reasonable sale of account for fair value is entirely consistent with the trustee’s primary duty under PACA . . . to maintain trust assets so that they are ‘freely available to satisfy outstanding obligations to sellers of perishable commodities.’” Id. at 1271 (quoting 7 C.F.R. § 46.46(d)(1)). Thus, while declining to rule that factoring agreements are per se breaches of the PACA trust, the court did not foreclose the possibility that a particular factoring agreement might breach the trust because it was not commercially reasonable. See id. at 1271-73.
The PACA, 7 U.S.C. §§ 499a-499t, regulates the marketing, shipping, and handling of perishable agricultural commodities to protect the interests of sellers of the commodities subject to the Act. In part, Congress created PACA to protect growers of fresh fruit and vegetables from buyers who are unable to pay their debts. Id., at 1270 (citing Sunkist Growers, Inc. v. Fisher, 104 F.3d 280, 282 (9th Cir. 1997); Farley & Calfee, Inc. v. USDA, 941 F.2d 964, 966 (9th Cir. 1991)).
Among the protections the PACA provides to unpaid sellers is the creation of a floating, non-segregated statutory trust that extends to commodities, the products derived from them, and to the receivables and proceeds of the sale of these commodities and products. See 7 U.S.C. § 499e(c). The PACA trust requires perishable commodity commission merchants, dealers, and brokers, as the trustees of the PACA trust, to hold receivables or proceeds in trust for all unpaid commodity sellers until the sale price is paid in full. Boulder Fruit, 251 F.3d at 1270 (citing 7 U.S.C. § 499e(c)(2)). “‘Through this trust, the sellers of the commodities maintain a right to recover against the purchasers superior to all creditors, including secured creditors.’” Boulder Fruit, 251 F.3d at 1270 (quoting Endico Potatoes, Inc. v. CIT Group/Factoring, Inc., 67 F.3d 1063, 1067 (2d Cir. 1995)).
“Factoring” is “the commercial practice of converting receivables into cash by selling them at a discount.” Id. at 1271 (citing Black’s Law Dictionary (7th ed. 1999)). A “factor” is a third party who pays a company a reduced amount, obtaining the right to collect on accounts receivable when due. Black’s Law Dictionary 484-85 (7th ed. 1999). The factor “assumes the risk of delay in collection and loss on the accounts receivable.” Id. at 485. The “factorage” is the amount of compensation a factor collects for his services. Id.
Boulder Fruit grew fresh fruit and vegetables and sold them on credit to Certified Organics, a fruit and vegetable wholesaler. Boulder Fruit, 251 F.3d at 1269. These sales were subject to the PACA. Certified Organics resold the fruits and vegetables it received from Boulder Fruit, creating accounts receivable expressly subject to the trust. Id. at 1270 (citing 7 U.S.C. § 499e(c)(2); 7 C.F.R. § 46.46). Certified Organics, in an attempt to generate cash, then sold the accounts receivable to Transportation Factoring Inc. for eighty percent of their face value. See id. at 1269. When Certified Organics failed to repay Boulder Fruit, Boulder Fruit sued Transfac and Capital Resource Funding, a factoring company who had introduced Transfac to Certified Organics.
Boulder Fruit contended, among other claims, that the factoring arrangement between Certified Organics and Transfac was a per se breach of the PACA trust. The district court, however, granted summary judgment in favor of both Transfac and Capital, holding that because Transfac paid more for the accounts than what they were worth, the factoring arrangement did not violate the trust. See id. at 1270.
In its de novo review of the district court’s judgment, the Ninth Circuit premised its analysis on the application of general trust principles, noting that these principles governed in the absence of a direct conflict between them and the PACA. Id. at 1271 (citing Sunkist, 104 F.3d at 282). Under these principles, noted the court, a breach of trust is “‘a violation by the trustee of any duty which as trustee he owes the beneficiary.’” Id. 1271 (quoting Restatement (Second) of Trusts § 201 (1959)). The court also observed that the PACA regulations require the trustee to maintain the trust assets in a “‘manner that such assets are freely available to satisfy outstanding obligations to sellers of perishable agricultural commodities.’” Id. (quoting 7 C.F.R. § 46.46(d)(1)). Finally, the court noted that the PACA regulations prohibit the “‘dissipation of trust assets,’” which is defined to mean “‘any act or failure to act which could result in the diversion of trust assets or which could prejudice or impair the ability of unpaid suppliers, sellers, or agents to recover money owed in connection with produce transactions.’” Id. (quoting 7 C.F.R. § 46.46(a)(2)).
Based on these principles, the Ninth Circuit rejected Boulder Fruit’s argument that factoring agreements were a per se breach of the PACA trust because they allow the sale of trust assets at less than the face value. The court reasoned that because it does not command the “perpetuation of unliquidated commercial paper,” the PACA does not prohibit a trustee from generating cash through the sale of receivables. Id. (citations omitted). Instead, noted the court, since the trustee has the duty to maintain the trust’s liquidity, the trustee’s sale of receivables at their fair market value may be prudent. In other words, because it generates cash, the commercially reasonable sale of accounts receivable can allow a trustee to achieve the overall PACA goal of paying growers for their products. See id.
The court opined, however, that the sale of trust assets could, in some instances, violate the PACA trust. For example, selling an account for “pennies on the dollar” might breach the PACA trust, while selling a trust at a “commercially reasonable rate” would not. Id. (citing E.Armata, Inc. v. Platinum Funding Corp., 887 F.Supp. 590, 593 (S.D.N.Y. 1995)). According to the court, the fact that some factoring arrangements might contemplate commercially unreasonable rates did not justify a holding that factoring agreements were a per se violation of the PACA trust. See id. at 1272.
Having concluded that factoring arrangements were not per se breaches of the PACA trust, the court turned Boulder Fruit’s contention that the agreement between Transfac and Certified Organics breached the PACA trust because Transfac did not pay face value for the accounts. See id. at 1272. In rejecting this contention, the court agreed with Transfac’s position that the factoring arrangement was commercially reasonable and actually added value to the trust. The court noted that Transfac charged a factoring discount of only twenty percent and that it paid Certified Organics $18,482 more than it collected from the accounts. Id. at 1272.
Finally, the court upheld the district court’s ruling that Boulder Fruit failed to prove that Certified Organics misapplied trust funds. Boulder Fruit had offered no evidence of how Certified Organics spent the trust funds. Moreover, noted the court, the PACA non-segregated floating trust funds could have been applied to the payment to perishable commodities producers other than Boulder Fruit without violating the trust. Id. at 1272 (citing 7 U.S.C. § 499e(c)).