Restaurant Bankruptcies: Protections and Pitfalls for Produce Suppliers

By: Jeffrey Lynne May 7, 2020 6:47 am

Time to read: 5 Minutes

Reports of potential restaurant bankruptcies, including in Palm Beach, Broward, and Miami-Dade counties, are on the rise. Executive Orders closed dining rooms and greatly impacted operations. Recently, South Florida based TooJay’s filed for Chapter 11 bankruptcy. More are restaurants likely to file for bankruptcy in the coming months. What options are available to produce suppliers who become creditors in bankruptcy cases?

PACA: Perishable Agricultural Commodities Act

Recognizing the importance of the US food supply chain, PACA was enacted in 1930 to protect farmers and growers in the event their buyers faced financial difficulties. PACA was later amended to allow for a “PACA Trust” for the benefit of farmers and growers who sell to a buyer. Under PACA, term “perishable agricultural commodity” means fresh fruits and fresh vegetables, whether frozen or packed in ice. In the bankruptcy context, the effect of a PACA Trust is to giver the PACA creditor priority in the commodity and proceeds thereof over other secured creditors, administrative fees and expenses, and unsecured creditors.

To obtain this powerful PACA Trust status, a licensed vendor must follow certain strict requirements, including:

• Compliant PACA language on invoices;
• Proper written notice to the buyer; and
• Notice must be timely under PACA (30 days after receipt and acceptance).

Absent strict compliance, an otherwise eligible vendor may lose the powerful PACA trust option; however, there may some alternative approaches (discussed below) for those who are unable to establish a PACA trust.

Critical Vendor Status under the Bankruptcy Code

The Bankruptcy Code recognizes that vendors, particularly those vital to the debtor’s business operation, will often provide goods shortly before the bankruptcy filing and that payment does not occur before the filing. In that instance, Section 503(b)(9) of the Bankruptcy Code provides for an administrative claim (a priority claim over ahead other classes of creditors) in the amount of the value of goods provided within 20 days of the bankruptcy filing. While not in the statute, case law has required a party seeking priority under this statute to establish that they are a “critical vendor.”  Critical vendor is not defined in the Bankruptcy Code and is instead based on a jurisdiction by jurisdiction test. Critical vendor status will not apply unless the creditor meets its burden showing entitlement because this provision upsets the ordinary distribution scheme in a bankruptcy and may result in unsecured creditors receiving less. The test followed by Courts in the Eleventh Circuit (covering Florida and Georgia, among others) requires:

• the payments are necessary for reorganization;
• the critical vendors will otherwise refuse to do business with the debtor; and
• that disfavored creditors will be as well off with the critical vendor order than they would have been without it.

In re Tropical Sportswear Int’l Corp., 320 B.R. 15, 16 (Bankr.M.D.Fla.2005).

Again, critical vendor status is not the preferred route for a creditor who has better remedies; however, it may provide an alternative for creditors who were unable to satisfy the PACA trust requirements.

Considerations as Restaurant Bankruptcies Increase

Agriculture is a vital part of Florida’s economy both in terms of goods sold and jobs created. As we enter an uncertain period for restaurants which purchase these goods, farmers and growers should evaluate their options by, among other things: (i) reviewing their invoices and procedure against PACA compliance requirements; (ii) timely performing requirements under applicable law; and (iii) having a system in place to receive timely notice of defaults and bankruptcies.