While Kornblum addresses whether an asset becomes a PACA trust asset at the time of purchase (and remains a PACA trust asset thereafter), lenders must be aware that an asset not subject to a PACA trust at the time of purchase can subsequently become an asset subject to PACA trust claims (i.e., when a purchaser of produce used the proceeds from the sales of produce to pay down the mortgage on real property that was not otherwise subject to a PACA trust). Courts consistently hold that while PACA allows for comingling of PACA trust assets (i.e., proceeds from produce sales with non-PACA trust assets), once PACA trust assets are comingled, the buyer has the burden of proof to establish which assets are not subject to the PACA trust.  At least one Federal Court has held that a debtor’s real estate was subject to PACA trust claims where the debtor could not meet its burden of proof and demonstrate that it did not use the proceeds from sales of produce to make its mortgage payments.

Lenders must be facile with PACA and its implications and take certain steps to avoid ultimately litigating a Kornblum dispute. Most lenders try to avoid lending into potential PACA situations, however, sometimes the PACA issue is latent, sneaks up, and unwittingly “bites” the lender. Imagine making a loan to a borrower in the business of manufacturing pre-prepared foods. When the loan was made, the borrower used canned – processed tomatoes, and unbeknownst to the lender, later switched to fresh tomatoes.  That is correct – PACA claims may prime the bank’s prior secured lien. Thus, a lender must monitor the borrower after making the loan to ensure the borrower does not later become subject to PACA.

Moreover, in these highly competitive times, it is difficult to resist a new borrower, especially if a lender can get comfort that PACA will not be an issue. If a lender, knowing the implications and risks, makes the business decision to lend to a borrower where PACA may become implicated, the lender must: (i) perform diligence regarding the origins of all of the borrower’s funds and assets prior to issuing the loan, (ii) perform diligence as to the existence of any PACA debt at the time of issuing the loan, (iii) require the borrower to satisfy all PACA debts prior to issuing the loan, and (iv) carefully monitor the borrower’s business operations and accounts payable to PACA creditors subsequent to issuing the loan. By taking these steps, and others, lenders may mitigate their risk of having to defend a PACA claim priority dispute.