Summary of a Recent
Judicial
Development in
Perishable Commodities
Bank Liable to PACA Beneficiaries
Sean BristerNational AgLaw Center Graduate Assistant
In an action brought under the Perishable Agricultural Commodities Act (PACA), 7 U.S.C. §§ 499a-499t, by several unpaid produce suppliers against a produce merchant's bank seeking to require the bank to disgorge funds deposited by the merchant that were used to pay down the merchant's overdraft debt to the bank, the United States District Court for the Southern District of New York has ruled that the bank was not a bona fide purchaser and was therefore liable for the merchant's breach of the trust as a third party transferee of the trust assets. Albee Tomato Co. v. Korea Commercial Bank of New York, No. 89 Civ. 01888(BSJ), 2003 WL 255246, at *1 (S.D.N.Y. Feb. 5, 2003) (Albee III). The district court also ruled that the bank was only required to disgorge those funds that were eventually used by the merchant to pay non-PACA beneficiaries. See id. at *12-13. In addition, the court ruled that nine of the produce suppliers perfected their rights in the statutory trust. See id. at *4-6.
The PACA was enacted "'in 1930 to promote fair trading practices in the marketing of perishable agricultural commodities, largely fruits and vegetables.'" Id. at *2 (citation omitted). The PACA was amended in 1984 "to create a statutory trust for the benefit of unpaid produce suppliers . . . ." Id. (citation omitted). "Congress created the PACA trust to address its concern that produce suppliers, forced by the nature of their perishable produce to sell their goods without security, would consistently recover from defaulting merchants only after secured lenders such as banks." Id. (citation omitted). A PACA trust "is created immediately upon a merchant's acceptance of perishable commodities and this merchant is required to maintain in trust all the proceeds from the sale of the supplier's produce and derivatives therefrom." Id. (citation omitted). When a "merchant fails to meet his obligations under the trust, the PACA trust 'gives unpaid suppliers . . . priority over secured lenders' in proceeds from the sales of their commodities." Id. (citation omitted).
The plaintiffs were unpaid sellers of perishable agricultural commodities who sold produce to A.B. Shalom Produce Corp. (Shalom) at the Hunts Point Market in Bronx, New York. See id. at *1. Shalom then resold the produce to retailers in the greater New York area. See id. The proceeds from these sales were held by Shalom in a statutory trust created by the PACA for the benefit of the unpaid produce sellers. See id. Beginning in August, 1988, Shalom breached the statutory trust by using trust funds to reduce its overdraft account with Korea Commercial Bank (KCB). See id. The breach continued until KCB froze Shalom's account on January 17, 1990. See id.
The plaintiffs brought this action in March, 1989. See id. They originally sued KCB, Shalom, Young Ok Lee, Ryung Cil Yi d/b/a RNK Produce, and RNK Grocery, Inc., but the claims against these defendants were dismissed on June 5, 1996. See id. n.3. In 1994, a motion for summary judgment was granted in favor of KCB on the theory that the bank was a "'bona fide purchaser for value.'" Id. (quoting Albee Tomato, Inc. v. A.B. Shalom Produce Corp., No. CIV.A.89-01888, 1995 WL 766306, at *3 (S.D.N.Y. Dec. 28, 1995) (Albee I)). The plaintiffs appealed the decision, and the Second Circuit reversed and remanded the case for a trial on the merits. See id. at *2 (citing Albee Tomato, Inc. v. A.B. Shalom Produce Corp., 155 F.3d 612 (2d Cir.1998) (Albee II)). The case at hand was before the district on the remand from the Second Circuit.
The plaintiffs alleged that KCB participated in the merchant's breach of the PACA trust and was therefore liable for the amount it accepted from trust funds. See id. at *3. The district court noted that courts have used general trust principles to determine if third parties have breached or participated in the breach of a PACA trust, even though the PACA does not explicitly provide remedies against third parties. See id. (citations omitted). The district court noted that "[c]ourts have routinely considered whether banks that have accepted PACA trust money as loan payments from trustee merchants are liable to PACA protected suppliers." Id. (citations omitted).
