Tuesday, May 28, 2019
Last week the USDA announced a second round of Market Facilitation Program (MFP) payments would be forthcoming. This is a support program in a long line of federal government support programs for farmers going back decades. Some farmers will pledge these payments to lenders as collateral for loans. That raises important questions – how are MFP payments classified from a secured transactions perspective? Are they “proceeds” of crops? In ag, “proceeds” can take many forms. Where do MFP payments fit, and what must a lender do to secure its interest in the payments?
Lenders’ rights in MFP payments – that’s the topic of today’s post.
MFP Payments – In General
The MFP is a USDA federal farm program that the Farm Service Agency (FSA) administers. The MFP provides “payments to farmers with commodities that have been significantly impacted by actions of foreign governments resulting in the loss of traditional exports.” 83 Fed. Reg. 169, p. 44173 (Aug. 20, 2018). In 2018, the first round of MFP payments was authorized. Those payments were paid for various crops as an advance payment of 50 percent of a producer’s final production times a rate for each crop or commodity. The MFP payment rate was $1.65/bu. for certified 2018 soybean production; $.86/bu. for sorghum; $.14/bu. for wheat; $.12/hundredweight for dairy; and $8/head for pork – just to name a few of the commodities that were covered by the program. There was a separate $125,000 payment limit that applied for the 2018 MFP payments, but they were subject to the $900,000 AGI limitation.
Now, the USDA has announced a 2019 MFP payment. This payment will be based on a per-acre payment tied to the county where the producer’s particular farm is located. But, to be eligible for an MFP payment, a producer must actually plant crops. Another form of payments – prevented planting payments – will be available under the rules applicable to that program for producers that aren’t able to plant due to weather-related conditions. Whether there will be a separate $125,000 payment limitation for the 2019 MFP payment remains to be determined. If not, larger farming operations where the operating entity limits liability will be subject to a single $125,000 payment limit for all payments, including the MFP payment. In addition, the $900,000 AGI limitation is waived for producers with at least 75 percent of their AGI from farming.
MFP payments are not deferable for income tax purposes as are crop insurance payments that are paid for actual physical destruction to the taxpayer’s crops. Instead, MFP payments are for lost profit rather than to compensate a producer for physical damage or destruction to crop, or the inability to plant (the requirement for deferability under I.R.C. §451(f)). Because they are intended to compensate a farmer for lost profits, they are included in gross income in accordance with I.R.C. §61(a). See also Rev. Rul. 73-408, 1973-2 C.B. 15; Rev. Rul. 68-44, 1968-1 C.B. 191. They are also similar to counter-cyclical and price-loss payments authorized under prior Farm Bills which a farmer/recipient had to include in gross income. MFP payments must included in net earnings from self-employment and, thus, subject to self-employment tax because they are tied to earnings derived by a farmer from the farming business. See, e.g., Ray v. Comr., T.C. Memo. 1996-436; IRS Legal Advice to Program Managers, PMTA-2018-21 (Dec. 10, 2018).
MFP Payments As Loan Collateral
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).
The “proceeds” issue. What are “proceeds” of crops or livestock? In ag, “proceeds” can take the form of crop insurance payments, prevented planting payments, storage payments, disaster relief payments, and other types of government payments. State law interpretations of Article 9 of the Uniform Commercial Code (UCC) can differ, but Article 9 provides an extensive and careful coverage for security interests in 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. But, a disposition is not necessarily required. See, e.g., Western Farm Service v. Olsen, 90 P.3d 1053 (Wash. 2004), rev’g, 59 P.3d 93 (Wash. Ct. App. 2003).
The general intent of Article 9 is to give the secured party with a security interest in collateral a similar security in anything which the debtor received from third parties in exchange for that collateral. No specific reference to proceeds is required in the security agreement. UCC §9-203. Indeed, the attachment of a security interest in collateral automatically gives the secured party an interest in the proceeds if they are identifiable. UCC § 9-203(f).
As noted above, in ag 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 forms. See, e.g., FMB-First Michigan Bank v. Van Rhee, 681 F. Supp. 1264 (W.D. Mich. 1987). 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. However, it should be noted that at least two courts have held that the Federal Crop Insurance Act (FCIA) preempts UCC Article 9. Thus, according to these courts, the exclusive method for a creditor to obtain a lien in undisclosed proceeds is through the FCIA authorized assignment process. In re Duckworth, No. 10-83603, 2012 Bankr. LEXIS 1219 (C.D. Ill. Mar. 22, 2012); In re Cook, 169 F.3d 271 (5th Cir. 1999).
