In past Produce and the Law articles, we have addressed the issue of whether individual owners or shareholders (principals) of a produce dealer can avoid personal liability for the dealer's PACA trust debts by filing for bankruptcy protection in their individual capacities. On May 13, 2013, the Supreme Court of the United States issued a decision in the case of Bullock v. BankChampaign, N.A., 569 U.S. ___ (2013) that may impact the standard by which discharge is granted or denied in the bankruptcy courts. This week, we take a look at the Supreme Court's decision, and its implications for produce sellers and suppliers.
In most situations, the principals of a business do not bear personal liability for the company's debts. However, when the insolvent business is a produce dealer that breached the PACA trust, produce creditors who properly preserved their trust rights may hold the principals of the produce dealer personally liable for the company's PACA trust debts. The principals may not hide behind its corporate status to avoid liability for their role in causing the produce dealer to breach the trust.
When such a principal files for bankruptcy protection in his or her individual capacity, the court may enter an order forgiving debts that simply cannot be paid with the assets available. For public policy reasons, certain obligations such as alimony, child support, student loans and taxes are not dischargeable, even though they may not be collectible. In addition, section 523(a)(4) of the Bankruptcy Code prohibits discharge of any debt incurred through "fraud or defalcation while acting in a fiduciary capacity..."
Thus, to successfully challenge discharge of a PACA trust debt, a produce creditor must file a lawsuit in the Bankruptcy Court objecting to discharge. In order to prevail, the creditor must prove that (1) the PACA trust is an express trust, (2) the person seeking discharge was acting in a fiduciary capacity for the produce dealer owing the debt, and (3) the person seeking discharge committed a "defalcation" while acting in his or her fiduciary capacity. Exactly what constitutes "defalcation" - a mishandling or misappropriation of funds - has been somewhat of a question mark for the courts, leading to varying decisions on the degree of conduct necessary to prove defalcation. In some jurisdictions, it has been sufficient to simply show that the principal controlled or was in a position to control the produce dealer's finances and failed in his or her fiduciary duty to direct the dealer to pay its PACA trust debts. In others, the creditor must prove something more - such as intentional conduct.
The Bullock case did not involve the sale of produce or the statutory trust created under PACA. Rather, the case involved a trust established for the purpose of administering a single asset - a life insurance policy. Under the terms of the trust, the trustee was allowed to borrow funds from the insurer against the value of the policy, provided that the funds were repaid with interest. The trustee borrowed funds on three separate occasions, repaying the trust with interest each time.
However, the beneficiaries of the trust sued the trustee for breach of fiduciary duty, arguing that the trustee had improperly engaged in self-dealing by using the trust funds for personal gain. A state court judgment was entered against the trustee, which the trustee subsequently attempted to discharge in bankruptcy. The Bankruptcy Court granted summary judgment in favor of a creditor of the trustee who objected to discharge of the debt. The Bankruptcy Court's decision was upheld on appeal by the District Court and the Eleventh Circuit Court of Appeals. On certiorari, the Supreme Court limited its review to the scope and meaning of the term, "defalcation" as used in the Bankruptcy Code.
In its decision, the Supreme Court noted that the term defalcation is used in the same section of the Bankruptcy Code as "larceny" and "embezzlement," both of which require culpable states of mind. That is, a person must intend to commit larceny or to embezzle; it doesn't happen by accident. The Supreme Court held that defalcation should be viewed in the same light; that it should require a showing of conduct the debtor knew was wrong or, where "actual knowledge of wrongdoing is lacking, we consider conduct as equivalent if the fiduciary 'consciously disregards' (or is willfully blind to) 'a substantial and unjustifiable risk' that his conduct will turn out to violate a fiduciary duty."
The import of this decision to produce creditors is that it arguably heightens the standard for successfully objecting to discharge of PACA trust debts by the principal of an insolvent produce dealer. No longer will it be sufficient to simply say that the principal controlled the assets of the produce dealer that failed to pay its PACA trust debts, regardless of the reasons for such failure. Under the Supreme Court's decision in Bullock, PACA trust creditors must now prove that the principal intended to misappropriate the PACA trust assets, or that his or her conduct consciously disregarded a substantial and unjustifiable risk that it would result in a violation of fiduciary duty. In the context of the produce industry, where written documentation is often somewhat thin, establishing a principal's state of mind may prove to be difficult. Accordingly, we recommend that a thorough evaluation of the true potential for meeting the heightened standard and showing intent or conscious disregard be conducted before an objection to discharge is filed.
If you have any questions regarding this or any other subject, please feel free to contact our office.