Summary of a Recent
Judicial Development in
Perishable Agricultural
Commodities

PACA Debtor's Equipment, But Not
Mutual Funds, Are Assets of PACA Trust

Harrison M. Pittman
Staff Attorney

In In re Bear Kodiak Produce, Inc., 283 B.R. 577 (Bank. D. Ariz. 2002), a produce supplier brought an action seeking a declaration that its claims to the assets of a statutory trust held by a produce broker were superior to all claims held by the broker, the bankruptcy trustee, and the broker's lender in the same assets because the supplier believed that it was a beneficiary of a statutory trust created under the Perishable Agricultural Commodities Act ("PACA"), 7 U.S.C. §§ 499a-499t. The United States Bankruptcy Court for the District of Arizona ruled that some, but not all, of the debtor's assets were reachable by the supplier, thereby giving the supplier superior claims only to those assets that were reachable. Bear Kodiak, 283 B.R. at 581-88.

Bear Kodiak Produce, Inc. ("Kodiak"), debtor, was a produce broker and had been in business since December, 1989. See id. at 580. Until August, 1998, Kodiak used a factoring company to finance its operation. See id. The factoring company collected all of Kodiak's accounts receivable and paid all of Kodiak's accounts payable, which included its produce suppliers. See id. Kodiak's principal, Joan Baumann, and her husband worked for Kodiak. See id. Joan's husband used part of his salary to pay premiums on a life insurance policy. See id.

After her husband died in February, 1998, Mrs. Baumann used the proceeds of his life insurance policy to purchase mutual funds. See id. She also obtained a loan from the Bank of Tucson ("Bank") for $500,000.00. See id. In connection with this loan, Kodiak "executed a commercial security agreement with the Bank and granted the Bank a security interest in substantially all of its assets, including its accounts receivables, equipment, and certain vehicles." Id. The vehicles and equipment were obtained by Kodiak after it opened for business. See id.

Kodiak used over $400,000.00 of the loan to pay off the debt it owed to the factoring company, "which included reimbursing the [company] for payment of all of the obligations to its produce suppliers, as of the Loan's July 7, 1998 closing date . . . ." Id. Joan pledged the mutual funds as collateral for the Bank's loan in September, 1998. See id. Callaway Produce Co., LLC ("Callaway"), delivered produce to Kodiak on April 18, 2001. See id. Callaway's invoices stated its intention to preserve its rights in the assets of a statutory trust held by Kodiak. See id.

Kodiak stopped conducting business in January, 2002, and filed a Chapter 7 bankruptcy petition on February 7, 2002. See id. Joan Baumann also filed a Chapter 7 bankruptcy petition on February 7, 2002. See id. The United States District Court for the District of Arizona entered a preliminary injunction that enjoined Kodiak from dissipating the assets of the PACA statutory trust. See id. The preliminary injunction applied to both the assets of Kodiak and Mrs. Baumann. See id.

Callaway brought an adversary proceeding on March 8, 2002, "seeking, among other things, a declaration that its claims, as a purported beneficiary of the trust created under PACA, were superior to all claims of the Debtor, the Chapter 7 Trustee or the Bank to the Debtor's assets." Id. The Bank filed a motion to dismiss Callaway's request "on the grounds that certain vehicles and equipment owned by the Debtor . . ., and the Mutual Funds pledged to the Bank for the Loan by Mrs. Baumann were not part of the PACA trust." Id. Callaway objected to the Bank's motion. See id.

& On June 4, 2002, the bankruptcy court conducted an evidentiary hearing to determine whether the equipment and mutual funds were part of the PACA trust assets. See id. at 581. Mrs. Baumann testified that Kodiak acquired the equipment "during a period of time when all perishable agricultural commodities . . . suppliers were being timely paid" by the factoring company and that the mutual funds were purchased with proceeds from her husband's life insurance policy. Id. In addition, she testified that it was likely that some of the premiums for the insurance policy derived from her husband's salary was paid by Kodiak. See id. Mrs. Baumann also testified that locating Kodiak's business records and her late husband's personal records "to determine if any of the premiums for the [p]olicy were paid for by [Kodiak] or from her husband's salary would take months and might prove to be impossible." Id. The Bank relied on this testimony to demonstrate that the equipment and mutual funds were not included in the assets of the statutory trust. See id.

Callaway argued that Mrs. Baumann's testimony "was insufficient to meet the Bank's burden of proving that the Equipment and Mutual Funds were not part of the PACA trust because it was not the 'best evidence.'" Id. It also argued that only Kodiak's records "demonstrating that there were no outstanding invoices from any produce supplier on the date the Equipment and Mutual Funds were acquired and/or pledged to [the] Bank would be sufficient to meet the Bank's burden of proof." Id. Callaway requested that the bankruptcy court provide additional time for it to produce records that would rebut Mrs. Baumann's testimony that Kodiak timely paid its suppliers between December, 1989, and July, 1998. See id. The court denied this request and ordered the parties to file supplemental briefs on "the scope and duration of the PACA trust" and "whether the scope of the PACA trust extended" to Mrs. Baumann's assets. Id.

The Bank argued that the equipment was not an asset included in the PACA trust because "such assets do not fall within the definition of § 499e(c)(2) as inventory, receivables, or proceeds derived from the sale of commodity products." Id. The court rejected this argument, stating that it "found no case authority which support[ed] the Bank's claims that certain types of assets are exempt from a PACA trust simply because of the character of the asset, i.e, vehicles, equipment, etc." Id.

