Restaurants and associated food service businesses are a big part of the local economy in the metropolitan Kansas City area. With the downturn in the economy, more restaurants, food service businesses, and commodity suppliers and vendors (especially produce) are finding themselves with thin profit margins. We have found from our experience that business owners should know all of their legal options well before financial troubles begin to press upon them. Running a restaurant is not easy even in the best of times, and we understand that. Phillips & Thomas LLC has worked with restaurant and food services businesses for many years, and is very familiar with the issues and challenges facing them.
Circumstances can change very quickly in the restaurant and food service business. The traffic of customers can evaporate or be diverted, suppliers can default on their obligations, tax issues can arise, employee problems can surface, ownership or managerial disputes can develop, or physical issues with the premises (fire, theft, damages) can happen. All of these changes require a rational, realistic response that takes into account the goals of the business and the economic management of the problem.
We have stated this principle before in other articles on this blog, and we will repeat it again: identifying and dealing with a problem quickly is vastly preferable to delay. In most situations, one’s options are widest at the beginning of a problem; those options can get narrower the longer the issue is delayed. Stated another way: in the food service business, get help quickly as soon as bad things happen. Communication is critical.
There are different types of bankruptcy options available to restaurants or food services businesses: Chapter 7, Chapter 13, or Chapter 11. Each of these options has its own merits, and is useful in different circumstances. Chapter 7 cases are liquidation cases, in the sense that a business would be “wound up” under the control of a Chapter 7 trustee. On the filing of a Chapter 7 case, the business premises would come under the control of the Trustee, who would then decide how to handle the inventory, equipment, and other issues. The operation of a business by a Chapter 7 trustee is complicated and involves many “moving parts”: dealing with landlords and leases, dealing with employees, dealing with customers or clients, and dealing with inventory and assets. It is important to consult with an attorney to go through all of these issues. Do not assume that you, the business owner, can diagnose or evaluate these issues yourself.
Chapter 13 cases can only be filed by individuals, but they are often filed in a business context where the individual is a sole proprietor, or has signed personally for the business’s debts and needs some way to reorganize those. It also often happens that a business owner is saddled with payroll or withholding taxes from the operation of a business, and needs some way to deal with those as well. Again, it is important to consult with an attorney to understand all the nuances and options available.
Chapter 11 cases can be filed by individuals or businesses for a variety of reasons. Under Chapter 11, the affairs of the business can be reorganized (or liquidated, in some situations) in such a way as to allow the business to get back to a position of profitability. We have a large number of articles on Chapter 11 cases here; if you go to the right side of your screen, you can click on the tab that says “Chapter 11 Bankruptcy”, and find numerous topics of relevance to Chapter 11 cases.
The Perishable Agricultural Commodities Act (PACA).
We do need to spend some time here talking about PACA. Restaurant owners, food sellers, produce suppliers, commodity suppliers, and other vendors should be aware of the existence and implications of this federal law. We have dealt PACA litigation in a variety of food service contexts, and can say that it is one of the most underappreciated and misunderstood issues that can arise in the context of restaurant and food service supplier bankruptcy cases. What is PACA? Over seventy years ago, Congress decided that sellers of farm products were at risk from buyers. Buyers had the right to reject shipment of produce from sellers, and in declining price markets, often these rejections were done to get out of inconvenient contracts. Sellers often had to spend a lot of money and travel great distances to try to sell their produce. Since agricultural commodities are perishable and easily spoil, this was seriously hurting sellers.
In order to regulate this type of interstate commerce, then, Congress in 1930 passed the Perishable Agricultural Commodities Act (PACA). The purpose of the law, as stated above, was to protect sellers from unscrupulous buyers. The US Department of Agriculture had the right to intervene when a buyer failed to honor a promise to pay for commodities. It also prevented brokers from making fraudulent charges, shippers from reneging on agreements, and a few other things. PACA was amended in 1984 in a significant way.
The 1984 amendment to PACA provided for the creation of a “trust” for the “benefit of all unpaid suppliers or sellers of such commodities until full payment of the sums owning in connection with such transactions has been received…” What happened, in effect, was that Congress created a new statutory remedy for the seller of perishable agricultural commodities to a possible debtor in bankruptcy. Basically, a seller now became something much more than an ordinary unsecured creditor. A trust was created by operation of law, and savvy sellers could now use this fact to argue for the creation of a “superpriority trust” within a bankruptcy case.
PACA litigation is complex. At issue are often the following questions:
- Does PACA even apply to the transaction in question?
- What is the definition of a “perishable agricultural commodity”?
- Is my restaurant covered under PACA?
- Will I be held responsible for the creation and maintenance of a “trust”?
- What is in a PACA trust? That is, what constitutes its “res”?
The bottom line is that restaurant owners, food suppliers, vendors, and other parties in the commodity chain are often unaware of PACA and its implications. The possible existence of a trust has important implications in a bankruptcy case, since the holder of an alleged trust may seek to file an adversary proceeding under 11 U.S.C. Sect. 523(a)(4) to have the debt declared non-dischargeable. Alternatively, such a creditor may seek to claim super-priority status in any reorganization plan under Chapter 11 or 13. If you are a restaurant owner or a dealer or handler of commodities in any way, please feel free to consult with us to discuss these issues.