Unsecured creditors in reorganizations involving grocery stores or the food service industry are well-versed on the nefarious provisions of the Perishable Agricultural Commodities Act (PACA), 7 U.S.C. §§499(a) et seq. PACA represents Congress' protection of sellers of "perishable agricultural commodities" (usually fruits, vegetables and meats) in the event that the purchaser files bankruptcy. Due to the perishable nature of these types of goods, sellers must sell them quickly, often before an adequate opportunity to assess the creditworthiness of a buyer. As a result, it is not uncommon that sellers find themselves with unsecured claims because lenders have security interests in the inventory and receivables of these buyers. Moreover, the suppliers of the goods are usually the least able to survive the delays and losses attendant with a bankruptcy filing by their buyers. See H.R. Rep. No. 543, 98th Cong., 1st Sess. 1983, reprinted in 1984 U.S.C.C.A.N. 405.

In order to protect the sellers, Congress further broadened the protections available under PACA pursuant to a 1984 amendment that provides that certain statutorily defined buyers of perishable agricultural commodities hold the "commodities...and all inventories of food or other products derived from perishable agricultural commodities, and any receivables from the proceeds or sale or such commodities or products...in trust for the benefit of all unpaid suppliers or sellers of such commodities..." 7 U.S.C. §499(e)(C)(2). In a bankruptcy case where the buyer has filed, traditional trust principles prevail, and goods held pursuant to a PACA trust are not assets of the bankruptcy estate.

Now to the rather interesting issue that was presented to Bankruptcy Judge Walrath in In re Long John Silver's Restaurants Inc., 230 B.R. 29 (Bankr. D. Del. 1999). Long John Silver's operates a chain of seafood restaurants. Not surprisingly, in the course of its operations, it purchases a substantial amount of food products. The food that gave rise to this decision is none other than the innocuous french fry. Because PACA essentially "trumps" consensual liens and security interests, only statutorily defined food products are covered within PACA. Equally as important, however, are regulations (and case law interpreting those regulations) that provide that only unprocessed or very minimally processed fruits and vegetables will be covered under PACA. See 7 C.F.R. §46.2(u). If a fruit or vegetable is processed too much so that the processing creates "articles of food of a different kind or character," then PACA protections are lost. See 7 C.F.R. §46.2(u).

In the Long John Silver's case, what was at issue was a type of coating that was put on french fries sold to Long John Silver's. The seller, in an effort to create a french fry that would hold up better and be crispier, even if it sat out under hot lights, produced a french fry with a special batter.¹ The debtors sought to avoid the imposition of a PACA trust with respect to the seller's french fries by utilizing two arguments. The first was what the court derisively called "The Name Game." Specifically, the debtor argued that the french fries at issue were not covered by PACA because they weren't called "french fries" but they were referred to strictly as "Crispy Fries" or "CrissCut Fries" and never as "potatoes" or "french fries." Judge Walrath (obviously a liberal arts major in college) dispensed with this argument, stating that PACA applicability does not hinge on the "marketing fancies of food industry executives," citing as an authority no less than William Shakespeare.²

The next issue was not disposed of as easily. Specifically, the debtor took the approach that the processing done by the seller to create the world-famous Crispy Fry was a type of processing that took the potatoes out of the purview of PACA. Apparently Judge Walrath conducted an involved evidentiary hearing on the processing that these Crispy Fries go through in order to be transformed from the mild-mannered french fry into the super-resilient Crispy Fry.³

Essentially, as part of the processing of these potatoes, the seller put the potatoes through the normal steps that one would undertake with respect to a french fry, but after cutting, cleaning, blanching, etc., the Crispy Fries took an ominous detour. According to the witnesses that testified, the potato strips are "run through a slurry of water and what's typically called the batter, [which] would be a suspension of batter solids in a slurry of water." Apparently this battering had nothing to do with preserving or otherwise helping the french fry in the freezing process. The debtor contended that by "exposing" the potatoes to this special batter, the seller changed the character of the food, thereby removing it from the protections of PACA.⁴ In addition, the debtor asserted that the seller adding salt to enhance flavor also constituted a material alteration of the food in such a way that it removed it from PACA protection.

While the court had no difficulty stating that adding salt for flavor did not suf-ficiently alter the food product, the court was persuaded that the addition of the batter did change the "essential character" of the food item. Based upon analogous situations in reported decisions where, for instance, potatoes had been sprayed with an oil coating to prepare them for oven baking as opposed to frying (thereby resulting in an alteration of the "essential character" of the potato such that PACA protections were denied),⁵ the court ruled that the addition of the batter to the potatoes was enough of an alteration of the potatoes to remove it from PACA's protection.⁶ Judge Walrath also found persuasive in Endico that the Second Circuit had no difficulty stating that foods which had been breaded would not be subject to PACA protection, such as breaded cauliflower and onion rings. The court held that the batter application in this case lies somewhere between an oil spray and a breading. The court found that, like the oil spray in Endico, the batter plays no role in the freezing process, but rather enhances texture and "doubles the hot hold life of the french fries (the amount of time that a french fry will stay warm under heat lamps after cooking)." Yummy.

Accordingly, the court held that the Crispy Fries purchased by Long John Silver's, by virtue of a "specially engineered batter coating," were such an enhancement to the normal french fry that they changed the "essential nature of the product." As such, Crispy Fries were not entitled to PACA protection, and the fries were not excluded from the bankruptcy estate.

While not stated in the opinion, as a result of this opinion it is believed that unsecured creditors will be receiving part of their distribution in cash, part in a long term note, part in stock, and part in Crispy Fries.

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Footnotes

¹ Apparently in the early 1990s, Long John Silver's conducted extensive market research to determine what qualities its customers sought in french fries—inquiring minds need to know. The research apparently revealed that by a more than two-to-one margin, the most common complaints were "old and cold, soggy french fries." In response to the complaints, Long John Silver's switched to a "crispy fry," which is coated in a batter named "Crispura." It was determined that this crispy fry could resist the old, cold and soggy characteristics of traditional french fries for up to 10 minutes—compared with five minutes for a traditional fry. While not stated in the opinion, it is the author's hope that these conclusions were verified by an independent testing laboratory under the auspices of appropriate international treaties and guidelines. Return to article

² Specifically, Judge Walrath cited as persuasive authority the lines from Romeo And Juliet, Act II, Scene ii, "O, be some other name! What's in a name? That which we call a rose by any other name would smell as sweet." See Long John Silver's, note 4. Return to article

³ The cross-examination of the witnesses has apparently made the highlights tape for the National Institute of Trial Advocacy, and it is rumored that a mini-series will be based upon this hearing for Court TV. Return to article

⁴ One cannot help but wonder what the long-term effects on the human intestinal tract are of "exposing" these potatoes to this "special slurry." Presumably that will be the subject of a future article in the "Toxins Are Us" column. Return to article

⁵ See Endico Potatoes v. CIT Group/Factoring Inc., 67 F.3d 1063, 1069 (2nd Cir. 1995). Return to article

⁶ The court also dispensed with the argument that Endico would not be controlling because, since the Endico decision, certain amendments had been made to the regulations interpreting PACA to permit "oil blanching." See 7 C.F.R. §46.2(u). The court stated that PACA protection was denied because of the "oil spraying," not "oil blanching"—apparently two distinct processes. Return to article