The rise in popularity and convenience of online shopping (i.e., the Amazon Effect) has triggered the bankruptcies of numerous retail consumer goods chains. Since 2015, there have been more than 50 major retail Chapter 11 filings. This trend is due to a number of factors, including (i) the marketplace shift to e-commerce and decline of physical retail, (ii) the failure of retailers to timely adopt e-commerce channels, and (iii) the mounting debt obligations of such retailers.
On the heels of this “retail apocalypse” came the next wave of retail restructurings: grocery stores. These debtors face many of the same issues as other retailers—asset-based loans, too many or unfavorable leases, and trade and reclamation claims. In addition, grocery store Chapter 11s face two additional challenges—a large amount of their inventory is perishable and much of their workforce is unionized. Addressing these two challenges is critical to any successful grocery chain restructuring.
First, given that grocery stores require frequent deliveries of fresh produce, sellers of perishable agricultural commodities (i.e., food suppliers) are afforded certain protections under the Perishable Agricultural Commodities Act (PACA). See 7 U.S.C. Section 499, et seq. PACA creates statutory constructive trusts for products that qualify as “perishable agricultural commodities.” The wide-ranging protections of PACA, which include automatically preserved rights, benefits, and defenses, have a significant impact on bankruptcy proceedings.1
PACA only applies to transactions involving perishable agricultural commodities, whereby any proceeds from the sale of such products must be held in trust for the benefit of an unpaid supplier. 7 U.S.C. Section 499e(c)(2). Perishable agricultural commodities are defined as fresh fruits and fresh vegetables of every kind and character, “whether or not frozen or packed in ice.” 7 U.S.C. Section 499a(b)(4). The statute, however, does not define “fresh fruit” or “fresh vegetable,” making it difficult to determine exactly what products are covered by the law.
U.S. Department of Agriculture (USDA) regulations define “fresh fruits and fresh vegetables” and suggest that PACA continues to apply even after the commodities have been subject to “blanching, chopping . . . cutting, dicing, drying . . . polishing, precooling, refrigerating, shredding . . .” See 7 C.F.R. Section 46.2(u). However, USDA regulations also provide that PACA may not protect growers whose commodities “have been manufactured into articles of food of a different kind or character.” Id.
Under PACA, upon delivery of a qualified product, a PACA trust is created and only terminates upon either payment to the PACA vendor or the vendor’s failure to timely perfect its security interest in the PACA trust, though perfection is a relatively simple process under 7 U.S.C. Section 499e(c)(3). To perfect its interest in a PACA trust, a PACA vendor simply needs to include boilerplate language on its ordinary and usual billing or invoice statements that provides notice of the intent to preserve the trust. 7 U.S.C. Section 499e(c)(4).
Further, PACA trusts differ from traditional statutory trusts by sidestepping the need to trace assets. Rather, the PACA trust applies to the debtor’s entire produce-related inventory and proceeds thereof, notwithstanding whether the goods originated with another supplier or are commingled with nonqualifying goods. See, e.g., Central Grocers Inc., et al., Case No 17-bk-10993 (Bank. D. Del. 2017) [Dkt No. 8].
Thus, to assert a PACA claim in a bankruptcy, the claimant need only demonstrate that the invoice is due and that some pool of produce-related inventory exists or proceeds from the sale of the same exists, regardless of the inventory’s origin or whether it was commingled with nonqualifying goods. The burden is on the debtor to show which assets are not subject to the PACA trust.
PACA’s robust statutory regime is particularly beneficial for food suppliers in grocery chain bankruptcies. The creation of the PACA trust silos PACA assets from the debtor’s bankruptcy estate, and thus such assets are not subject to bankruptcy’s priority scheme. Consequently, as opposed to most unsecured trade claims, a PACA claim is entitled to payment ahead of all other creditors in the bankruptcy proceeding, including DIP lenders, secured creditors, and administrative claimants, which typically stand first, second, and third in payment priority, respectively.
