Imagine you loan $1,000,000 to a third party concerning the purchase of a commercial property and you secure the loan with a “purchase-money mortgage” or deed of trust in first position. Months later, the borrower defaults and you initiate the foreclosure sale. Then, days before the scheduled foreclosure, you are served with a lawsuit claiming you can’t foreclose because the property is encumbered by a PACA lien in senior position to your purchase money mortgage!
Most real estate professionals understand that a purchase-money mortgage is senior to all other liens. But that is only mostly true. One important exception for all real estate professionals to be aware is the “PACA Trust.”
The U.S. Congress enacted the Perishable Agricultural Commodities Act (PACA) in 1930 to protect farmers from unlawful conduct and to subject violators to civil liabilities. In 1984, Congress amended PACA “to encourage fair trading practices in the marketing of perishable commodities by suppressing unfair and fraudulent business practices in marketing of fresh and frozen fruits and vegetables… and providing for collecting damages from any buyer or seller who fails to live up to his contractual obligations. Stated another way, the PACA “provides a code of fair play . . . and an aid to agricultural traders in enforcing their contracts.” The PACA makes it unlawful for produce buyers, inter alia, to:
- Fail to make full payment promptly for any produce they purchase.
- To make, for a fraudulent purpose, any false or misleading statement in connection with any transaction involving any perishable agricultural commodity which is received in interstate or foreign commerce.
- To fail or refuse to truly and correctly account to the seller of produce.
- Fail, without reasonable cause, to perform any specification or duty, express or implied, arising out of any undertaking in connection with any such [produce purchase].
- Fail to maintain the trust as required under section 5(c) [7 U.S.C. 499e(c)].
- Fail to maintain trust assets in a manner that such assets are freely available to satisfy outstanding obligations to sellers of perishable agricultural commodities. Any act or omission which is inconsistent with this responsibility, including dissipation of trust assets, is unlawful and in violation of section 2 of the Act, (7 U.S.C. 499b).
The 1984 Amendment to PACA provides farmers with extraordinary remedies, including a constructive lien or trust that follows the revenues received from the produce. Congress provided this extraordinary protection because it concluded “sellers of fresh fruits and vegetables [were] unsecured creditors and receive[d] little protection in any suit for recovery of damages where a buyer ha[d] failed to make payment required by the contract.” Specifically, Congress recognized that due to the produce “sellers’ status as unsecured creditors, the [produce] sellers recover, if at all, only after banks and other lenders who have obtained security interests in the defaulting purchaser’s inventories, proceeds and receivables.”
To redress this imbalance, Congress added Section 499e(c) to section 5 of PACA to impress a trust in favor of the sellers on the inventories of commodities, the products derived therefrom, and the proceeds of the sale of such commodities and products.
Indeed, Section 499e(c)(2) of PACA provides:
[p]erishable agricultural commodities received by a commission merchant, dealer, or broker in all transactions, and all inventories of food or other products derived from perishable agricultural commodities, and any receivables or proceeds from the sale of such commodities or products shall be held by such commission merchant, dealer or broker in trust for the benefit of all unpaid suppliers or sellers of such commodities… until full payment of the sums owing in connection with such transactions has been received by such unpaid suppliers, sellers or agents.
This provision imposes an express, non-segregated “floating” statutory trust on the perishable commodities and their derivatives in which a produce buyer as trustee holds its produce-related assets in trust as a fiduciary until full payment is made to the unpaid seller/trust beneficiary. The foregoing trust provision also permits the commingling of trust assets without defeating the trust. Through the PACA trust, the sellers of perishable commodities maintain a right to recover against the purchasers from PACA trust assets that is superior to all other creditors, including secured creditors.
The take away is that purchase money loans and other liens which are “secured in first” position by real property may not always be as secure as the lender intends. But since PACA trusts only arise in the context of agriculture, real estate professionals should pay careful attention to any transaction involving a party connected with the agricultural industry, for example a grower, retailer, or distributor.
Mr. Charles regularly represents property owners concerning foreclosures and other real estate disputes. If you or someone you know has questions regarding a PACA trust or any other real estate matter, please call or email today to speak with Mr. Charles.