Greenberg Traurig Alert

Third Circuit Rules that PACA Applies to Restaurants

April 2000
By John B. Hutton, Greenberg Traurig, Miami Office

  View or download the PDF version of this Alert here.

In a decision that contravenes the position taken by the United States Department of Agriculture ("USDA") for the past seventy years, the Third Circuit Court of Appeals has recently ruled that a restaurant chain that operates fifteen restaurants is a "dealer" of "perishable agricultural products" subject to the trust provisions Perishable Commodities Act, 7 U.S.C. § 499 et. seq. ("PACA"). In re Magic Restaurants, Inc., ___ F.3d ___, 2000 WL 230310 (3d Cir. March 1, 2000). This judicial decision threatens to impair the priority of financing liens granted by restaurants and other businesses in the food service industry, by creating a trust in favor of unpaid produce suppliers. The trust provisions of PACA impose a floating, non-segregated trust on produce buyers for the benefit of unpaid produce suppliers, which grants the unpaid supplier an interest in the trust corpus superior to the interest of any other lien or secured creditor.

The corpus of the PACA trust is comprised of (1) the perishable agricultural commodities purchased from these suppliers, (2) all inventories of food or other products derived from the perishable agricultural commodities, and (3) receivables or proceeds from the sale of such commodities or products. The unpaid supplier loses the benefits of the trust unless written notice of intent to preserve the trust is given to the trustee within thirty calendar days after payment must be made. As a practical matter, many produce suppliers include such a notice on their invoices.

The Third Circuit is the highest court to rule on this issue, and the decision was rendered by a split panel, with one judge dissenting. In rejecting the USDA’s long-held interpretation of the statute, the majority on the panel held that the restaurant chain was a "dealer" under the plain language of PACA, which applies to "any person engaged in the business of buying or selling in wholesale or jobbing quantities . . . any perishable agricultural commodity . . ." 7 U.S.C. § 499a(b)(1). The term "wholesale or jobbing quantities" is defined by USDA regulations as "aggregate quantities of all types of produce totaling one ton (2,000 pounds) or more in weight in any day shipped, received, or contracted to be shipped or received." The definition of dealer, however, provides an exception for persons whose invoice cost of produce in any calendar year is not in excess of $230,000. The restaurant chain had argued that it was not a "dealer" because it was not primarily engaged in the business of buying and selling produce, but the Third Circuit did not believe the statutory definition was restricted to those primarily in such business. The Court acknowledged that the USDA, the federal agency charged with administering PACA, has consistently indicated for seven decades since the enactment of the statute that it does not have jurisdiction over restaurants, but rejected this position as contrary to the clear and unambiguous language of the statute.

Among other things, the Court’s ruling requires "dealers" under PACA to apply for licenses with the Secretary of Agriculture. Because any person doing business without a license is subject to monetary penalties, the Third Circuit acknowledged that its ruling would mean that the many restaurants that have never applied for licenses under PACA have been in violation of federal law for decades. At the same time, the Third Circuit expressed doubt as to whether the Secretary of Agriculture would aggressively pursue such "violations," and anticipated that currently unlicensed restaurants would have certain defenses to any attempted retroactive application of the licensing requirement.

The decision has broad implications for many types of businesses that purchase "wholesale or jobbing quantities" of produce, other than just restaurants, and potentially applies to schools, hospitals, nursing home chains, hotels and cruise lines. As noted by the dissent in the case, "[t]he majority reading would make most prisons ‘dealers,’ yet prisons are not engaged in the perishable commodity-buying business." Any such entity that consumes large quantities of produce should consider whether it needs to apply now for a license under PACA.

In addition, lenders to such entities (including restaurants) that may now be considered "dealers" under PACA need to increase their monitoring or they could be primed on both inventory and accounts. Prospectively, lenders to "dealers" need to evaluate their collateral position with respect to produce inventory and its proceeds.

The Court’s decision in Magic Restaurant is binding upon all lower courts in the Third Circuit, including Delaware, Pennsylvania and New Jersey. Although the Third Circuit is the only federal circuit court to rule on the issue, the decision is controversial, and it is not clear at this point whether lower courts in states outside of the Third Circuit will apply this precedent. At the same time, many major bankruptcies are filed in Delaware (as the state of incorporation), and this holding may apply in such bankruptcies, even if the business is operated elsewhere.

Greenberg Traurig attorneys are prepared to advise on the applicability of PACA to any entity, license companies as dealers, set up a monitoring program for lenders, review loan documents for lenders, and lobby congress for legislative reform.

© 2000 Greenberg Traurig