In general, for governmental agricultural payments to qualify as proceeds, three conditions must be met: (1) the crop must have been planted; (2) the crop must have been lost or destroyed; and (3) the government payment being claimed must have been received by the producer for the lost or destroyed crop. See, e.g., In re Schmaling, 783 F.2d 680 (7th Cir. 1986); ConAgra, Inc. v. Farmers State Bank, 602 N.W. 2d 390 (Mich. Ct. App. 1999). Thus, the majority of courts hold that if deficiency payments are made to supplement a planted crop's depressed market price, they are proceeds. Other courts have held that deficiency payments are not proceeds primarily because the payments are made regardless of whether the farmer harvests or sells a crop. See, e.g., In re Hunerdosse, 85 B.R. 999 (Bankr. S.D. Iowa 1988); In re Kruger, 78 B.R. 538 (Bankr. N.D. Ill. 1987); In re Kingsley, 865 F.2d 975 (8th Cir. 1989). Similarly, government payments received for the inability to produce crops have been determined to not be proceeds. See, e.g., In re Schmitz, 270 F.3d 1254 (9th Cir. 2001). The courts seem to distinguish between payments that replace lost crops (or their markets) and payments that are paid in substitution of a crop. The former constitutes “proceeds” of crops and the later are general intangibles. See, e.g., In re Mattick, 45 B.R. 615 (Bankr. Minn. 1985).
What about MFP payments? Given the regulatory definition of MFP payments noted above, they are supplemental payments to farmers based (at least for 2018) on certified crop production. Presently, there aren’t any reported court decisions on the issue of what the method is to properly perfect an interest in MFP payments. But, logic indicates that MFP payments are intended to serve as a substitute for what would have been crop proceeds if it were not for conduct by foreign governments. Thus, perhaps a strong argument can be made that MFP payments are like disaster relief payments. Disaster relief payments have been held to be “proceeds” of crops (or livestock). See, e.g., In re Nivens, 22 B.R. 287 (Bankr. N.D. Tex. 1982). Thus, if a lender holds a perfected security in the crops (or farm products) “and proceeds thereof” of a farm debtor, the perfected security interest would include the MFP payments. But, is a mere reference in a security agreement/financing statement to “government payments or programs” of the farm debtor enough to cause the security interest to attach and become enforceable in MFP payments? Without a specific reference to the debtor’s crops or farm products, maybe not.
Does a statutory lien extend to MFP payments? Probably not. Lien statutes are typically tied to a specific crop that crop inputs and related services benefitted. Thus, a properly perfected secured creditor in proceeds of crops would beat out a lien creditor with respect to MFP payments. However, the precise answer to this issue is dependent on the particular state lien statute at issue and court opinions in that particular state construing the reach of the lien. Also, it’s important to note that rules for the 2018 MFP payment allowed a landlord operating under a crop-share lease to submit a separate MFP application for the landlord’s share of the crop irrespective of whether the landlord has a landlord’s lien that would beat out a secured creditor.
The FSA is also not subject to state central filing rules or direct notice provisions. Those rules provide relief to a lender in the event a buyer of a crop that serves as loan collateral fails to issue a jointly payable check to the farmer and the lender. This is an important point for lenders to understand. With respect to the 2018 MFP payments, the FSA was encouraging the amounts to be direct deposited into the farmer’s operating account. If the lender is other than the depository bank, the payments could become subject to a prior perfected security interest of the bank upon deposit. The banks interest will beat out the lender holding an interest in the debtor’s farm products and proceeds thereof.
MFP payments raise some important questions from a lending standpoint. Regardless of the classification of farm program payments that a jurisdiction adopts, a creditor must always comply with applicable UCC requirements for the creation, attachment, and perfection of a security interest in the payments. In any event, however, the most effective manner for a creditor to perfect a claim against a farmer's federal farm program payments is to include specific references to federal farm program benefits (and comparable benefits such as the MFP program payments) in the lender’s blanket security agreement. A lender should also closely pay attention to the status of a borrower’s MFP application and require that any payments be direct deposited into the debtor’s account with the lender (if there is such an account). But, the advice remains for lenders drafting documents designed to take an interest in farm program benefits: 1) the security agreement must “reasonably identify” the collateral and; 2) the collateral must be sufficiently identified in the financing statement.
Another good question is whether the differences in the MFP program between 2018 and 2019 make a material difference on the “proceeds” issue. While the 2019 payment is tied to the county where the producer’s farm is located, the rule appears to require the producer to actually plant crops to receive a payment. From a lending and security perspective, that could be a key point.