Spring Valley Produce, Inc. v. Forrest (In re Forrest) (11th Cir.)

The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:

SUMMARY

In a case of first impression, the United States Court of Appeals for the Eleventh Circuit (the Circuit) recently ruled that the Bankruptcy Code’s exception to discharge in 11 U.S.C. § 523(a)(4) does not apply to debts incurred by a produce buyer who is acting as a trustee under the Perishable Agricultural Commodities Act (PACA). Spring Valley Produce, Inc., v Forrest (In re Forrest), 2022 WL 3908803 (11th Cir. August 31, 2022).

To view the opinion, click here. 

FACTS

The debtors Nathan and Marsha Forrest (the Debtors) were the owners and officers of Central Market of FL., Inc. which buys and sells produce. Plaintiff Spring Valley Produce, Inc. (SVP) sold about $261,000 worth of produce to Central Market and did not receive payment. During these transactions both SVP and Central Market were licensed under PACA. Under PACA, upon receiving SVP’s produce shipments, Central Market became a PACA trustee of a trust res consisting of that produce. Also, under PACA the Debtors as owners and officers were liable for Central Market’s debt to SPV.

The Debtors filed chapter 7 bankruptcy in May 2020. SVP filed an adversary proceeding against the Debtors, asserting that their debt to it was nondischargeable under the provisions of § 523(a)(4) of the Bankruptcy Code which provides that debts “for fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny” were excepted from discharge. SVP asserted that under PACA the Debtors were trustees of a trust res and that defalcation occurred when Central Market’s debt to SVP went unpaid. The Debtors filed a motion to dismiss, asserting that the statutory trust created by PACA did not qualify as the necessary express trust because it did not require them to segregate the trust assets nor did it prohibit them from using those assets for non-trust purposes. The bankruptcy court agreed with the Debtors and dismissed the adversary complaint for failure to state a claim. SVP filed a notice of appeal. The bankruptcy court then certified the SVP appeal for a direct appeal to the Circuit, which accepted the certification and affirmed in a published opinion.

REASONING

The Circuit recognized immediately that this case of first impression raised issues which had fostered divided rulings from the bankruptcy courts in the Eleventh Circuit as well as around the country. For purposes of its opinion, the Circuit referred to the § 523(a)(4) exception as the “Fiduciary Capacity Exception”. The mixed rulings most frequently turned on whether the failure of PACA to (a) require the trustee to segregate the PACA assets from others and (b) constrain their use only for non-trust purposes caused the unpaid PACA debt to fall within the Fiduciary Capacity Exception. The Circuit therefore focused on the meaning of the term “fiduciary capacity” as used in this context.

The Circuit traced the history of the Fiduciary Capacity Exception from its inception in the mid 1800’s, recognizing that the Supreme Court had ruled that in this setting it should not be construed expansively and should be limited to its role in technical trusts, the type required by the statute. To determine the needs of a technical trust, the Circuit looked to treatises on trusts as well as the Restatement (Third) of Trusts and concluded that technical trusts require (1) a trustee; (2) an identifiable beneficiary; (3) an identifiable trust res; and (4) sufficient trust-like duties. The first three elements were satisfied by the PACA provisions, which left the question of what were sufficient trust-like duties as the key to the answer here.

The Circuit then reviewed the cases dealing with technical trusts and trust-like duties from both the Eleventh Circuit and its predecessor Fifth Circuit. Almost without exception the cases determined that in a technical trust there must be segregation of the trust assets for the benefit of the beneficiary of the trust and likewise there must be a restriction on use of the assets to only for trust purposes. For sufficient fiduciary capacity to exist, those two duties must be imposed on the trustee. Without them, the trust was more in the nature of a constructive or imposed trust, not a technical or express trust.

The Circuit then analyzed whether PACA imposed the necessary requirement of segregation and found it did not. Although PACA created a duty to hold produce “in trust”, it did not impress upon the trustee any specific duties. In fact, the PACA guidelines refer to the preservation of a nonsegregated “floating trust” and contemplate commingling of the trust assets with others. With the commingling came the lack of restriction on the use of identified trust assets only for the good of the single beneficiary. Therefore, the PACA trust did not impose trust-like duties as required for the Fiduciary Capacity Exception. The provisions of § 523(a)(4) did not except the Debtors’ PACA liability from discharge.

AUTHOR’S COMMENTS

If widely adopted, this opinion will shake up PACA creditors and the attorneys who represent them. While on the bench in the Central District of California, I frequently was asked to rule on this discharge exception where the debtors were PACA “trustees” on similar facts as here: generally, the debtors had been the owners or officers of an entity which had defaulted in paying for produce or other commodities and then filed bankruptcy because the amount of debt was overwhelming. Often, I was faced with a motion for summary judgment or even a default prove up by the PACA creditor where I was cited ample case law, mostly at the bankruptcy court level around the country but without any contrary precedent in the Ninth Circuit, which found the debt nondischargeable. And usually I had no brief nor articulated defense from the debtors, who like most individuals in chapter 7 are hard-pressed to afford competent counsel. I looked at the factors critical to section (a)(4) nondischargeability under Ninth Circuit law which were an express or statutory trust, an identifiable trust res, and a defalcation (although the Supreme Court’s decision in Bullock v BankChampaign, N.A., 569 U.S. 267 (2013) later Supreme Court authority made finding a sufficient defalcation more difficult) and I concluded the elements were met. I generally granted the exception to discharge. What I never considered was whether there were sufficient “trust-like duties” as the Eleventh Circuit considered. If I had, I may well have concluded that the Fiduciary Capacity Exception did not apply to PACA debts, as the Eleventh Circuit has done here. It will be interesting to see whether other cases, particularly those with precedent, will follow this pathway. 

This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.