Ninth Circuit Expands Paca Exposure For Factors

Ninth Circuit Expands Paca Exposure For Factors

The U.S. Court of Appeals for the Ninth Circuit sharply expanded the scope of liability for factors dealing with fresh produce distributors.  In doing so, the Ninth Circuit distinguished its 17 year-old precedent, Boulder Fruit Express & Heger Organic Farm Sales vs. Transp. Factoring, Inc., 251 F.3d 1268 (9th Cir. 2001) (“Boulder Fruit“).

In Boulder Fruit, the Court held that “factoring agreements do not, per se, violate PACA [the Perishable Agricultural Commodities Act],” and that a “commercially reasonable sale of accounts for fair value is entirely consistent with the trustee’s primary duty under PACA . . . to maintain trust assets so that they are freely available to satisfy outstanding obligations to sellers of perishable commodities.”  Id. at 1271.  An en banc panel of the Circuit Court expressly overturned Boulder Fruit in S & H Packing & Sales Co., Inc. v. Tanimura Distrib., Inc. (“Tanimura“) to the extent it disagreed with its Tanimura decision.

Tanimura presents the typical story of a struggling produce distributor.  Tanimura Distributing, Inc. (“Tanimura”) purchased perishable commodities from produce growers.  As such, Tanimura became a trustee for the growers’ produce and any accounts receivable arising from the sale of the produce under PACA.  Tanimura sold the produce on credit to third parties and sold the resulting accounts receivable to AgriCap Financial Corporation (“AgriCap”).  When Tanimura could not repay its growers, they sued Tanimura.

Tanimura responded by filing for chapter 7 bankruptcy protection.  The growers then added AgriCap to their action against Tanimura, contending it received trust property in breach of the PACA trust.  Despite prevailing before the lower court and a prior panel of the Ninth Circuit, an en banc panel of the Ninth Circuit vacated its earlier ruling.

The Ninth Circuit concluded that in determining if a factor is liable for a breach of the PACA trust, courts must first conduct an inquiry as to whether the sale of the accounts receivable is a “true sale” and then determine if the sale was “commercially reasonable.”  If the sale was not a “true sale,” then it is a lending transaction and the factor may be liable.  The factor may nonetheless still be liable if the sale is not determined to be commercially reasonable, i.e., whether the sale was a fair deal.

To determine if there was a “true sale,” courts must now rely upon a transfer-of-risk test and not upon the labels contained in the factoring agreement.  Under the transfer-of-risk test, courts will be focused on whether the factor actually purchased the accounts receivable and bears the risk of non-performance by the account debtors.  In particular, courts will be looking at the following factors: (1) whether the factor may recover a deficiency against its assignor if the accounts sold are insufficient to repay the factor for its purchase; (2) the effect on the assigned accounts if the assignor were to repay the debt owed to its factor from its other assets; (3) whether the assignor has a right to recover on any of the accounts assigned; and (4) whether the assignment reduces the assignor’s obligation to the factor.

The transfer-of-risk test is a factual determination and will lead to further litigation for factors.  No longer may factors as easily dispose of claims that they received PACA trust assets in breach of the trust because the PACA creditors may inquire into the nature of the factoring arrangement to challenge the sales of the accounts as being “true sales.”