The Bank also asserted that under Six L's Packing Co. v. Des Moines State Bank, 967 F.2d 256 (8th Cir. 1992), neither the equipment nor mutual funds were assets of the PACA statutory trust because, as Six L's held, "a PACA trust does not include property acquired before the PACA beneficiary first enters into a PACA qualified transaction with the produce broker." Id. (citing Six L's, 967 F.2d at 259). Callaway asserted that under Tom Lange Co., Inc. v. Kornblum & Company, Inc., 81 F.3d 280 (2d Cir. 1996), both the equipment and mutual funds were part of the PACA trust. See id. In Kornblum, the Second Circuit held that

a party opposing a claim that a particular asset of a PACA buyer is part of a PACA trust, must demonstrate that: (1) no PACA trust existed when the asset in question was purchased; or (2) even though a PACA trust existed when the asset was purchased, the asset was not purchased with PACA trust assets; or (3) although a PACA trust existed when the asset was purchased, and the asset was purchased with trust assets, thereafter all produce sellers were paid in full, thereby terminating the trust.

Id. (citing Kornblum, 81 F.3d at 287). Noting that the Ninth Circuit had not directly addressed the issue of what assets in a PACA trust can be reached by a "'late'" supplier such as Callaway, the bankruptcy court adopted, "to the extent it is applicable, . . . the holding in Kornblum . . . ." Id. at 582, 583.

The Bank also argued that the equipment was not part of the PACA trust because Kodiak purchased it "at a time when all PACA suppliers were being paid, and . . . upon receipt of the proceeds of the Loan in 1998, . . . [Kodiak] paid . . . [the factoring company] in full, who in-turn paid all outstanding invoices from PACA suppliers, thus extinguishing any PACA trust then in existence." Id. at 583-84. The court noted that the Bank relied entirely on Mrs. Baumann's testimony to support both of its arguments. See id. at 584. It added that although Mrs. Baumann's testimony

are essentially uncontroverted by Callaway, Mrs. Baumann's . . . testimony . . . [is] insufficient to meet the Bank's burden under § 499e(c)(2). Even though Mrs. Baumann, as the principal of the Debtor, was competent to testify about the Debtor's business practices with respect to how the Debtor paid its produce suppliers and the circumstances surrounding the Loan, such testimony in the absence of any documentary support is simply inadequate to carry the Bank's burden . . . . Therefore, the Bank has failed to meets its evidentiary burden under § 499e(c)(2) and consequently, the court finds that the Equipment is part of a PACA trust.

Id.

Next, the court examined whether the mutual funds were considered assets of the statutory trust. See id. Callaway argued that the mutual funds were included in the assets of the statutory trust because they were traceable to the salaries Kodiak paid to the Baumanns in the ordinary course of Kodiak's business while a PACA trust was presumably in place and "because such monies were, at least in part, comprised of PACA trust assets, the Mutual Funds, as the proceeds of such monies, are subject to the trust." Id. at 585-86.

The court explained that in Boulder Fruit Exp. & Heger Organic Farm Sales v. Transportation Factoring, Inc., 251 F.3d 1268 (9th Cir. 2001), the Ninth Circuit ruled that "third-party transferees of PACA trust assets are not guarantors of the PACA trust, and are liable only if they had some role in causing a breach of a trustee's fiduciary duty or dissipation of the trust." Id. at 585 (citing Boulder Fruit, 251 F.3d at 1272). It also explained that in Boulder Fruit, the Ninth Circuit held that a factor who had obtained trust assets through a financing agreement it had with a produce buyer was not required to disgorge the assets it had obtained absent a showing that the factor received the assets in breach of trust. Id. n.11 (citing Boulder Fruit, 251 F.3d at 1272). "Thus," the court stated, "for Callaway to prevail under Boulder Fruit, the court must find that a PACA buyer's payment of salaries, in the ordinary course of business, constitutes a breach of a PACA trust." Id. at 585.

The court noted that there was a split of authority among the courts that had considered whether the payment of salaries and other ordinary business expenses constituted a breach of trust. See id. (citingC.H. Robinson Co. v. Alanco Corp., 239 F.3d 483, 488 (2d Cir. 2001); Red's Market v. Cape Canaveral Cruise Line, Inc., 181 F.Supp.2d 1339, 1344 (M.D.Fla. 2002); Farm-Wey Produce, Inc. v. Wayne L. Bowman Co., Inc., 973 F.Supp. 778, 783 (E.D. Tenn. 1997); Morris Okun v. Harry Zimmerman, Inc., 814 F.Supp. 346 (S.D.N.Y. 1993)). The court stated that it concurred with the holding in Farm-Wey, in which the court held "that minimal salaries and expenses paid in the ordinary course of a PACA buyer's business do not constitute a breach of trust." Id.

The court stated that

[i]t could not have been Congress' intent in enacting § 499e(c)(2) to allow a PACA supplier to reach into the pockets of innocent employees and third parties to satisfy a debt owed by a dealer. In addition, Congress did not intend to fashion a scheme which would impose strict secondary liability of a PACA buyer's officers and shareholders for authorizing ordinary course business payments to employees and other creditors-there must be some outward limit on a suppliers's ability to collect its debts . . . . Consequently, the court finds that payments made in the ordinary course of a produce buyer's business, including minimal salaries and expenses, do not constitute a breach of a PACA trust.

Id. at 587.

The court noted that the evidence only indicated that at the time the Baumanns' received their salaries Kodiak "was maintaining a sufficient reserves to satisfy all of its outstanding debts and all suppliers were being timely paid. Thus, Callaway has failed to demonstrate that the Baumanns received their salaries in breach of a PACA trust." Id. It added, "[c]onsequently, even assuming that the salaries included PACA trust assets, and such assets are traceable into the Mutual Funds, those assets are not reachable by Callaway." Id.

The case was decided on September 4, 2002; this summary was posted August, 2003