Summary of a Recent
Judicial Development in
Perishable Ag Commodities

Producer Failed to Preserve Trust
Benefits Under PACA

John D. Mead
National AgLaw Center Research Fellow

The United States Court of Appeals for the Sixth Circuit held that a produce wholesaler could not recover from a commercial lender the assets of a statutory trust created by the Perishable Agricultural Commodities Act ("PACA"), 7 U.S.C. §§ 499a-499t, because it failed to properly preserve its rights to the PACA statutory trust. Overton Distrib., Inc. v. Heritage Bank, 340 F.3d 361, 366-68 (6th Cir. 2003).

Plaintiff Overton Distributors, Inc. ("Overton") supplied produce to Quality Foods of Tennessee, Inc. ("Quality") from 1993 through 2000. See id. at 363. In 1993, Overton sent a letter to Quality stating that Quality would pay Overton's invoices within twenty-five days of receiving deliveries of produce. See id. at 364. For the following four years, Overton's invoices reflected these payment term. See id.

In 1998, Overton changed its invoices to provide that it was to receive payment from Quality within ten days after the end of each calendar month in which Overton delivered its produce to Quality. See id. The payment terms were changed because Quality consistently submitted late payments to Overton. See id. The invoices also contained the following statement:

The perishable agricultural commodities listed on this invoice are sold subject to the statutory trust authorized by section 5(c) of the Perishable Agricultural Commodities Act, 1930 (7 U.S.C. 499e(c)). The seller of these commodities retains a claim over these commodities, and any receivables or proceeds from the sale of these commodities until full payment is received.

Id.

Quality continued to pay Overton "on an irregular and tardy basis," often taking between forty and sixty days to make payment. See id. Although Overton complained about Quality's late payments, "it never required Quality to strictly abide by any specific terms of payment." Id.

Defendant Heritage Bank ("Heritage") provided banking services to Quality. See id. at 364. In 1996, after experiencing significant financial difficulties, Quality entered into a financing agreement with Heritage that allowed Quality to obtain loans using its accounts receivable as collateral. See id. Approximately ninety percent of those accounts arose from the sale or resale of produce covered by PACA. See id. at 363.

The financing agreement contained numerous provisions that limited Heritage's exposure. See id. at 364. The BMA provided that Quality would remain liable for all of the advances it received if the proceeds from the accounts receivable did not cover the amount of the loans advanced by Heritage. See id. The agreement also included "a blanket security interest on all of Quality's assets and a representation that Quality's receivables were free and clear of security interests, liens, and claims of third parties. See id.

Quality went out of business in January, 2000, leaving Overton unpaid for more than $220,000 in produce. See id. In July of 2000, Quality filed a Chapter 7 bankruptcy petition. See id. at 363. Because Quality was insolvent, Overton filed suit against Heritage to recover its losses, asserting that it had properly preserved its claim to trust benefits under PACA, that the financing agreement between Quality and Heritage breached the PACA trust, and that Overton was therefore entitled to recover from Heritage. See id. at 365. Heritage argued that "Overton had not properly preserved its trust benefits, and that, even if it had, the . . . [financing agreement] represented a bona fide sale of the accounts receivable to the bank, not a security interest that would allow Overton to claim priority over these funds." Id.

The district court determined that Overton had properly preserved its PACA trust benefits, that the financing agreement breached the PACA trust, and that "Heritage's bona-fide-purchaser defense was without merit." Id. It ordered Heritage to pay the full amount due from Quality plus prejudgment interest. See id.

On appeal, the Sixth Circuit reversed the district court's decision. The court explained that one of the purposes of PACA was to protect unpaid sellers of perishable agricultural commodities because "[d]ue to the need to sell perishable commodities quickly, sellers of perishable commodities are often placed in the position of being unsecured creditors of companies whose creditworthiness the seller is unable to verify." Id. at 364-65 (citing Endico Potatoes, Inc. v. CIT Group/Factoring, Inc., 67 F.3d 1063, 1067 (2d Cir. 1995)). It also explained that in 1984, Congress amended PACA when it added a statutory trust in favor of unpaid sellers that protects them "against financing arrangements made by merchants, dealers, or brokers who encumber or give lenders a security interest in the commodities" that provide them with priority over secured creditors. Id.

The court explained that to preserve its rights in a PACA statutory trust, a seller must give written notice to the buyer of its intention to preserve its trust benefits and that such notice may be provided on the invoices given to the buyer. See id. at 365. It further explained that

[i]f the seller and the buyer use the default payment terms provided in the regulations ("within 10 days after the day on which the produce is accepted"), this notice of intent to preserve benefits is all that is necessary. On the other hand, if the parties agree to payment terms greater than 10 days after acceptance, but in no event more than 30 days after acceptance, this agreement must be in writing. The seller must also disclose these non-statutory payment terms "on invoices, accountings, and other documents relating to the transaction. . . ." "The maximum time for payment for a shipment to which a seller, supplier, or agent can agree and still qualify for coverage under the trust is thirty days, after receipt and acceptance of the commodities . . . ."

Id. (citing 7 U.S.C. § 499e(c)(3); 7 C.F.R. § 46.46(e)(1),(2)).

The court ruled that the district court erred when it determined that Overton had preserved its PACA trust benefits. Overton, 340 F.3d at 366. It stated that although Overton provided a statement of its intention to preserve its benefits in a PACA statutory trust, it failed

to place the payment terms as agreed to in the 1994 written agreement on these invoices. Instead, the payment terms on all invoices from 1998 were "10 days EOM," establishing that the payment was due within 10 days after the end of each calendar month in which produce was delivered. Because payments for produce delivered on the first of the month could be made as late as 40 days after the date of acceptance, the invoices indicated that Overton was agreeable to a payment schedule outside of PACA's protection.

Id.

Overton asserted that it should have been able to avoid the consequences of its failure to comply with PACA because the parties' 1994 agreement "and the payment terms on the relevant invoices" differed so as to make the agreement ambiguous, and therefore there was no agreement at all. Id. In the alternative, Overton argued that is failure to comply with PACA should be excused because "the different terms on the invoices were the result of a clerical error, and . . . [it] should be given benefit of the doubt due to its good faith effort to substantially comply with PACA." Id.

The court rejected Overton's assertions, stating that the statutory language of PACA is clear and that "[a]bsent a written agreement altering the payment terms set in 1994, all of the subsequent invoices from Overton to Quality were required to disclose the agreed terms of payment." Id. (citing 7 U.S.C. § 499e(c)(3) and 7 C.F.R. § 46.46(e)(1)). See id. It added that

[t]he parties had clearly agreed in 1994 to terms different from the standard 10-day payment provision contained in the PACA regulations. Consequently, PACA and the regulations mandate that those terms had to be disclosed on the invoices. Overton cannot have it both ways. It cannot, on the one hand, list terms on its invoices that are not only different from those mutually agreed upon, but also permit payment outside of PACA's requirements, and then on the other hand argue that it has substantially complied with PACA.

Id. at 366-67.

The court held that "[b]ecause Overton's 40-day maximum payment term failed to preserve its trust benefits under PACA, it is not entitled to assert priority over Quality's accounts receivable that arose from the sale of Overton's produce." Id. at 368. Thus, it did not consider whether the financing agreement was merely a security interest in Quality's accounts receivable or whether Heritage was a bona fide purchaser of those accounts. See id.

The case was decided on Aug. 25, 2003; this summary was posted Dec. 10, 2003.