In Coosemans Miami v. Arthur (In re Arthur), the Bankruptcy Court for the Southern District of Florida held last week that individuals in control of a PACA trust may still receive a bankruptcy discharge of debts arising from their breach of such PACA trust.  A link to the opinion is here.

The facts of the case are familiar to most insolvency professionals that deal with food / restaurant / distributor cases.  The Arthurs owned a produce distributor.  Their company experienced financial trouble, and the Arthurs and their company were sued by their produce supplier.  They resolved the matter by a stipulated judgment of $300,000.

Later, the Arthurs filed personal bankruptcy petitions under Chapter 7; the judgment owed by the Arthurs to their produce supplier was still outstanding.  Their supplier filed a non-dischargeability action against them under Section 523(a)(4) of the Bankruptcy Code, which exempts from discharge “any debt . . . for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.”

One would think this is a pretty simple analysis.  PACA (the Perishable Agricultural Commodities Act, 7 U.S.C. § 499a et seq.) requires that buyers of produce hold such produce – and its proceeds – in trust for the benefit of produce sellers.  A trustee, including a trustee of the PACA trust, is a fiduciary.  Diversion of PACA trust assets would be the “defalcation” required by Section 523(a)(4).

Not so fast, according to the Arthur Court.  Section 523(a)(4) speaks of a “fiduciary capacity,” which is not the same as a “fiduciary duty.”  And in the 11th Circuit, according to the Arthur Court, the type of trust at issue controls whether Section 523(a)(4) applies to those who allegedly misuse those trust assets.  According to the Arthur Court, only “technical trusts” – those created by voluntary agreement – subject someone to the risks of non-dischargeability under Section 523(a)(4).  Other trusts, those that arise only from unintended consequences of an improper transfer (like resulting or constructive trusts, or certain statutory trusts), are not technical trusts.

Here, since PACA operates as a floating, non-segregated trust, it only requires segregation of PACA trust assets when there is a dissipation of the PACA trust – that is, when PACA suppliers are not being paid.  As such, the Arthur Court held, the PACA trust is more akin to a constructive trust (not subject to Section 523(a)(4)), instead of a technical trust.  Until segregation of assets of a PACA buyer is required (such as when a PACA seller seeks to enjoin the PACA buyer’s further dissipation of assets), there is no technical trust.  And absent a technical trust, Section 523(a)(4) does not apply.

The Arthur Court recognizes that many PACA non-dischargeability cases hold to the contrary, including cases from Maryland, New York, and Georgia.

We respectfully disagree with this decision.

• By only imposing the risks of 523(a)(4) when legal action has already been taken to require segregation of assets, this ruling encourages more litigation – quicker action by PACA sellers to seek injunctive remedies against PACA buyers.
• Moreover, our experience in this area, representing many PACA buyers in trouble over the years, indicates that PACA buyers are well aware, at all times, that PACA imposes greater duties on them then they owe to other creditors.  This is not akin to a constructive or resulting trust, which often arise through mistake or inaction.  PACA buyers very much know what they are getting into.
• Finally, this decision encourages forum shopping – there is now an increasing split among US courts on how individuals that control the PACA trust will be treated if a non-dischargeability action is brought against them.
• Editors’ Note:  For those of you who like to get something you can use from blog posts, attached here is a Form PACA Nondischargeability Complaint for a PACA seller against a party that controlled a PACA buyer, where such controlling party later files for bankruptcy.  Although, in light of the case discussed below, there is an open legal question of whether violations of the PACA trust by an individual in control of a PACA buyer result in a non-dischargeable debt under Section 523(a)(4) of the Bankruptcy Code. 

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