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FDA Releases First Two Rules under the Food Safety Modernization Act

December 01, 2015 (13 min read)

By: Breia L. Schleuss and Rachael Dettmann Spiegel, Faegre Baker Daniels LLP

THE FOOD SAFETY MODERNIZATION ACT (FSMA) REPRESENTS one of the most sweeping and substantial changes to U.S. food safety laws in over 70 years. After years of delays in publishing final rules, the U.S. Food and Drug Administration (FDA) must adhere to court-ordered deadlines to release final rules throughout 2015 and 2016. The first two of these rules were released by the FDA on August 31, 2015. Compliance with the new rules is expected within one year, depending on the size of the company. Non-compliance with the FSMA’s final rules may lead to significant business impacts for food and feed companies and may also increase risk to secured lenders in the food and feed industry.

What is the FSMA?

Following a number of large food safety outbreaks, some resulting in death, the FSMA was signed into law in January 2011. FDA Food Safety Modernization Act, Pub. L. No. 59-384, 124 Stat. 3885 (2011) (codified in scattered sections of 21 U.S.C.). It should be noted, for purposes of the FSMA, and throughoutthis article, that the term “food” encompasses both human food and animal food.

The FSMA is broadly aimed at addressing three issues: (1) prevention of food safety outbreaks, (2) detecting and responding to food safety outbreaks, and (3) improving the safety of imported foods. The FSMA fundamentally shifts the FDA from being a reactionary agency—waiting for a food safety outbreak to occur before responding—to an agency focused on prevention—detecting and preventing food safety problems before they cause public harm. Before the FSMA, the FDA lacked authority to order a mandatory food recall. Under the FSMA, the FDA can now order a food safety recall and even shut down a facility if food poses a reasonable probability of causing a serious food safety outbreak. In addition, facilities will be subjected to more frequent FDA inspections, and FDA inspectors will have access to company food safety records.

A company that is affected by a recall or that has had its facility registration revoked by the FDA may suffer significant and immediate costs, particularly if the company is unable to shift production to a different registered facility or cannot quickly obtain regulatory (and vendor) approval for the sale of its products after the recall has been managed. As a result, a company may need increased working capital very quickly (whether in the form of a bridge loan, an incremental term loan, or an accordion increase in its revolving line of credit), at the very time that its lender may be reassessing the risk profile of the company.

In addition, a foreclosing lender that has a lien on the company’s assets may be unable to sell the food and feed products that have been subject to the recall, and no person— including a foreclosing lender—may sell or otherwise introduce into commerce any products that were produced during the time when a facility’s registration has been revoked by the FDA. This may pose some very real consequences to a lender that has been viewing that collateral as a source of repayment, particularly at a time when a company may not have sufficient cash flow to repay the lender.

As a result, food and feed companies—and their lenders— should carefully consider a company’s operations. Specifically, they could consider whether the company is adopting a risk-based hazard analysis plan in accordance with the FSMA to protect against the company’s identified risks, whether the company has multiple registered facilities to which the company can shift production if needed, and whether the company has suffered material recalls in the past or has otherwise been identified by the FDA as having “high risk” products or facilities. Each of these items is discussed below.

Which food and feed companies are affected by the FSMA?

Congress intended the FSMA to strengthen food safety practices throughout the food and feed manufacturing supply chain. The FSMA impacts food manufacturers, animal feed manufacturers (including even ethanol facilities manufacturing co-products sold as animal feed), distributors, processors, foreign suppliers, certain storage facilities, and those that transport food or feed products. The FSMA also regulates growers of fruits and vegetables. It does not affect retail grocery stores or restaurants, nor does it cover processors of meat, poultry, and processed egg products—which are regulated by the U.S. Department of Agriculture’s food safety requirements.

What will the first round of rules encompass? Although the FDA has been keen to solicit as much industry feedback as possible on the proposed rules, due to a court order, the FDA is now required to release final rules for the seven primary FSMA regulations throughout 2015 and 2016. The first two (and most significant) of these rules, concerning Preventive Controls for Human Food and Preventive Controls for Animal Feed, were released August 31, 2015, in compliance with a court order. However, given the size and breadth of the initial rules, publication in the Federal Register is still pending. Both final rules will solidify requirements for covered entities’ food safety plans. All but the smallest businesses will need to comply with these two rules within one year after they are released.