Under the PACA, produce suppliers are required to perfect their rights in the trust, or they are deemed to have waived their PACA rights. See id. The method of perfection applicable here requires a supplier to notify in writing both the Department of Agriculture and the merchant of its intent to preserve PACA benefits within a certain time limit. See id. (citing In re Marvin Properties, Inc., 854 F.2d 1183, 1186 (9th Cir.1988)). Unless the parties contract otherwise, the statutory and regulatory time limit for notification is forty days. See id. In this case, the court applied the forty-day time limit. See id.
KCB contested the plaintiff's notification to Shalom, but not the notification to the USDA. See id. at *4. Under New York law, the mailing of a letter creates the presumption of receipt by the addressee. See id. (citations omitted). Evidence of mailing can be provided either by the person who actually mailed the letter or by proof that the mail was sent through normal office procedures followed during the normal course of business. See id. (citations omitted). The court noted that fourteen of the plaintiffs presented witnesses that were in positions of authority that testified that the PACA notices were sent to merchants and the USDA at the same time. See id. The same witnesses testified to the procedures used by the employees under their supervision. See id. This testimony was corroborated with certified copies of USDA receipts of notice of intent. See id.
In addition, the court noted that Shalom's principal, Young Ok Lee, did not deny receipt of the notices, but, in fact, admitted receiving notices in October, 1988. See id. Lee did not dispute the amount of the debts and held a meeting with the suppliers in which he agreed to use account receivables to pay their claims. See id. The court found Lee's testimony credible, and because KCB did not produce any evidence that Lee contested the notice even when it was in his best interest to do so, it ruled that the fourteen plaintiffs who offered testimony met the burden of proving timely notice to Shalom. See id.>/p>
The claims of timely notice made by one of the plaintiffs, however, was rebutted by KCB. See id. at *5. KCB offered proof that some of the notices from this particular plaintiff were received by Shalom after the forty-day time limit. See id. The court agreed with KCB's rebuttal and reduced the amount of claimed damages by the amount of the notices that arrived after the deadline. See id.
Nine other plaintiffs failed to offer testimony in support of their claims of timely notification to Shalom. See id. The court determined that their USDA-certified notices and the testimony of Young Ok Lee were insufficient to meet the burden of proving timely notice. See id. The district court therefore dismissed the claims of those nine plaintiffs. See id.
In addition to the timely notice requirement, the plaintiffs were required to prove the amounts that they were owed by Shalom. See id. All fourteen plaintiffs testified about the amounts they were owed, based largely on invoices submitted to the USDA. See id. Lee stated that when Shalom received a notice to preserve the PACA benefits from a supplier, Shalom would check the notice against relevant invoices to determine if the amount was correct. See id. Lee recalled that the notices matched Shalom's records, and the court noted that Lee never disputed the suppliers' PACA claims against Shalom. See id.
KCB argued that negative inferences should have been drawn against the plaintiffs because they offered no further evidence and because they had destroyed the relevant records. See id. at *6. The district court rejected that argument, noting that the plaintiffs discarded the records several years after they made the PACA claims "in the normal course of business." Id. It also rejected the argument because KCB offered no proof that the destroyed documents contained information other than what was included in the invoices to the USDA. See id. at n.12.
After determining that the PACA suppliers met their burden of proof under the PACA trust requirements, the court examined whether the claims could be enforced against KCB as a third party transferee in breach of the trust. See id. at *6. KCB asserted that although it could be found liable under the third party transferee theory, it was not liable because it was a bona fide purchaser. See id. The court stated that in order for KCB to be considered a bona fide purchaser, it had to give value for the trust assets and had to have had no actual or constructive notice of the breach of trust. See id. (citing Albee II, 155 F.3d at 615; and Restatement (Second) of Trusts § 284(1)).
The district court explained that although "a transfer of trust assets to satisfy a pre-existing debt is generally not for value, an exception lies where the lender accepts a negotiable instrument or money." Id. (citation omitted). However, the Second Circuit in Albee II stated that KCB could not have the benefit of the exception if it were on notice of a breach of trust by Shalom. See id. (citing Albee II, 155 F.3d at 616). The Second Circuit also noted that because "Shalom had 'self-evident cash flow problems' . . . KCB could not defeat the PACA suppliers['] claims on a motion for summary judgment[,] and . . . it had a higher burden to establish a bona fide purchaser defense." Id. at *7 (quoting Albee II, 155 F.3d at 617). Thus, the Second Circuit adopted the following test:
[W]here . . . [a] PACA trustee has self-evident cash-flow problems, a lender . . . must make 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. The district court explained that this required the court to look at the facts presented at trial to determine if "Shalom suffered self-evident cash-flow problems and yet KCB failed to conduct a proper inquiry under this heightened standard." Id.
