Summary of a Recent
Judicial
Development in
Perishable Commodities
"Business Manager Agreement" Between
Bank and Produce Dealer Found
to Violate PACA Trust
Eduardo Gabriel AranaNational AgLaw Center Graduate Fellow
The United States District Court for the Middle District of Tennessee has ruled that a commercial bank, acting pursuant to a “Business Manager Agreement” between it and a produce buyer, violated a trust created under the Perishable Agricultural Commodities Act (PACA), 7 U.S.C. §§ 499a – 499t, for the benefit of unpaid sellers of produce. Overton Distributors Inc. v. Heritage Bank, 179 F.Supp.2d 818 (M.D. Tenn. 2002). In essence, the court concluded that the agreement did not provide for the sale of the produce buyer’s accounts receivable as it purported to do. Instead, it gave the bank a security interest in the accounts. The court also concluded that the bank did not acquire the accounts receivable as a bona fide purchaser because it did not give value for them, and that the bank had notice that such a transfer to the bank was a breach of the PACA trust. See id. at 828-36.
The produce buyer, Quality Foods of Tennessee, Inc., had a history of financial difficulties. To improve its finances, Quality entered into a Business Manager Agreement (“BMA”) with Heritage Bank, its principal lender. Under the BMA, Heritage administered and managed Quality's accounts. The BMA also allowed Quality to obtain advances against the face value of the accounts receivable that it presented to Heritage. These accounts were purportedly purchased by Heritage and became Heritage’s assets. Quality and its owners, however, remained liable for the repayment of the advances if the proceeds from the account receivable were insufficient to cover the funds advanced. See id. at 827-29. Notwithstanding this arrangement, Quality subsequently defaulted on its loans and ceased operations.
Overton Distributors, Inc., a produce wholesaler, brought this action to recover approximately $220,000 from the Heritage Bank. Overton alleged that the sums it sought represented PACA trust assets in the form of Quality’s accounts receivables and their proceeds that Heritage had acquired under the BMA. Overton premised its claim on its assertion that the PACA had created a trust in its favor as an unpaid seller of produce to Quality, and the Heritage Bank’s receipt of the funds was in breach of the trust. See id. at 823-24.
Under the PACA, a statutory trust in favor of unpaid sellers arises when a perishable agricultural commodity commission merchant, broker, or dealer receives perishable agricultural commodities. The trust extends to the commodities, products derived from the commodities, receivables, and proceeds from the sale of the commodities or their products. See 7 U.S.C. § 499e(c)(1). Sellers seeking to benefit from the trust must affirmatively preserve their rights, either by sending notice to the buyer within thirty days after payment is due or by including certain statutory language on produce invoices. See Overton Distributors, 179 F. Supp.2d at 825. Sellers who preserve their trust rights have a claim to the trust assets that is superior to the claim of the secured lenders of the commission merchant, broker, or dealer. See id.
In an earlier order, the court had concluded that Overton had preserved its rights as a PACA trust beneficiary by using the “‘invoice method.’” Id. at 825-26. Turning to the central issue presented--whether Heritage received trust assets from Quality in breach of the trust--the court found that the funds held by Heritage were trust assets. The parties had agreed that about ninety percent of Quality’s business involved the sale of produce covered by the PACA, and the court concluded that Heritage had failed to prove that the assets received from Quality in payment for services or through Quality’s liquidation were not PACA trust assets. See id. at 828.
Turning to the question of whether Heritage had received these assets in breach of the trust, the court concluded that the BMA between Heritage and Quality constituted a breach of trust. The court found that the BMA created a relationship that was more analogous to a loan or line of credit than to a purchase of accounts receivable under a factoring arrangement. In the court’s view, the evidence showed that Heritage considered the BMA was both a service arrangement, whereby Heritage essentially provided bookkeeping services, and a line of credit. The latter provided Heritage with a profit greater than the service charge. See id. at 828-29.
Under the BMA, Heritage had loaned money to Quality based on Quality’s accounts receivable. These accounts, which were PACA trust assets, were then transferred to Heritage. Heritage received payments from Quality’s customers and applied them against the loan balance. Quality, however, retained the risk of nonpayment, for it remained indebted to Heritage for the cash advances until they were repaid. Thus, the court reasoned, Heritage did not actually purchase the accounts receivable. Instead, it only acquired a security interest in the accounts receivable, and this interest was inferior to the rights of the PACA trust beneficiaries, in this case Overton. See id. at 829.
Having concluded that Heritage received trust assets through a security interest in the accounts receivable, the court addressed and rejected Heritage’s claim that it was a bona fide purchaser of those assets and thus entitled to retain them. While bona fide purchasers of trust assets are not liable to the trust beneficiaries, bona fide purchaser status requires the giving of value for the trust property with neither notice of the breach of trust nor knowing participation in any illegal transaction in relation to the trust. See id. at 830.
The court concluded that because Heritage did not assume any risk of loss under the BMA, it had not given value for the accounts receivable. The court also concluded that Heritage had notice of the breach of trust. Heritage was deemed to have constructive notice of the existence of a PACA trust because a federal statute created the trust. Also, Heritage was aware that it was dealing with a PACA licensee and that Quality was experiencing financial difficulties, as was revealed by Quality’s frequently overdrawn account. The court further reasoned that even if Heritage were not aware of the PACA as it claimed, it had the duty to inquire, under the standard of a reasonably prudent lender, whether its customer was a PACA trustee and whether the trust had been breached. The court opined that a reasonably prudent businessman would have noticed the explicit PACA language in Overton’s invoices and would have concluded that it was dealing with trust assets. See id. at 834-35. For these reasons, the court ruled that Heritage was not entitled to the bona fide purchaser defense. See id. at 835.