This Ag Alert identifies three growing legal developments in agricultural finance that emerged in 2013 and what to expect and be aware of in 2014. For a summary of these, and other recent agricultural finance cases, click here.
1. Courts are requiring strict compliance with agricultural finance statutes.
Over the past year federal and state courts have continued to require strict compliance with state agricultural finance statutes. Unlike other areas of commercial finance, courts have been unwilling to allow a creditor to substantially comply with agricultural finance statutes to get the benefit of the statute. This is evident in recent statutory agricultural lien cases requiring agricultural suppliers to comply with all aspects of state agricultural lien statutes to be entitled to priority agricultural liens and cases limiting the rights of secured lenders under CNS filing statutes in cases where there have been clerical errors by the lender.
With the fallout of high feed prices in 2008 and 2009, courts continue to hand down decisions interpreting state agricultural lien statutes that allow agricultural suppliers to priority liens. The decisions continue to require the lien claimant to comply with the underlying state lien statutes. Arguments that the lien statutes only require substantial compliance have failed. In First Nat'l Bank v. Farmers Coop Soc’y (In re Coastal Plains Pork, LLC) 2012 WL 6571102 (E.D. N.C. Bankr. 2012), an Iowa feed supplier filed a lien statement asserting a lien in “[a]ll livestock located at [certain barn locations].” The feed supplier asserted that its lien also flowed to hogs fed at other barn locations. A North Carolina Bankruptcy Court limited the lien to the barns identified on the UCC-1 lien statement. This case is consistent with earlier agricultural lien decisions including First Nat'l Bank v. Profit Pork, LLC, 820 N.W.2d 592, 2012 Minn. App. LEXIS 96 (Minn. Ct. App. 2012), which held the lien claimant was not entitled to multiple Minnesota liens and In re Shulista, 451 B.R. 867 (Bankr. N.D. Iowa 2011), which held the agricultural supplier must fully comply with statute and file the lien statement every 31 days.
Courts have also limited the rights of lenders which have made clerical errors or mistakes related to CNS filings and notices. For states like Minnesota that require the lender to file the CNS statement with the state, a court has held that the lender is only entitled to the collateral that is actually described in the CNS statement even though the UCC-1 finance statement contained a broader collateral description. A Mississippi Court held that a CNS statement for sweet potatoes that only included county codes for two counties and six parcels within those two counties is limited to the sweet potatoes actually grown within those specific parcels. The buyer did not have to make the check jointly payable to the secured lender for sweet potatoes grown in other counties and on other parcels even though the lender’s UCC-1 finance statement contained a broader collateral description. In re Moore, 2013 Bankr. LEXIS 2060 (Bankr. N.D. Miss. May 17, 2013).
Similar decisions have been made in states like Iowa, Wisconsin, Nebraska, and Illinois that require the lender to send notice to the potential buyers of its borrower’s farm products. In two separate Illinois cases, the secured lender failed to include in the notice the names of certain counties where the borrower grew crops. The Illinois Court held that the Federal Food Security Act expressly requires the secured lender to provide a description of the farm products subject to the security interest created by the borrower and the name of each county where the farm products are located. No exceptions. State Bank of Cherry v. CGB Enters., 984 N.E.2d (Ill. 2013). The notice better also include the borrower’s social security number. The other Illinois Court rejected a notice that failed to include the borrower’s social security number. CNH Capital v. Trainor Grain and Supply Co. (In re Printz), 2012 LEXIS 4506 (Bankr. C.D. Ill. Sept. 27, 2012). This remains a frequently litigated issue, with courts in Kansas (First Nat’l Bank & Trust v. Miami County Cooperative Ass’n, 897 P.2d 144 (Kan. 1995), Ohio (Farm Credit Services of MidAmerica, ACA v. Rudy, Inc., 680 NE2d 637 (Ohio Ct. App. 1996), and Nebraska (Lisco State Bank v. McCombs Ranches, Inc., 752 F. Supp. 329, 13 UCC Rep. 2d 928 (D. Neb. 1990), not requiring strict compliance by the lender as to the notices.