The district court first examined whether or not Shalom had self-evident cash-flow problems. See id. Shalom established an overdraft account with KCB in July, 1986. See id. The account had a credit limit of $120,000.00. See id. In its application, Shalom reported that any necessary payments toward reduction of the overdraft would come from company earnings. See id. (citation omitted). The court noted that KCB knew the deposits consisted of proceeds from the sale of produce. See id. (citation omitted). The account was secured by a $80,000.00 certificate of deposit, a $40,000.00 mortgage on Lee's residence, and personal guarantees from Lee, his wife, and other parties. See id. (citations omitted).
During the first year, Shalom exceeded the $120,000.00 line of credit continuously, and KCB collected the $80,000.00 deposit and reduced Shalom's credit to $40,000.00. See id. at *8. (citation omitted). The next year, 1997, Shalom abused its line of credit and continually incurred daily negative balances that ranged from $100,000.00 to $300,000.00. See id. (citation omitted). In 1988, the account was in extreme arrears, "offering a clear red flag to KCB that Shalom was having significant difficulty controlling its cash-flow." Id. Shalom's negative balance "rarely went below $300,000 and often hovered in the $400,000 and $500,000 ranges." Id. (citation omitted). In June and July, 1988, because Shalom was nearing renewal of the account, the negative balance was reduced to $26,021.37. See id. (citation omitted). In July, the account was renewed with an overdraft limit of $150,000.00. See id. (citation omitted). During August and September when Shalom breached the trust, the account's negative balances consistently remained close to the credit limit. See id. (citation omitted).
The district court stated that "[t]here is no doubt that KCB should have recognized Shalom's cash-flow problems." Id. The court noted that monthly reports of account transactions were prepared and sent to Shalom. It also noted that each time the account exceeded its credit limit, an insufficient funds report (NSF) was generated. See id. (citation omitted). The NSF was reviewed by the person overseeing the overdraft accounts, usually a deputy manager, and a loan clerk. See id. (citations omitted). Also, KCB reviewed Shalom's financial information in July, 1988. See id. (citation omitted). The information showed a net profit margin of 0.1 percent in 1987 and 0.3 percent in 1988. See id. (citation omitted).
The court also noted that KCB's actions toward Shalom demonstrated a concern about the overdraft account. See id. at *9. In 1987 and 1988, KCB continually "pressed Lee to reduce the overdrafts to within the authorized credit limit." Id. In November, 1987, KCB assisted Lee in developing a plan to reduce his debt to KCB. See id. (citation omitted). KCB also sent Lee a sharply written letter demanding that the overdraft be cleared in five business days or the account would be closed. See id. (citation omitted). Throughout 1988, KCB continued to speak to Lee about improving the negative balances. See id. (citation omitted). Lee constantly reassured KCB that Shalom had a plan to reduce the debt. See id. (citation omitted). The court observed that, "KCB's efforts demonstrate that it was aware of and concerned by Shalom's cash-flow problems." Id.
In its defense, KCB presented the testimony of an expert witness who testified that, based on Shalom's bank statements, KCB had no reason to be alarmed. See id. He described the negative balances as a normal situation for Shalom. See id. However, he also described the overdrafts in excess of $500,000.00 as "'disturbing.'" See id. (citation omitted). The district court rejected his testimony stating, "[h]is testimony with respect to normal overdraft procedure simply does not fit the facts of this case." Id. (citation omitted).
The court determined that a reasonable bank officer looking at the account should have been concerned about the sufficiency of funds to cover Shalom's expenses and debts. See id. It determined that "Shalom had self-evident cash-flow problems and that the bank was well aware of them." Id. The court stated that KCB should have investigated whether Shalom was satisfying other obligations before automatically deducting deposits against the overdraft to better its own position. See id.
The court explained that it also had to determine whether KCB "took steps 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. at *10 (quoting Albee II, 155 F.3d at 617). KCB argued that it met this standard when it reviewed Shalom's account and renewed it with a higher credit limit. See id. The district court was not convinced by this argument because KCB obtained security in Shalom's accounts receivables, property, and a mortgage on Lee's property. See id. The court also explained that analysis of credit risk is not the same analysis as whether a debtor is meeting its obligations to a prior creditor. See id. (citing Albee II, 155 F.3d at 617). The court noted that "it would have been reasonable and prudent for the Bank to require some form of third party review of Shalom considering the state of Shalom's financials." Id.
