Written by: Amie Alexander, JD/MPS Candidate, William H. Bowen School of Law

The United States Court of Appeals for the Ninth Circuit recently sided with produce growers in a dispute with a trustee of a PACA trust holding. The court joined the Second, Fourth, and Fifth Circuits in determining that a true sale test should determine whether assets transferred in transactions that are labeled as “sales” remain assets of a PACA trust. Specifically, the court held that before considering the commercial reasonableness of a transaction, a court must first apply a threshold true sale test for which the transfer-of-risk is a primary factor.

Factual Background

Appellants, who are produce growers (“Growers”), sold perishable agricultural products on credit to Tanimura Distributing, Inc. under the Perishable Agricultural Commodities Act (“PACA”) (See 7 U.S.C. §§ 499). Tanimura served as the trustee over a PACA trust which held the perishable products and resulting proceeds for Growers, who were the PACA-trust beneficiaries. Tanimura sold these products on credit to third parties, transferring the resulting accounts receivable to AgriCap Financial (“AgriCap”), who is the appellee in this action. AgriCap calls this transaction a “Factoring Agreement,” or sale of accounts.

After Tanimura’s business failed, the Growers did not receive full payment for their produce. Growers filed suit against Tanimura, “alleging: (1) that the Factoring Agreement was merely a secured lending arrangement structured to look like a sale; (2) that the accounts receivable and proceeds, therefore, remained trust property under PACA; (3) that because the accounts receivable remained trust property, Tanimura breached the PACA trust and AgriCap was complicit in the breach; and (4) that under PACA the PACA-trust beneficiaries, including Growers, held an interest superior to that of any secured lender.” Therefore, Growers allege that AgriCap was liable to repay the value of the accounts receivable.

PACA was enacted by Congress in 1930 to prevent unfair business practices and promote financial responsibility in the fresh fruit and produce industry. The court cited congressional reports detailing history of sellers of perishable commodities often being placed in the position of unsecured creditors of companies who were unable to verify the creditworthiness of sellers and therefore subject to a large number of defaults by the purchasers, leaving sellers likely to recover little of their rightful share. PACA’s purpose was therefore to shield agricultural growers from risk in the public interest and “not to give a one-sided boon to growers, but instead, to benefit all parties and society by ensuring that growers are protected; lenders know their risk; and agricultural commerce is encouraged to benefit society” (See 7 U.S.C. § 400e(c)(1)).

District Court’s Ruling

In its motion for summary judgment, AgriCap cited Ninth Circuit case law holding that a trustee is allowed to remove assets from the trust in any commercially reasonable way without breaching the trust, and because the factoring agreement was commercially reasonable, it was not in breach (See Boulder Fruit Express & Heger Organic Farm Sales v. Transportation Factoring Inc., 251 F.3d 1268 (9th Cir. 2001). In response, the Growers argued that conflicting precedents from the Second, Fourth, and Fifth Circuits held that a court should not review the commercial reasonableness of a factoring agreement until the court first demonstrates a true sale actually occurred. Growers maintained that a true sale “only occurs when a PACA trustee transfers not only the right to collect the underlying accounts, but also the risk of non-payment on those accounts.”

The district court granted AgriCap’s motion for summary judgment, rejecting the separate transfer-of-risk test. The Growers argued on appeal to a three-judge panel that the court was not bound by Boulder Fruit because it never discussed the transfer-of-risk test, leaving an open question as to whether the transfer-of-risk test applies in the Ninth Circuit. The three-judge panel agreed with AgriCap, reasoning that the Boulder Fruit court had rejected the transfer-of-risk test by declining to apply it after the parties raised the issue.

This Court’s Holding

A majority of active judges on the Ninth Circuit Court of Appeals agreed to hear the appeal en banc to eliminate the circuit split on the transfer-of-risk test. This court focused on whether, in the context of determining the assets included in a PACA trust, a court needs to conduct a threshold true sale inquiry before it determines whether a transaction transferring PACA trust assets was a commercially reasonable sale.

The court joined the Second, Fourth, and Fifth Circuit approaches. The court determined that the true sale test should determine whether assets transferred in transactions that are labeled as “sales” remain assets of a PACA trust. Specifically, the court held that a court must conduct a two-step inquiry when determining whether the questioned transactions is a sale or creates a security interest. The court concluded that the transfer-of-risk test should be applied to avoid reliance on labels in factoring agreements that would defeat the purposes of PACA.

First, the court must apply a threshold true sale test, in which the transfer-of-risk is a key factor, but not the only one. If there was not a true sale, the assets should remain in the trust. The court further held that “a district court should look to the substance of the transaction to determine whether the transaction is a true sale or a secured loan. In doing so, the transfer of risk should be a primary factor to which the court looks.”

If a court concludes there a true sale occurred, the true sale must have been commercially reasonable. If the sale was not commercially reasonable, this constitutes a breach of the trust and the assets should remain in the trust. If the true sale was commercially reasonable, the buyer now owns the assets free and clear of the trust.

In reaching this decision, the court stressed that Congress clearly gave PACA creditors priority over secured creditors within the purpose of the legislation, and courts should keep PACA’s purpose in mind when reviewing transactions that may in substance limit that congressional policy. Here, the court offers that “if Tanimura made a true sale of its receivables to AgriCap, acting as a factor, and if it was for fair value and a commercially reasonable amount, then the PACA trust was not offended. But on the other hand, if the challenged transaction was not a true sale but rather a secured ending arrangement, then the plaintiff Growers have a claim that must be resolved in further proceedings.”

Because the transaction here has features of both a sale and a loan, on remand, the district court should make findings of fact to determine whether the agreement in substance was a true sale or was a lending agreement. The case was vacated and remanded, overruling the portions of Boulder Fruit inconsistent with the following holding: “before considering the commercial reasonableness of a transaction, a court must first apply a threshold true sale test for which the transfer-of-risk is a primary factor.”