Dealer Trust Act Faces First Test Case

OMAHA (DTN) -- The U.S. Department of Agriculture and a bankruptcy trustee in Texas are at odds over a new law, the Dealer Trust Act, and how to move ahead with $119.3 million in potentially unpaid claims tied to a Ponzi and check-kiting scheme involving a cattle operation in Kentucky and Texas.

The claims involve a pair of feedyards -- McClain Feed Yard outside Hereford, Texas, and 7M Feeders near Friona, Texas -- and McClain Farms in Benton, Kentucky.

The bankruptcy trustee, Kent Ries, an attorney from Amarillo, Texas, finds himself trying to navigate USDA and the Dealer Trust law, a 2-year-old law that only recently published regulations and has no cited case law or precedent on how to handle it. USDA has asserted the McClain cases are the first time the Dealer Trust Act has been used.

More than 100 livestock producers nationally filed $122 million in unpaid claims with USDA while Rabo AgriFinance has more than $53 million filed as a secured creditor with claims involving all three cattle operations. Rabo AgriFinance claims McClain may have sold 78,000 cattle earlier this year without paying its loans.

Brian McClain, 52, died April 18 from apparent suicide just days after he turned over management of his feedyards to a financial management company. McClain Farms, McClain Feed Yard and 7M Cattle Feeders filed for Chapter 7 bankruptcy on April 28.

As unpaid producers and others have filed claims, there were thousands of cattle that haven't been accounted for that were sold or removed from the McClain feedyards in about a two-week span between McClain's feedyards shutting down and the operation filing for bankruptcy.

Ries filed a motion asking the bankruptcy court to rule on a conflict between USDA's interpretation of the Dealer Trust Act and the traditional management of a bankruptcy case by a trustee. USDA's view on how attorneys are paid for their work as bankruptcy trustees would also be turned on its head.

DEALER TRUST ACT

The Dealer Trust Act is a new provision of the Packers and Stockyards Act (P&S Act) that came into law under a 2021 federal spending bill. It was created specifically to protect cash sellers of livestock. USDA's Agricultural Marketing Service (AMS) examines claims that are filed.

The Livestock Marketing Association (LMA) pushed for the Dealer Trust Act following a series of situations in which cattle producers made cash sales to feeders, brokers or small processors that immediately collapsed. Those cattle sellers typically found themselves at the back of the line in a bankruptcy case behind secured creditors.

"And that felt patently unfair," said Jara Settles, general counsel and vice president of risk mitigation for LMA. "The bank didn't raise those cattle, the bank didn't do anything to get those cattle, and the bank didn't even lend the money to procure them, because if they had, then the rancher would have been paid. So, we had a situation where it was pretty unfair to people that were in a position that couldn't protect themselves."

The Dealer Trust Act essentially now ensures those unpaid livestock producers who sold cattle can move to the front of the payment line. The act specifically requires trusts to be set up to ensure producers are paid.

In early May, USDA issued a notice on the McClain case, calling on producers to promptly file Dealer Trust claims if they had not received payment from any McClain operation. It was the first time USDA had filed such a notice using the Dealer Trust Act.

BANKRUPTCY VS. DEALER TRUST

Ries laid out in a court motion that there are several issues involving legal overlap between the bankruptcy estate and USDA's Dealer Trust Act claims. The first is whether the law even applies at all given that Rabo AgriFinance's loan made it a secured creditor. Ries also indicated there are questions about which claims filed with USDA are valid and what assets would fall under the trust or the bankruptcy.

Ries noted, "The potentially expansive definition of trust assets is a major issue" in the case. Courts have been inconsistent in the past over Packers and Stockyards Act trusts, but some courts have alluded that any asset tied to a buyer who did not pay could be part of the trust.

"Like most agricultural businesses, like the Debtors' (McClains'), all their income is from the sale of such products, so theoretically, all their assets could be considered trust assets," Ries stated in his court motion.

Along with that, USDA has told Ries the department believes all claims must be paid in full before any costs tied to a Dealer Trust asset or claim are paid out of any trust assets.

USDA has denied $119.34 million of the $122 million in claims as not being "cash sellers."

USDA cleared roughly $2.69 million in claims from ranchers who sold cattle to a McClain entity but did not get paid.

Ries stated he and USDA had cooperated on recovering more than $2.47 million from the purchase of 2,437 cattle that went to help pay for claims in the Dealer Trust.

The $119.34 million in claims were tied to investors who had provided the McClain operations with money to buy, raise and sell cattle, but didn't meet USDA's definition under the new law as a cash seller.

It's likely at least some of those rejected claims will end up challenging USDA's determination in court given the money involved. Records show at least 14 claims involved $1 million or more. Four livestock-related businesses around Mayfield, Kentucky, reported combined losses totaling $85.6 million.

At least one other Texas cattle feeder has filed bankruptcy because of connections to the McClain losses.

Ries stated in his motion that any attempt to recover more funds would require the trustee or others to track down the cattle that were taken from the feedyards up until McClain's death. At the same time, given USDA's restrictions on trust funds, there's no guarantee the trustee would be paid for that work.

"Just like there is an overlap in claims, there is the potential of an overlap in assets between the statutory trust and the bankruptcy estates," Ries stated in an email to DTN. "That is one of the main issues for my notice. Assets that belong in the trust will have to be used for trust claimants until their claims are paid in full. Once paid in full, it's very likely those same assets will go to the bankruptcy estates. Of course, if the trust assets aren't sufficient to pay trust claims in full, then there is nothing to go to the estates. There are also assets that could go to the estates and not the trust. Again, a final determination of trust versus estate assets would have to be made by a court."

Ries suggested USDA's position on the Dealer Trust Act essentially puts him in "judicial purgatory," trying to resolve the Dealer Trust issues in what amounted to a $175-million Ponzi and check-kiting scheme.

Ries laid out some possible scenarios such as whether the judge could determine the Dealer Trust Act doesn't apply because Rabo's loan predates the law. USDA also could formally intervene to administer the act trusts. It would have to file a separate lawsuit naming the trust claimants and ask for a judgment on their claims.

NEXT STEPS

The U.S. Bankruptcy Court for the Northern District of Texas has a hearing set Oct. 11 to sort out some of the challenges Ries laid out for the case going forward. The judge will also rule on a motion to move the bankruptcy case out of Texas to the federal Bankruptcy Court for the Western District of Kentucky where several of the main livestock businesses are located.

Settles said a "best-case scenario" would be for the bankruptcy just to order the trustee to pay out the rest of those trust claims, then the trustee can move ahead with the normal business of dealing with the bankruptcy assets.

"For the people who actually sold cattle and didn't get paid, it would be very impactful for them to get their money back," Settles said.

Also see "Unpaid Claims by Producers Against Bankrupt Cattle Feeder Top $122 Million" here: https://www.dtnpf.com/….

Chris Clayton can be reached at Chris.Clayton@dtn.com

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