Opinion ID: 8414542
Heading Depth: 1
Heading Rank: 2

Heading: Transfer-of-Risk Test for Identifying True Sales

Text: The treatment of true sales and security interests, therefore, is clear. What remains unclear is the analysis to apply when the true nature of the transaction is ambiguous. How should a court treat a transaction if the parties to a factoring agreement label the transaction a sale of accounts but provide substantial recourse for the factoring agent, such as requiring the distributor to “repurchase” non-performing accounts or permitting the factoring agent to withhold payments or otherwise recoup payments already made to the distributor? What if, such labels notwithstanding, the recourse and security provided include a security interest in the accounts receivable? Has a true sale actually occurred? Growers and the Second, Fourth, and Fifth Circuits apply a threshold transfer-of-risk test to determine if such a transaction is a true sale or a mere secured lending relationship. Agricap, relying on Boulder Fruit, argues the court need only ask if the transaction was commercially reasonable. In Boulder Fruit, the Ninth Circuit held factoring agreements do not per se breach the PACA trust because, consistent with general trust principles, “a trustee can sell trust assets unless the sale breaches the trust.” 251 F.3d at 1272. The court concluded “a commercially reasonable sale of accounts for fair value is entirely consistent with the trustee’s primary duty under PACA and 7 C.F.R. § 46.46(d)(1) — to maintain trust assets so that they are freely available to satisfy outstanding obligations to sellers of perishable commodities.” Id. at 1271 (internal quotation marks omitted). The court indicated that whether a factoring agreement is commercially reasonable depends upon the terms of the agreement. For example, “[a] PACA trustee who sells accounts for pennies on the dollar, just to turn a quick buck, might well have breached the PACA trust, while a trustee who factors accounts at a commercially reasonable rate would not.” Id. In reaching its conclusion, the Boulder Fruit panel stated the factoring agreement “actually enhanced the trust” for three reasons. Id. at 1272. First, it allowed the distributor to quickly convert accounts receivable to cash. 1 Id. Second, in the course of performance, the distributor “actually received ... more for the accounts than the accounts would prove to be worth.” Id. And third, “a factoring discount of 20% was never shown to be commercially unreasonable.” Id. The Ninth Circuit therefore considered not only the up-front payment from factoring agent to distributor but also the actual sums paid to the distributor by the factoring agent during the course of performance of the factoring agreement. 2 The Ninth Circuit did not, however, examine the substance of the rights transferred to determine what the factoring agent agreed to do, what risk the factoring agent accepted when it accepted the right to collect on the transferred accounts, and whether the transaction properly should be deemed a sale rather than a mere secured lending arrangement. Rather, the Ninth Circuit in Boulder Fruit merely characterized the transaction as a sale or factoring agreement without discussing the factoring agent’s rights and ability to seek recourse against the distributor. In contrast, the Fourth, Fifth, and Second Circuits considered it necessary to examine the rights and risks transferred between the parties to a factoring agreement. See Nickey Gregory, 597 F.3d at 600-03; Reaves Brokerage, 336 F.3d at 414-16; Endico Potatoes, 67 F.3d at 1068-69, As the Fourth Circuit stated, “[I]f the accounts receivable were not sold but rather were given as collateral for a loan, then the accounts receivable would have remained trust assets, subject to [the factoring agent’s] security interest.” Nickey Gregory, 597 F.3d at 598 (emphasis in original). Whether the accounts receivable remained accounts or were converted into cash, however, the factoring agent’s “position with respect to that cash would have been subordinate to the claims of produce sellers while they remained unpaid.” Id. In contrast, ‘[i]f [the distributor] had transferred these trust assets ... by means of a sale in exchange for cash, the transaction would have been nothing more than a permissible conversion of trust assets from one form to another — i.e., from accounts receivable into cash.” Id. at 599. If such a true sale had occurred, “the accounts receivable would no longer have remained trust assets, and the commodities sellers would not have had any claim for payment from them.” Id. at 599-600. Nickey Gregory, 597 F.3d at 594, and Reaves Brokerage, 336 F.3d at 412, involved factual patterns similar to the present case. Endieo Potatoes involved a similar question: whether a “purchaser” of accounts was a bona fide purchaser for true value or merely a lender. 67 F.3d at 1065-66. In these cases, the courts examined the text and legislative history of PACA, as well as the regulations promulgated under PACA, to conclude Congress intended to elevate the interests of produce growers above the interests of secured lenders. See, e.g., Nickey Gregory, 597 F.3d at 594-95, 598-99; Endieo Potatoes, 67 F.3d at 1066-68. The. Fourth Circuit noted in particular that representatives of the secured lending community had expressed concern over PACA’s likely effect upon secured lenders and the factoring industry. Nickey Gregory, 597 F.3d at 599. The court concluded that Congress nevertheless found the balance of policy interests to favor placing those lenders in a position subordinate to unpaid growers. Id. For example, the House Report explaining the 1984 PACA amendments states: [Purchasers/Distributors of perishable agricultural commodities] in the normal course of their business transactions, operate on bank loans secured by the inventories, proceeds or assigned receivables from sales of perishable agricultural commodities, giving the lender a secured position in the case of insolvency. Under present law, sellers of fresh fruits and vegetables are unsecured creditors and receive little protection in any suit for recovery of damages where a buyer has failed to make payment as required by contract. H.R. Rep. No. 98-543, at 3 (1984), as reprinted in 1984 U.S.C.C.A.N. 405, 407. The Second Circuit, citing this report, explained: According to Congress, due to the need to sell perishable commodities quickly, sellers of perishable commodities are often placed in the position of being unsecured creditors of companies whose creditworthiness the seller is unable to verify. Due to a large number of defaults by the purchasers, and the sellers’ status as unsecured creditors, the 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. Endico Potatoes, 67 F.3d at 1067. Given this focus, it becomes evident that this circuit’s focus, too, should be upon the true nature of the transactions at issue and the true nature of the parties’ roles, i.e., that of seller and buyer or that of secured lender and borrower. Importantly, Congress not only knew it was elevating the interests of growers above the interests of secured lenders, Congress expressly found the secured lenders’ practices had been resulting in a “burden on commerce,” H.R. Rep. No. 98-543, at 4, and further found the creation of statutory trust would aid commerce. As recognized in Nickey Gregory, the American Bankers Association had testified to Congress that creation of the PACA trust would create “difficulties for] lenders ... in administering their secured loans.” 597 F.3d at 599. Congress nevertheless “made th[e] policy choice to make the unsecured credit extended by commodities sellers superior to the position of lenders holding a security interest in those commodities and proceeds.” Id. The House Report stated: The Committee believes that the statutory trust requirements will not be a burden to the lending institutions. They will be known to and considered by prospective lenders in extending credit. The assurance the trust provision gives that raw products will be paid for promptly and that there is a monitoring system provided for under [PACA] will protect the interests of the borrower, the money lender, and the fruit and vegetable industry. Prompt payments should generate trade confidence and new business which yields increased cash and receivables, the prime security factors to the money lender. H.R. Rep. No. 98-543, at 4. Given the remedy Congress created to address the perceived problem (creation of the trust elevating commodities sellers’ interests over lenders’ interests), given Congress’s clear concern with the relative interests of secured lenders and commodities sellers, and given the general backdrop of trust law (in particular, a trustee’s ability to sell or convert trust assets), courts must focus on the true substance of PACA-relat-ed transactions and not on superficial indicators or labels. Simply put, it runs counter to PACA and its history to permit the simple use of the words “sale” or “purchase” or “factoring agreement” to control for purposes of assessing the relative rights of lenders and produce growers.