Summary of a Recent
Judicial Development in
Secured Transactions

Texas Milk Statute Is a Valid Exercise of State Law

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In Lone Star Milk Producers, Inc. v. Litzler, 370 B.R. 671 (Bankr. N.D. Tex. 2007), the United States Bankruptcy Court for the Northern District of Texas held that a cooperative of dairy farmers was entitled to funds held by the Debtor in trust pursuant to chapter 181 of the Texas Agriculture Code.

Background

On October 11, 2006, an involuntary Chapter 7 petition was filed against Americana Foods by its general partner CB Americana LLC, and a few weeks later the court entered an order of relief Id. at 674. Prior to the petition date, the Debtor was in the business of manufacturing and selling ice cream to wholesalers for major brands such as Dreyers and TCBY. Id. After the petition date, the Trustee obtained authorization to sell off finished ice cream products and certain raw materials. Id. Lone Star was a cooperative association of milk producers that was principally engaged in marketing and distributing raw milk produced by its members. Id. Americana bought milk products from Lone Star prior to the petition date, and it owed Lone Star $585,593. Id. Lone Star alleged that from August 1, 2006, until the petition date, Americana had received in excess of $8 million deposited directly into its lock box account, and continued receiving money after the petition date from the sale of ice cream products. Id. Lone Star filed a motion for relief from automatic stay to allow them to send Americana a notice to preserve its rights under chapter 181 of the Texas Agriculture Code (Texas Milk Statute), or in the alternative, to compel Americana to surrender the trust funds pursuant to chapter 181. Id. The court lifted the stay, and Lone Star brought an adversary proceeding against Americana. Id.

Arguments

Lone Star argued that it was entitled to proceeds from the sale of dairy products held in trust by Americana under the Texas Milk Statute. Id.

Americana argued that the Texas legislature, in enacting the Texas Milk Statute, was effectively rewriting priorities established by the Bankruptcy Code and impermissibly putting dairy farmers ahead of other creditors. Id. at 676. It alternatively argued that the trust created was an implied trust that did not arise until after the bankruptcy case was filed, and so any dairy product proceeds from the sale of raw milk became property of the estate. Id. at 678.

Analysis and Holdings

The issues before the court were whether chapter 181 of the Texas Agricultural Code was valid, whether Lone Star was a "dairy farmer" as defined by the Texas Milk Statute, whether the statute obligated Americana to hold proceeds in trust for Lone Star, and whether the funds from the sale of dairy products belonged to Lone Star under the Milk Statute or to the bankruptcy estate. Id. at 675.

The Texas Milk Statute is a valid exercise of state law
Chapter 181 of the Texas Agriculture Code states that "a milk processor shall hold in trust all payments received from the sale of milk for the benefit of the dairy farmer from whom the milk was purchased until the dairy farmer has received full payment of the purchase price for the milk." Id. at 676. The court noted that the Fifth Circuit has held that "[w]here state law impresses property that a debtor holds with a constructive trust in favor of another, and the trust attaches prior to the petition date, the trust beneficiary normally may recover its equitable interest in the property through bankruptcy court proceedings." Id. The court pointed out, however, that a state's right to create trusts to separate property from the bankruptcy estate is not absolute; for example, states may not create laws that are solely meant to manipulate bankruptcy proceedings, or that create liens effective only in bankruptcy. Id. The court stated the following rule: "a state may create a statute that imposes a trust excluding property from a bankruptcy estate as long as the statute also has valid non-bankruptcy applications and the trust attaches prior to the petition date." Id. at 677. Applying that rule, the court held that the Texas Milk Statute is a valid exercise of state law. Id.

Lone Star is a "dairy farmer"
The term "dairy farmer" is defined by the statute as a "farmer engaged in the business of producing milk for sale to milk processors directly or through a cooperative association of which the dairy farmer is a member," and adds that "[w]hen a dairy farmer sells or markets milk through a cooperative association of which the dairy farmer is a member, the cooperative association is considered a dairy farmer." Id. at 677. The undisputed evidence presented by Lone Star showed that the entities for which it claimed payment were dairy farmers and were its members, so the court concluded that Lone Star was a "dairy farmer" for purposes of the statute. Id. at 677-78.

Funds held in trust
The court rejected Americana's argument that the trust created by the Milk Statute was an implied trust, and held that it was an express trust. Id. at 679. The court further found that Americana was never in possession of the funds because the Milk Statute clearly states that funds held in escrow are the property of the dairy farmer. Id.

For the aforementioned reasons, the court held that Lone Star had satisfied its burden of proof and was therefore entitled summary judgment. Id. at 681.

The case was decided on June 27, 2007.