Secured lenders extending financial accommodations to borrowers whose collateral includes perishable food items should consider certain specific risks associated with such collateral. Notably, the Perishable Agricultural Commodities Act of 1930 (PACA) creates a statutory trust for the benefit of persons who originally sell the perishable agricultural commodities to such borrowers and are not paid. The PACA trust creates a tier of claims that “float above” the secured lenders’ priority interests in the perishable agricultural commodities. Thus, until all suppliers of perishable agricultural commodities to a borrower are paid in full, a secured lender’s security interests in the borrower’s collateral consisting of perishable agricultural commodities or the proceeds thereof are trumped by the sellers’ PACA claims. Types of borrowers whose collateral may be subject to these PACA statutory trusts include restaurants, grocery stores, or any other businesses that deal with perishable agricultural products.

The burden is on the borrower/PACA debtor (as opposed to the beneficiary of the PACA trust) to establish that the subject assets (including inventory and accounts receivable) are not PACA trust assets. See Sanzone-Palmisano C. V. M. Seaman Enterprises, 986 F.2d 1010 (6th Cir. 1993) (finding that the PACA debtor had the burden of proving the assets producing the commingled proceeds were not produce or related assets and thus not subject to a PACA trust). In certain instances, a lender may be able to avail itself to the bona fide purchaser defense and thus avoid the “floating” PACA claims. However, case law in this area makes it clear that in order to prevail on this issue, a lender must establish that it acquired the subject assets without knowledge of the “floating” PACA claims only after such lender conducted a thorough investigation into the matter. Courts hold that a thorough investigation generally requires the lender to contact all potential sellers within the sale and distribution channels. See Consumer Produce Co. v. Volante Wholesale Produce, 16 F.3d 1374 (3d Cir. 1994).

So then, what can a secured lender do to protect itself when it lends to a borrower with collateral potentially subject to these “floating” PACA claims? First, a lender may insert representations and warranties within the credit agreement to ensure that all third parties have been, and will continue to be, timely paid in full. Second, a lender may insert a “PACA Reserve” within the borrowing base formula in order to ensure that obligations under any PACA trust are excluded from the value of collateral that the borrower may borrow against. Here is a sample definition of such a PACA Reserve:

PACA Reserve” means all amounts owed from time to time by the Borrower to any person on account of the purchase price or other amounts owed in respect of agricultural products or any services related to the foregoing and subject to PACA, to the extent that (i) such amounts are secured (by way of a grower’s lien, seller’s lien, statutory trust or similar security interest or priority arrangement) by the applicable agricultural products (such lien, a “PACA Super Priority Lien”) in accordance with PACA and (ii) the Lender determines in its permitted discretion that such PACA Super Priority Lien would have priority over the Lender’s lien in any portion of the Collateral.

Third, a lender should assume that it will not have first-priority security interest in the perishable agricultural commodity inventory of a borrower. Finally, lenders should always consult with experienced legal counsel with knowledge of the PACA statutory framework and related case law.