Monday, December 31, 2018
2018 was a big year for developments in law and tax that impact farmers, ranchers, agribusinesses and the professionals that provide professional services to them. It was also a big year in other key areas which are important to agricultural production and the provision of food and energy to the public. For example, carbon emissions in the U.S. fell to the lowest point since WWII while they rose in the European Union. Poverty in the U.S. dropped to the lowest point in the past decade, and the unemployment rate became the lowest since 1969 with some sectors reporting the lowest unemployment rate ever. The Tax Cuts and Jobs Act (TCJA) doubles the standard deduction in 2018 compared to 2017, which will result additional persons having no federal income tax liability and other taxpayers (those without a Schedule C or F business, in particular) having a simplified return. Wages continued to rise through 2018, increasing over three percent during the third quarter of 2018. This all bodes well for the ability of more people to buy food products and, in turn, increase demand for agricultural crop and livestock products. That’s good news to U.S. agriculture after another difficult year for many commodity prices.
On the worldwide front, China made trade concessions and pledged to eliminate its “Made in China 2025” program that was intended to put China in a position of dominating world economic production. The North-Korea/South Korea relationship also appears to be improving, and during 2018 the U.S. became a net exporter of oil for the first time since WWII. While trade issues with China remain, they did appear to improve as 2018 progressed, and the USDA issued market facilitation payments (yes, they are taxed in the year of receipt and, no, they are not deferable as is crop insurance) to producers to provide relief from commodity price drops as a result of the tariff battle.
So, on an economic and policy front, 2019 appears to bode well for agriculture. But, looking back on 2018, of the many ag law and tax developments of 2018, which ones were important to the ag sector but just not quite of big enough significance nationally to make the “Top Ten”? The almost Top Ten – that’s the topic of today’s post.
The “Almost Top Ten” - No Particular Order
Syngenta litigation settles. Of importance to many corn farmers, during 2018 the class action litigation that had been filed a few years ago against Syngenta settled. The litigation generally related to Syngenta's commercialization of genetically-modified corn seed products known as Viptera and Duracade (containing the trait MIR 162) without approval of such corn by China, an export market. The farmer plaintiffs (corn producers), who did not use Syngenta's products, claimed that Syngenta's commercialization of its products caused the genetically-modified corn to be commingled throughout the corn supply in the United States; that China rejected imports of all corn from the United States because of the presence of MIR 162; that the rejection caused corn prices to drop in the United States; and that corn farmers were harmed by that market effect. In April of 2018, the Kansas federal judge handling the multi-district litigation preliminarily approved a nationwide settlement of claims for farmers, grain elevators and ethanol plants. The proposed settlement involved Syngenta paying $1.5 billion to the class. The class included, in addition to corn farmers selling corn between September of 2013 and April of 2018, grain elevators and ethanol plants that met certain definition requirements. Those not opting out of the class at that point are barred from filing any future claims against Syngenta arising from the presence of the MIR 162 trait in the corn supply. Parties opting out of the class can't receive any settlement proceeds, but can still file private actions against Syngenta. Parties remaining in the class had to file claim forms by October of 2018. The court approved the settlement in December of 2018, and payments to the class members could begin as early as April of 2019.
Checkoff programs. In 2018, legal challenges to ag “checkoff” programs continued. In 2017, a federal court in Montana enjoined the Montana Beef Checkoff. In that case, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, No. CV-16-41-GF-BMM, 2017 U.S. Dist. LEXIS 95861 (D. Mont. Jun. 21, 2017), the plaintiff claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was unconstitutional. The Beef Checkoff imposes a $1.00/head fee at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board. The plaintiff claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision was finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. On further review by the federal trial court, the court adopted the magistrate judge’s decision in full. The trial court determined that the plaintiff had standing on the basis that the plaintiff would have a viable First Amendment claim if the Montana Beef Council’s advertising involves private speech, and the plaintiff did not have the ability to influence the advertising of the Montana Beef Council. The trial court rejected the defendant’s motion to dismiss for failure to state a claim on the basis that the court could not conclude, as a matter of law, that the Montana Beef Council’s advertisements qualify as government speech. The trial court also determined that the plaintiff satisfied its burden to show that a preliminary injunction would be appropriate.
The USDA appealed the trial court’s decision, but the U.S. Court of Appeals for the Ninth Circuit affirmed the trial court in 2018. Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, 718 Fed. Appx. 541 (9th Cir. 2018). Later in 2018, as part of the 2018 Farm Bill debate, a provision was proposed that would have changed the structure of federal ag checkoff programs. It did not pass, but did receive forty percent favorable votes.
