Wednesday, September 12, 2018
The vast majority of agricultural businesses depend on financing to buy crop inputs, machinery, equipment, livestock and land. For financed purchased items other than land, the lender will obtain in interest in collateral to secure the loan. That is done by the parties executing a security agreement and the lender filing a financing statement as a public record of the transaction. Often the lender will also obtain an interest in the “proceeds” of the collateral. A state’s version of Article 9 of the Uniform Commercial Code governs the matter.
But, just what are “proceeds” of crops and livestock? It’s an interesting question that sometimes arises in ag financing situations? It’s the topic of today’s post.
“Proceeds” – The Basics
The security interest created by a security agreement is a relatively durable lien. The collateral may change form as the production process unfolds. Fertilizer and seed become growing crops, animals are fattened and sold, and equipment is replaced. The lien follows the changing collateral and, in the end, may attach to the proceeds from the sales of products (at least up to ten days after the debtor receives the proceeds). In other words, a security interest in proceeds is automatically perfected if the interest in the original collateral was perfected. However, a security interest in proceeds ceases to be automatically perfected ten days after the debtor receives the proceeds.
Proceeds are generally defined as whatever is received upon the sale, trade-in or other disposition of the collateral covered by the security agreement. Revised UCC § 9-102(a)(64)(A). “Proceeds” also includes whatever is distributed or collected on account of collateral. That does not necessarily require a disposition. See, e.g., Western Farm Service v. Olsen, 90 P.3d 1053 (Wash. 2004), rev’g, 59 P.3d 93 (Wash. Ct. App. 2003). But, “proceeds” does not include a deposit account unless monies from the disposition of collateral are deposited into the account. See, e.g., Community Trust Bank v. First National Bank, 924 So. 2d 488 (La. Ct. App. 2006).
“Proceeds” in Ag Settings
In agricultural settings, “proceeds” of crops or livestock can take several forms. These can include federal farm program deficiency payments, storage payments, diversion payments, disaster relief payments, insurance payments for destroyed crops, Conservation Reserve Program payments and dairy herd termination program payments, among other things. This is significant in agriculture because of the magnitude of the payments. In fact, in debt enforcement or liquidation settings, the federal payments are often the primary or only form of money remaining for creditors to reach.
Crops fed to livestock. If both a farmer's crops and livestock are items of collateral for the same lender, the lender does not usually object to use of the crops as feed. The lender's filed financing statement describing the crop and animals would give sufficient notice of the continuing lien and preserve an interest in the disappearing feed. However, where one lender has a lien on the crops that are fed and another has a lien on the animals that eat the crops as feed, a so-called “split line” of credit, the outcome is not completely clear. If rules as to commingling apply, a perfected security interest in the feed which loses its identity by becoming part of the animal ranks equally with other perfected security interests in the animals according to the ratio that the cost of the assets to which each interest originally attached bears to the total cost of the resulting animal. However, the Nebraska Supreme Court determined in a 1988 decision that the commingling of feed rule does not apply to feed where there is no evidence that the feed was fed to livestock. Beatrice National Bank v. Southeast Nebraska Cooperative, 230 Neb. 671, 432 N.W.2d 842 (1988). But, when feed that is collateral for one lender is fed to livestock that is collateral for another lender, the courts are split on the outcome. In a Colorado case, the court held that the feeding of grain to cattle that was pledged as collateral under a security agreement terminated the creditor's security interest in the grain. First National Bank of Brush v. Bostron 39 Colo. App. 107, 564 P.2d 964 (1977). But, in a later Wisconsin decision where the debtor raised cattle that were owned by third party investors, the court determined that the creditor's security interest in the crops that were fed to the cattle continued in cattle proceeds under either Article 9 or because the feeding was considered to be a sale of the crops to the investors. In re Pelton 171 B.R. 641 (Bankr. W.D. Wis. 1994)
“Proceeds” and bankruptcy. The “identifiable proceeds” problem may also be a concern to a creditor in the event the debtor files bankruptcy. In Pitcock v. First Bank of Muleshoe, 208 B.R. 862 (Bankr. N.D. Tex. 1997), the debtor borrowed money from a bank to plant crops and granted the bank a security interest in all crops and equipment. The debtor grew crops, but instead of harvesting the crops and selling the grain, the debtor pastured cattle “on the gain” on leased land. The debtor received a rental payment based upon the amount of weight the cattle gained from consuming the crops that served as collateral for the loan from the creditor. The debtor received the rent checks and used all of the proceeds for business and living expenses. Shortly after the loan became due, the debtor filed bankruptcy and the creditor filed a claim for the unpaid loan. The creditor argued that its security agreement extended to the pasture rents. The court held, however, that because the crops were not in existence when the debtor filed bankruptcy, no collateral remained to secure the bank's loan. As such, the bank's claim was unsecured.
What about milk? A recent case dealt with the issue of the rights to the sale proceeds of milk. In, In re Velde, No. 18-11651-A-11 2018 Bankr. LEXIS 2621 (Bankr. E.D. Cal. Aug. 23, 2018), the plaintiff owned three dairies including one that delivered the milk it produced to a processor, Columbia River Processing. The plaintiff gave multiple creditors a consensual lien against the milk-delivering dairy’s, crops, milk, milk checks, equipment and other personal property at a time when the aggregate amount due the creditors was about $78 million. Custom Feed Services, LLC; Western Ag Improvements, Inc.; Cold Springs Veterinary Services, Inc.; and Scott Harvesting, LLC (collectively known as ASL holders) provided goods and/or services to the plaintiff’s milk-delivering dairy. The plaintiff then filed Chapter 11 bankruptcy.
Each of the ASL creditors claimed a non-possessory chattel lien under Oregon Rev. Stat. § 87.226, encumbering the dairy’s crops and livestock, as well as the sale proceeds of the sales of the crops and livestock. The amount due ASL Holders on the date of bankruptcy filing was almost $1.1 million. The ASL Holders served notice of their liens on Columbia River. Columbia River owed the dairy approximately $1.2 million for milk delivered to it. Uncertain as to whether the plaintiff, the Consensual Lienholders or the ASL Holders were entitled to those funds, Columbia River Processing impounded and held the milk proceeds. The plaintiff sued the Consensual Lienholders and the ASL Holders to determine the nature, extent and validity of the agricultural service liens.
Oregon's non-possessory lien statutes specifies that persons who provide services and suppliers who provide materials a lien against chattels improved by the services and materials. Agricultural Services Liens extend to crops and animals, their "proceeds," and, in limited instances, to the offspring of those animals. The court determined that the text and context of the statute revealed a legislative intent that the agricultural services lien reach only crops and animals, the proceeds of crops or animals generated by their sale or similar disposition and, in limited instances, the products of crops or animals, unborn regency of animals that are in utero on the date a notice of lien is filed and, in the case of stud or artificial insemination services, offspring. The court also pointed out that in common parlance, “milk” is neither a product nor a proceed, and §87.226 narrowly tailored the circumstances in which agricultural service liens attach to products (i.e., unborn progeny and offspring of stud/artificial insemination services). Because this was not one of those circumstances, the court held that “proceeds” did not attach to milk, or the funds generated by its sale, produced by a cow encumbered by an Agricultural Service Lien. As such, the milk held by Columbia River was not subject to the lien of ASL lienholders.
What are proceeds of crops and livestock? It depends! Ag financing situations can get complex quickly. This is certainly another one of those situations where a good ag lawyer comes in very handy. Farming and ranching is complex in many respects, not the least of which is agricultural financing.