The Takeaway: Make sure you understand the requirements in your state and take every necessary action to submit complete and accurate notices. For priority agricultural liens, courts are requiring crop and livestock suppliers to file accurate and complete lien statements. Sloppy lien filings are being rejected by the courts. Courts are also requiring the suppliers to trace the crops/livestock in which they have a lien to the later proceeds from the sale of those crops and livestock; a time consuming and costly expense. As for CNS filings, lenders should avoid limited filings. Broad collateral descriptions (i.e. “all commodities in all counties”) should be used. For lenders in direct notice states, the lender should obtain the necessary information from the borrower to be able to give complete and accurate notice to prospective buyers.
2. The future of Chapter 12 bankruptcy? We may see more farmers and ranchers liquidating a portion of their operations before filing Chapter 12 bankruptcy. The issue in 2012 was whether a Chapter 12 farmer/rancher must pay all of his unpaid taxes through his Chapter 12 plan or whether he can just pay a portion of the taxes as an unsecured claim. The United States Supreme Court took up this issue in 2012 and held that if the farmer/rancher sells the property during his bankruptcy, the farmer/rancher must pay all of the unpaid taxes. Hall, 617 F.3d 1161 (2012). The Court did not address property sold before the bankruptcy.
Building on the Supreme Court decision in Hall, in 2013, Illinois Bankruptcy Court ruled that a farmer cannot use his property (which becomes property of the bankruptcy estate when he filed bankruptcy) to pay the taxes. In re Ferguson, 2013 Bankr. LEXIS 6 (Bankr. C.D. Ill. Jan. 2, 2013).
The Supreme Court in Hall did not address the sale of assets before the bankruptcy was filed. Two recent decisions did address this issue. In 2013, an Iowa Bankruptcy Court held that if the property is sold before the bankruptcy is filed, Hall does not apply and the resulting taxes from the sale can be treated as an unsecured claim. In re Hemann, 2013 Bankr. LEXIS 1385 (Bankr. N.D. Iowa Apr. 3, 2013). However, another 2013 Kansas case held that unpaid taxes related to the pre-bankruptcy sale of crops and finished cattle must also be paid in full because, to get the benefit of the tax write-down, the property must be equipment, machinery, real estate, or other assets “used” in the farming operation. In re Keith, 2013 Bankr. LEXIS 2802 (Bankr. D. Kan. 2013).
The Takeaway: Expect more pre-bankruptcy workouts with a packaged Chapter 12 bankruptcy filing at the backend of the workout. All of these decisions push a farmer/rancher to make significant decisions about their farming operations before filing bankruptcy. Between Hall and if other courts adopt the In re Ferguson decision, it will become increasingly difficult to use the bankruptcy court to liquidate and downsize the farming operation while in a Chapter 12 bankruptcy. The decision to liquidate assets will need to be considered and acted on before the bankruptcy is filed. The Chapter 12 bankruptcy will then be used to deal with the resulting tax liability from the sale of the assets and to discharge any unsecured trade debts.
3. A custom feeding endorsement may not insure against losses incurred in conventional custom feeding operations. Two cases out of Iowa highlighted this issue in 2013. Both have similar facts. The farmer operates a custom feeding operation; feeding and finishing livestock of another person. The farmer had a general property insurance policy and, in addition, obtained a custom feeding endorsement. Livestock died because of either mechanical failure or for unknown reasons. The farmer tenders a claim on his policy and the claim is denied because the general policy had a custom feeding exception and the endorsement only related to livestock owned by the farmer, and not the livestock of others. See Boelman v. Grinnell Mut. Reinsurance Co., 826 N.W.2d 494 (Iowa 2013) and Grinnell Mutual Reins. Co. v. Schwieger, 685 F.3d 697 (8th Cir. 2012). In both cases the court held that the damages were outside the scope of both the policy and the custom feeding endorsement, rejecting the claim of the farmer.
The Takeaway: Require and review your borrower’s property insurance policy. Considering the Boelman and Schwieger cases, livestock and poultry growers should obtain, and lenders should require, a custom feeding endorsement which specifically addresses the policy exclusion. Although not addressed in the case, many custom feeding contracts shift legal liability from one party to another through risk of loss, indemnification, or other provisions. Some standard liability policies contain exclusions from coverage which also exclude losses incurred as a result of these contractual agreements. Contract growers should carefully review their policies to evaluate these exclusions as well.