GIPSA rules withdrawn. In the fall of 2016, the USDA sent to the Office of Management and Budget (OMB) an interim final rule and two proposed regulations setting forth the agency’s interpretation of certain aspects of the Packers and Stockyards Act (PSA) involving the buying and selling of livestock and poultry. The proposals generated thousands of comments, with ag groups and producers split in their support. The proposals concern Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) which makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. The “effect” language of the statute would seem to eliminate any requirement that the producer show that the packer acted with the intent to control or manipulate prices. However, the federal courts have largely interpreted the provision to require a plaintiff to show an anti-competitive effect in order to have an actionable claim.
The interim final rule and the two proposed regulations stemmed from 2010. In that year, the Obama administration’s USDA issued proposed regulations providing guidance on the handling of antitrust-related issues under the PSA. 75 Fed. Reg. No. 119, 75 FR 35338 (Jun. 22, 2010). Under the proposed regulations, "likelihood of competitive injury" was defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.” It included, but was not limited to, situations in which a packer, swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers. It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace." According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace. The scope of PSA §202(a) and (b) was stated to depend on the nature and circumstances of the challenged conduct. The proposed regulations specifically noted that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases. The proposed regulations also specified that a PSA violation could occur without a finding of harm or likely harm to competition, contrary to numerous court opinions on the issue.
On April 11, 2017, the USDA announced that it was delaying the effective date of the interim final rule for 180 days, until October 19, 2017, with the due date for public comment set at June 12, 2017. However, on October 17, 2017, the USDA withdrew the interim rule. The withdrawal of the interim final rule and two proposed regulations was challenged in court. On December 21, 2018, the U.S. Court of Appeals for the Eighth Circuit denied review of the USDA decision. In Organization for Competitive Markets v. United States Department of Agriculture, No. 17-3723, 2018 U.S. App. LEXIS 36093 (8th Cir. Dec. 21, 2018), the court noted that the USDA had declined to withdraw the rule and regulations because the proposal would have generated protracted litigation, adopted vague and ambiguous terms, and potentially bar innovation and stimulate vertical integration in the livestock industry that would disincentivize market entrants. Those concerns, the court determined, were legitimate and substantive. The court also rejected the plaintiff’s argument that the court had to compel agency action. The matter, the court concluded, was not an extraordinary situation. Thus, the USDA did not unlawfully withhold action.
No ”clawback.” In a notice of proposed rulemaking, the U.S Treasury Department eliminated concerns about the imposition of an increase in federal estate tax for decedents dying in the future at a time when the unified credit applicable exclusion amount is lower than its present level and some (or all) of the higher exclusion amount had been previously used. The Treasury addressed four primary questions. On the question of whether pre-2018 gifts on which gift tax was paid will absorb some or all of the 2018-2025 increase in the applicable exclusion amount (and thereby decrease the amount of the credit available for offsetting gift taxes on 2018-2025 gifts), the Treasury indicated that it does not. As such, the Treasury indicated that no regulations were necessary to address the issue. Similarly, the Treasury said that pre-2018 gift taxes will not reduce the applicable exclusion amount for estates of decedents dying in years 2018-2025.
The Treasury also stated that federal gift tax on gifts made after 2025 will not be increased by inclusion in the tax computation a tax on gifts made between 2018 and 2015 that were sheltered from tax by the increased applicable exclusion amount under the TCJA. The Treasury concluded that this is the outcome under current law and needed no regulatory “fix.” As for gifts that are made between 2018-2025 that are sheltered by the applicable exclusion amount, the Treasury said that those amounts will not be subject to federal estate tax in estates of decedents dying in 2026 and later if the applicable exclusion amount is lower than the level it was at when the gifts were made. To accomplish this result, the Treasury will amend Treas. Reg. §20.2010-1 to allow for a basic exclusion amount at death that can be applied against the hypothetical gift tax portion of the estate tax computation that is equal to the higher of the otherwise applicable basic exclusion amount and the basic exclusion amount applied against prior gifts.
The Treasury stated that it had the authority to draft regulations governing these questions based on I.R.C. §2001(g)(2). The Treasury, in the Notice, did not address the generation-skipping tax exemption and its temporary increase under the TCJA through 2025 and whether there would be any adverse consequences from a possible small exemption post-2025. Written and electronic comments must be received by February 21, 2019. A public hearing on the proposed regulations is scheduled for March 13, 2019. IRS Notice of Proposed Rulemaking, REG-106706-18, 83 FR 59343 (Nov. 23, 2018).
These were significant developments in the ag law and tax arena in 2018, but just not quite big enough in terms of their impact sector-wide to make the “Top Ten” list. Wednesday’s post this week will examine the “bottom five” of the “Top Ten” developments for 2018.
December 31, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Thursday, October 18, 2018
For the Spring 2019 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of next spring’s online Ag Law course – that’s the topic of today’s post.