The FSMA and these two final rules will require each covered food facility (depending on the size of operation) to establish a safety program that should include, among other things:

  • a hazard analysis and risk-based preventive control plan, which requires facilities to identify all known and reasonably foreseeable potential hazards and, if any of those hazards are significant, develop preventive controls sufficient to provide assurance that the food or feed will not be adulterated or misbranded;
  • procedures for following good manufacturing practices (GMPs);
  • a recall plan;
  • environmental sampling and controls;
  • allergen controls and labeling; and
  • supplier verification and management.

Although preventive controls are not new to the food and feed industry—many companies employ similar methods already—the FSMA and these two final rules will broaden the scope of preventive controls regulated by the FDA and provide the FDA with significant enforcement powers. In addition, a “Qualified Individual” must now be engaged by a facility to prepare and oversee implementation of its food safety plan. Under the preventive control rules, a Qualified Individual is anyone who has undergone specialized training or who possesses relevant work experience to develop a food safety plan. A Qualified Individual may, but is not required to be, an employee of the facility. Each of the foregoing components of a food and feed safety program (including the engagement of a Qualified Individual and that individual’s training) will need to be documented. For example, the FSMA requires that a hazard analysis and risk-based preventive control plan include procedures for product testing as appropriate to the facility, the food or the feed, and the nature of the preventive control. Product testing in and of itself, however, is insufficient; the FSMA also requires the facility to have written procedures for product testing, written corrective action procedures, and records of product testing. Food and Drug Administration, “Proposed Rule: Current Good Manufacturing Practice and Hazard Analysis and Risk-Based Preventive Controls for Human Foods,” 21 CFR Parts 1, 16 and 117, Docket No. FDA-2011-N-0920 (2011). If the product testing is not documented, a facility will not be in compliance.

Considerations for Lenders

The FSMA and its final rules have three central tenets— prevention, inspection, and response—each of which may have important implications for secured lenders and their collateral.

Prevention and Documentation

The FDA’s new focus on prevention and risk-based analysis should align nicely with a lender’s interest in extending credit to companies that effectively identify and manage potential risks to the company’s inventory and operations. Cf. Office of the Comptroller of the Currency, Bank Supervision Process: Comptroller’s Handbook 18–19 (Sept. 2007) (describing “Supervision by Risk” and explaining that “[e]xaminers determine whether the risks a bank assumes are warranted by assessing whether the risks are effectively managed, consistent with safe and sound banking practices”). For example, the final rules for Preventive Controls for Human Food and Preventive Controls for Animal Feed will likely require companies to identify and evaluate all known and reasonably foreseeable biological, chemical, physical, and public health hazards associated with food or feed safety, and then evaluate those hazards to determine whether they are significant. “Significant hazards” will, under the final rules, likely require mitigation through adoption of hazard controls. These hazard controls and other preventive policies required by the FSMA may result in companies adopting expanded risk management policies for the protection of food and feed products, which may protect inventory (and thus, in some cases, a lender’s collateral) from some risks.

A company’s risk management policy is often requested by a lender when the lender is underwriting a loan. As a result of the FSMA, a lender could expand its request to ask for copies of the company’s hazard analysis and risk-based preventive control plan, recall plan, and other documentation. A lender will not be in a position to comment on the sufficiency of any such plan or documentation, but the request may at a minimum initiate a conversation between the lender and the company as to whether the company is aware of the FSMA, whether the company believes it is subject to the FSMA, how the company is interpreting the FSMA, and (perhaps most importantly) the potential significant food and feed safety hazards identified by the company. Lenders might consider including failures to implement and follow hazard controls or other FSMA plans as events of default in the relevant loan documents.

Similarly, the FSMA and its final rules require companies to maintain extensive records, all of which must be provided to the FDA upon written or oral request. See, e.g., 21 U.S.C. § 350c (2012). Records must be maintained with respect to a company’s monitoring, any episodes of material noncompliance, any corrective actions, and its verifications of efficacy of its preventive controls. A lender could—either in connection with a lender’s underwriting due diligence or as part of an ongoing reporting covenant under the loan documentation— request disclosure of any recalls, any episodes of material non- conformance with the FSMA, any corrective actions taken by the company at any time, and copies of any correspondence with the FDA as a result of any of the foregoing. Evidence of frequent or material recalls or non-compliance might lead a lender to further investigate the nature of the food or feed products, the operations at the company’s facilities, whether to adjust any borrowing base advance rates with respect to those food or feed products or associated receivables, or whether to add a reserve under the calculation of any borrowing base.