KCB did not check the information that Shalom presented it but relied on faith in Lee, his character, and his standing in the community. See id. at *11. The court stated that these characteristics may be worthy of KCB's attention, but they did not remove KCB's duty to inquire into Shalom's prior creditors. See id.
In addition, the court noted that even the information supplied by Shalom did not present a strong financial picture. See id. Those documents showed profits of $10,956.00 in 1986 and $14,485.00 in 1987. See id. The court reasoned that such small profits should have demonstrated to KCB that Shalom would have had trouble paying its suppliers and even KCB itself. See id.
Another factor that indicated KCB's failure to make a prudent inquiry was the fact that it failed to perform credit checks for prior creditors. See id. In a similar case involving KCB, the district court ruled that a bank made an appropriate inquiry after it checked the merchant's outstanding debts using reports from national credit agencies, "standard tools that a reasonably prudent lender would [use]." Id. (quoting E. Armata, Inc. v. David Lee's Produce Service Corp., No. 99 Civ.2042(AGS), 2002 WL 31834451, at *6 (S.D.N.Y. Dec.17, 2002)).
Finally, the district court noted that during Shalom's abuse of its overdraft account, KCB encouraged and demanded that Shalom increase the collection rate of his account receivables. See id. KCB had to have been aware that deposits into the account were from these accounts receivable and that Shalom would likely forego paying its suppliers to reduce its overdraft. See id. The court stated that based upon the facts and evidence, this was exactly what had occurred. See id. at *12.
The court noted that when KCB became firm with Shalom and bounced checks that Lee was writing, Shalom suddenly reduced the amount of the negative balance. See id. It also noted that the checkbook from the account reveals that at that same time Shalom stopped making payments to suppliers. See id. When Shalom began making payments to suppliers again, the account was once again exceeding its credit limit. See id. Therefore, the court concluded that KCB was on notice during the breach of the trust of Shalom's financial distress and that KCB failed to conduct an inquiry that a reasonable and prudent lender would make. See id.
Lastly, the district court examined the issue of damages to determine how much money KCB was required to disgorge. See id. The court explained that it was significant that even though the deposits into the account were used to reduce the overdraft, most of the payments from the account went to suppliers. See id. It noted that this was a permissible purpose because the funds were "bridging the time gap between payments due to suppliers and Shalom's collections of account receivables from retailers." Id. Obtaining cash for fair value of accounts receivables is consistent with trustee duties under the PACA. See id. at *13 (citations omitted). The court determined that KCB could only be liable for receipt of funds that were used to pay non-PACA beneficiaries. See id. It stated that no breach of trust existed for those funds deposited into Shalom's account but used to pay PACA beneficiaries. See id. The court used Shalom's checkbook to determine the amount of money paid to non-PACA beneficiaries during the course of the breach, $319,954.94. See id.
KCB argued that it was "entitled to equitable defenses of laches, unclean hands, and a failure of plaintiffs to mitigate damages." Id. KCB asserted that by notifying it of the lawsuit against Shalom ten months after it was filed, the plaintiffs were complicit in any breach of the trust. See id. KCB further asserted that the plaintiffs benefitted from the delay because they continued to receive checks from the account. See id. The court determined that this argument was unpersuasive because of its determination of damages that excluded payments made to plaintiffs. See id.
The court stated that the only relevant argument made by KCB was its claim that the plaintiffs should forfeit any payments made to non-PACA beneficiaries from the time of the filing of the lawsuit until the time of notification. See id. However, the court stated that equity did not favor KCB, even though the plaintiffs were delinquent in their notification to KCB. Because of "the ongoing circumstances of the overdraft account and Shalom's [sic] utter failure to explore whether Shalom was meeting its obligations to suppliers," the court denied equitable mitigation of damages to KCB. See id.
The district court concluded by entering a judgment for $319,954.90 plus interest from August 26, 1988. See id. The damages were to be divided pro rata among the fourteen prevailing plaintiffs according to the amount of their PACA claims.
The case was decided on February 5, 2003; this summary was posted April, 2003