Thus, any secured lender providing financing to a debtor that owns PACA assets must be aware of PACA’s broad protections and understand it will not be able to “prime” the interests in cash or inventory of a debtor that are subject to a PACA trust. Similarly, a purchaser of a debtor’s assets cannot solely rely on the “free and clear of liens” language found in a sale order, since a PACA trust does not give rise to a lien. Rather, such language should specifically reference PACA claims and provide that any such claims be paid solely out of a separate escrow account.
PACA is an integral protection for suppliers of produce and other perishable agricultural items, and turnaround professionals need to be aware of, and account for, potentially significant PACA claims, which stand to receive payment first and may absorb a debtor’s remaining cash that otherwise may be used to pay other claims or finance its reorganization.2 While there is some precedent allowing the debtor’s use of proceeds that would otherwise be subject to a PACA trust, the PACA claimants in these cases were found to be oversecured and adequately protected.3
A foundational element in bankruptcy is the ability of the trustee or debtor in possession to avoid any preferential transfer made to creditors prior to filing a Chapter 11 petition. Specifically, the Bankruptcy Code permits a trustee or debtor-in-possession to avoid and recover from creditors payments made within the 90-day period before the bankruptcy filing. Bankruptcy Code Section 547.
The policy behind this provision is to prevent aggressive creditor collection activities that can force the debtor into bankruptcy or result in unfair distributions. However, in the grocery space, the frequency of fresh food deliveries from a supplier to the grocer may unintentionally result in more transactions at risk of being avoidable as preferences.
For example, in the bankruptcy of supermarket mega chain A&P, the unsecured creditors’ committee attempted to claw back more than $19 million from PepsiCo and Frito-Lay, arguing that the debtor paid them for deliveries too close to the bankruptcy filing. The committee claimed that in the 90 days leading up to A&P’s bankruptcy filing, PepsiCo and subsidiary Frito-Lay sought and received preferential payment transfers for goods while they and other Pepsi subsidiaries withheld payments due to A&P for various promotional programs. The dispute is ongoing. See The Great Atlantic & Pacific Tea Co. v. PepsiCo, Inc., et al., Adv. Proc. No. 18-08245 (Bankr. S.D.N.Y. 2018).
A logical consequence of frequent deliveries of fresh food is that deliveries are made and payments are received by suppliers right up until the petition date of a Chapter 11 filing, impacting the restructuring process in several ways. First, a number of a grocery chain’s ongoing vendors may have preference exposure. This may result in negotiations over the value of such claims through the Chapter 11 plan process. Second, it may make creditors particularly focused on attempts to encumber (through DIP financing) or sell (through 363 sales) these avoidance actions. It may also make preference actions an asset sought out by financial creditors to improve their recoveries.
Because grocery stores make up the majority of unionized retail workplaces, labor issues are also of significant concern in restructurings of grocery chains. The rights of unionized retail food employee are typically governed by a collective bargaining agreement (CBA), which regulates employee salaries, working conditions, benefits, and other aspects of workers’ compensation and employee rights. These CBAs often include provisions that may make it difficult for retail food debtors to sell assets or otherwise effectuate a restructuring.
For example, in the Central Grocers bankruptcy case, the debtor sought to sell substantially all of its assets to a stalking horse buyer. See Central Grocers Inc., et al., Case No. 17-bk-13886 (Bankr. N.D. Ill. 2017). The proposed sale was met with objections from numerous local labor unions and pension funds that took issue with the sale of two Midwestern chains where many union members were employed because the pension plans at issue included withdrawal liability provisions.
In most multiemployer pension plans, employers are liable for certain amounts if they withdraw from a pension plan by permanently ceasing all covered operations. When a grocery chain debtor sells its assets, including its retail chains, it effectively withdraws from its employees’ pension plan, triggering withdrawal liability.