Inspection and Compliance

In addition to requiring companies to maintain extensive documentation, the FSMA provides the FDA with enhanced authority to inspect facilities. As a result of the FDA’s finite budget, however, the FDA is focusing its inspection resources on those facilities and food or feed products that the FDA (in coordination with the USDA and the U.S. Department of Health and Human Services (HHS)) determine are “high risk.” See, e.g., 21 U.S. C. § 350j (2012). The FDA intends to inspect each high risk facility at least once by 2016, and at least every three years thereafter. The FDA also intends to inspect other facilities at least once by 2018, and at least every five years thereafter. A lender could expand its reporting covenants under its loan documentation to require copies of any inspection reports, any FDA warning letters received by the company, and any corrective action plans. These inspection reports and other documents may supplement inspections or collateral audits that the lender may already be conducting.

When underwriting a loan, a lender could also ask a company to disclose whether any of its facilities or food or feed products has been identified as “high risk” by the FDA, USDA, or HHS. In addition, the loan documentation could incorporate a representation that, except as disclosed, neither the borrower nor any of its facilities or products has been identified by a governmental authority as a “high risk” facility or product. A “high-risk” facility or product may not necessarily be excluded from a borrowing base or from a lender’s collateral, but a “high-risk” identification may provide the lender with additional information about a company, its operations, or its products when the lender is structuring (or restructuring) its loan.

The general “compliance with laws” representations and covenants made by a company under its loan documentation could also be expanded to have the company represent that it is in compliance with the FSMA, the company’s own policies and procedures that it implemented to minimize the risks of food and feed contamination, and any corrective action plans that it enacted in response to any contamination or inspection report received by the company from the FDA.

FDA Enforcement Powers

While preventive controls required by the FSMA are designed to prevent future food or feed contaminations, hazards still exist. When issues arise, the FDA now has enhanced enforcement authority under the FSMA. The FDA can detain food or feed products if the FDA has reason to believe that food or feed is adulterated or misbranded; normally such an administrative detention lasts no longer than twenty days. The FDA can also issue a mandatory recall when a company fails to voluntarily recall unsafe food or feed products after being asked to do so. See, e.g., 21 U.S.C. § 350l (2012). Mandatory recalls are rare, as most companies will voluntarily recall products upon their own initiative or upon request by the FDA.

The FDA can now also suspend a facility’s registration if the FDA determines that the food or feed poses a reasonable probability of serious adverse health consequences or death to humans or animals. See, e.g., 21 U.S.C. § 350d (2012.) Violations may lead to penalties, imprisonment, and fines. Accordingly, notwithstanding any security interest that a lender may have on the food or feed products, neither the company nor any foreclosing lender may be able to sell any product produced at the facility during this time. The value of any such collateral, and associated receivables, may effectively be reduced to zero—at the time the collateral is needed most. Whether the company has another facility and, if so, whether production can be shifted to the other facility during this time, could be of critical importance to the continued operations of the company.

The lender may also have a lien on the facility itself. Any owner, operator, or agent in charge of a facility engaged in manufacturing, processing, packing, or holding food or feed products must register the facility with the FDA and comply with the facility registration requirements. A lender may not want to foreclose on its lien and become the owner, operator, or agent in charge of a facility that has had its registration revoked by the FDA, depending on the steps and resources that may be needed to reinstate such registration before the facility can again be operable.

As a result of the enhanced enforcement powers given to the FDA under the FSMA, a lender may want to expand the reporting covenants and the events of default under its loan documentation to specifically require notice of and, where material, provide for an event of default upon the occurrence of any administrative detention, recall, or suspension of registration.

Bottom Line

Compliance with the FSMA and its final rules requires companies to invest additional time and expense for training, hazard analyses, policy implementation, equipment upgrades, and capital improvements for infrastructure changes. In return for this investment, the FDA, the food and feed companies and, indirectly, their lenders may benefit from increased information and preventive inventory and operational controls. When food safety issues do arise, however, the FDA’s expanded enforcement authority narrows a lender’s options with respect to potentially contaminated or misbranded food or feed product.

Breia L. Schleuss is a banking and finance attorney, and Rachael Dettmann Spiegel is a food litigation and regulatory attorney, both of whom practice within the food and agriculture industry group at Faegre Baker Daniels LLP.

Article Courtesy of Clark’s Secured Transactions Monthly, Volume 31, No. 8

*Copyright © 2015. Matthew Bender & Company, Inc., a member of the RELX Group. All rights reserved. Materials reproduced from Clark’s Secured Transactions Monthly, Volume 31, No. 8 with permission of Matthew Bender & Company, Inc. No part of this document may be copied, photocopied, reproduced, translated or reduced to any electronic medium or machine readable form, in whole or in part, without prior written consent of Matthew Bender & Company, Inc.