In my last Produce and the Law article, I addressed two relatively common questions from a client whose produce-buying customer filed for bankruptcy protection: 1) Whether the individual owners or shareholders of a produce dealer that files for bankruptcy protection can still be held personally liable for the dealer's unpaid PACA trust debts; and, 2) whether the principals can avoid personal liability by filing for bankruptcy protection in their individual capacities.
As often is the case, answering those two questions generated another inquiry from a client whose customer claimed to be filing for bankruptcy protection, but wanted to send a payment for credit to their outstanding balance. The client wanted to know if there were any risks associated with accepting a payment under these circumstances. The issue to which the inquiry pertains is the "preferential payment" of debts by an insolvent debtor, and whether such payments conflict with a PACA trust beneficiary's right to payment from trust assets held by the debtor. This week, I thought we would spend a few minutes looking at this issue.
A "preferential payment" is a payment of a bona fide debt to one creditor when the debtor has insufficient funds to fully pay debts owed to other creditors. The law developed by the courts generally supports the right of a debtor to "prefer" one creditor over another, even though the remaining assets available to pay other debts will be depleted. There are several reasons for this, including the fact that a distressed debtor may survive if allowed to pay existing suppliers that extend additional credit. However, an insolvent debtor typically may not choose to pay its corporate officers rather than outside creditors.
The Bankruptcy Code allows a Trustee to recover certain payments to creditors made within ninety (90) days of an insolvent debtor filing for bankruptcy protection. This is referred to as a "preference action" and is available to the Trustee even if the payments satisfied bona fide debts. Let me repeat that - even the payment of a valid debt may be recovered by the Trustee if it was made within ninety (90) days of the debtor's bankruptcy filing. Therefore, the question for a PACA trust beneficiary is whether an insolvent debtor's payment of a valid PACA trust debt is the type of preferential payment subject to recovery under the Bankruptcy Code.
The PACA statute defines the corpus of the trust as all produce, including all inventories of food or other products derived from produce, receivables or proceeds from the sale of produce or its products, and all inventory acquired with PACA trust funds or funds from a commingled account. Bankruptcy courts have found that these PACA trust assets are not property of a debtor's estate and must be set aside for distribution to the PACA trust beneficiaries.
By definition, a Trustee can only recover assets of the estate that were the subject of preferential payments. The distinction that PACA trust assets held by an insolvent debtor are not part of the debtor's estate provides a PACA trust beneficiary with a defense to a preference action by a Trustee. In other words, the payment of a valid PACA trust claim consists of trust assets belonging to the trust beneficiary, not of assets belonging to the bankrupt debtor's estate.
Notice that I said that a PACA trust beneficiary has a "defense to a preference action by a Trustee." Every defense is challengeable and a Trustee could take a hard-line approach, arguing that a particular payment is not protected by the PACA trust. It has been our experience, however, that payment of a valid PACA claim will be protected from a Trustee's preference action.
Should you have any questions regarding this or any other issue, please feel free to contact our office.