Debtors typically try to include provisions in an asset sale stalking horse agreement that releases the rights of unions or pension funds to assert successor liability claims for withdrawal liability against the purchaser of the debtor’s assets. In Central Grocers, the proposed sale would allegedly trigger more than $100 million in withdrawal liability that would be payable to the various pension funds objecting to the sale. [Dkt Nos. 142, 145, 148, 400, 439].
The debtors identified a purchaser and sought court authorization to sell their assets. The unions objected to the sale, challenging the Bankruptcy Court’s authority to authorize the sale free and clear of successor liability claims, including the withdrawal liability claim. The court overruled all sale objections and entered an order authorizing the sale and also rending the sale order effective immediately, requiring the unions to seek a stay of the sale order if they wanted to appeal the sale. The unions failed to do so, but later appealed the entry of the sale order. Since the pension funds failed to seek to stay the sale before filing their appeal, the appeal was dismissed as moot. See The Chicago Area I.B. of T. Pension Fund and The Local 703 I.B. of T. Pension Fund v. Central Grocers, Inc., Adv Proc. No. 17-cv-05808 (N.D. Ill. 2017) [Dkt No. 35].
There remains limited authority regarding the successor liability risk for withdrawal liability claims, which makes the efficacy of 363 sales in grocery Chapter 11 cases unclear. But cf. Tsareff v. ManWeb Services, Inc., Case No. 14-1618 (7th Cir. July 27, 2015) (held that an asset purchaser may be liable for the asset seller’s ERISA multiemployer pension plan withdrawal liability, despite an explicit exclusion of liability assumption in the asset purchase agreement); Chicago Truck Drivers, Helpers & Warehouse Workers Union (Indep.) Pension Fund v. Tasemkin, Inc., 59 F.3d 48 (7th Cir. 1995) (finding successor liability in a foreclosure sale).
Another recurring issue arises when retail grocer debtors seek to modify CBAs to eliminate certain contractual provisions or reject a CBA altogether. In A&P’s bankruptcy, the debtors sought to strike certain “bumping” provisions, as well as cap out severance obligations at 25%. A&P’s CBAs included provisions allowing senior employees at stores that are closed to take the jobs of junior employees elsewhere—in other words, to “bump” less senior employees from their positions—creating a potentially major administrative burden, which was seemingly unnecessary given that A&P planned to close virtually all of its stores in a liquidation process.
Further, A&P also sought to reject its CBAs and, in turn, terminate its retirement benefits. Unions objected to both motions, arguing that modifying and/or rejecting CBAs is only appropriate under the Bankruptcy Code when such modifications are essential to the continuation of the debtor’s business, which the unions argued was not the case since the debtors were liquidating their business.
The debtors and unions ultimately resolved the issue and entered into a settlement in connection with the liquidation. Under the agreement, the debtors agreed to provide continued funding for retiree medical, hospitalization, postemployment long-term disability benefits, and life insurance or death benefits through an agreed upon date as part of the settlement, which involved: (i) $11.25 million of the secured lenders’ cash collateral (which was used to pay continuing pension obligations); (ii) a share in the proceeds of certain of the debtor’s prepetition causes of action (also used to pay ongoing pension obligations); and (iii) the debtor’s support for the payment of the union’s professional fees through a substantial contribution claim. See The Great Atlantic & Pacific Tea Co., Case No. 15-bk-23007 (Bankr. S.D.N.Y. 2015) [Dkt Nos. 526, 552, 820, 1273, 2113, 2786].
While debtors, secured lenders, and unions can typically find common ground and reach a resolution regarding CBAs and pension obligations, turnaround professionals need to plan for and anticipate strong participation from union groups and pension funds in any grocery chain Chapter 11. Depending on the terms of the CBAs, secured lenders and other creditors may be at risk of diminished recoveries.
These cases illustrate how grocery chain restructurings present turnaround professionals with their own unique legal issues. As the Amazon Effect lingers and the number of failing grocery chains continues to rise, turnaround professionals should consider these distinct issues to best serve their clients.
Mariam Kamran, an associate with O’Melveny, contributed to the preparation of this article.