The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?
Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.
Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.
Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate. A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.
Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.
Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.
Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.
Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.
Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.
Further Information and How to Register
Information about the course is available here:
You can also find information about the text for the course at the following link (including the Table of Contents and the Index):
If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution. Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.
If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.
I hope to see you in January!
Checkout the postcard (401 KB PDF) containing more information about the course and instructor.
October 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
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.
Wednesday, July 18, 2018
Next month, Washburn Law School and Kansas State University (KSU) will team up for its annual symposium on agricultural law and the business of agriculture. The event will be held in Manhattan at the Kansas Farm Bureau headquarters. The symposium will be the first day of three days of continuing education on matters involving agricultural law and economics. The other two days will be the annual Risk and Profit Conference conducted by the KSU Department of Agricultural Economics. That event will be on the KSU campus in Manhattan. The three days provide an excellent opportunity for lawyers, CPAs, farmers and ranchers, agribusiness professionals and rural landowners to obtain continuing education on matters regarding agricultural law and economics.
This year’s symposium on August 15 will feature discussion and analysis of the new tax law, the Tax Cuts and Jobs Act, and its impact on individuals and businesses engaged in agriculture; farm and ranch financial distress legal issues and the procedures involved in resolving debtor/creditor disputes, including the use of mediation and Chapter 12 bankruptcy; farm policy issues at the state and federal level (including a discussion of the status of the 2018 Farm Bill); the leasing of water rights; an update on significant legal (and tax) developments in agricultural law (both federal and state); and an hour of ethics that will test participant’s negotiation skills.
The symposium can also be attended online. For a complete description of the sessions and how to register for either in-person or online attendance, click here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
Risk and Profit Conference
On August 16 and 17, the KSU Department of Agricultural Economics will conduct its annual Risk and Profit campus. The event will be held at the alumni center on the KSU campus, and will involve a day and a half of discussion of various topics related to the economics of the business of agriculture. One of the keynote speakers at the conference will be Ambassador Richard T. Crowder, an ag negotiator on a worldwide basis. The conference includes 22 breakout sessions on a wide range of topics, including two separate breakout sessions that I will be doing with Mark Dikeman of the KSU Farm Management Association on the new tax law. For a complete run down of the conference, click here: https://www.agmanager.info/risk-and-profit-conference
The two and one-half days of instruction is an opportunity is a great chance to gain insight into making your ag-related business more profitable from various aspects – legal, tax and economic. If you are a producer, agribusiness professional, or a professional in a service business (lawyer; tax professional; financial planner; or other related service business) you won’t want to miss these events in Manhattan. See you there, or online for Day 1.
July 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, February 14, 2018
Farmer and ranchers regularly engage in secured transactions. For instance, the typical farmer doesn’t have enough cash on hand to buy high-priced farm machinery and equipment outright. That means that the seller extends credit to finance the purchase or the farmer finds acceptable financing elsewhere to make the purchase. In either situation, the parties execute a security agreement evidenced by a financing statement that is then filed of public record. The filing allows other potential creditors to check if a lien already exists on the debtor’s property before extending credit.
The public filing means that the debtor must be identified. The proper identification of the debtor is key, and many creditors have learned the hard way that a slight slip up in properly identifying the debtor in the financing statement can change their secured interest to an unsecured one.
The property identification of the debtor in a financing statement, that’s the topic of today’s post.
Perfecting a Security Interest
Normally, a security interest in tangible property is perfected (made effective against other creditors) by filing a financing statement or by filing the security agreement as a financing statement. Indeed, filing a financing statement usually is the only practical way to perfect when the debtor is a farmer or rancher. An effective financing statement merely indicates that the creditor may have a security interest in the described collateral and is sufficient if it provides the name of the debtor, (UCC §9-502(a)(1)) gives the name and address of the secured party from which information concerning the security interest may be obtained, gives the mailing address of the debtor and contains a statement indicating the types or describing the items of collateral.
Note: An adequate description of the collateral is critical if there is to be attachment and perfection. UCC §9-108. This is an important point that can arise in an agricultural context with respect to real estate, livestock and equipment that can be used either directly or indirectly in agricultural production activities.
Name of the debtor. The name of the debtor is the key to the notice system and priority. The financing statement is indexed under the debtor’s name. If the debtor is a registered organization, only the name indicated on the public record of the debtor’s jurisdiction or organization is sufficient. For example, in In re EDM Corporation, 431 B.R. 459 (B.A.P. 8th Cir. 2010), a bank identified a corporate debtor on the financing statement as "EDM Corporation D/B/A EDM Equipment” and the court held that the identification was seriously misleading because a search conducted by using standard search logic did not reveal the bank's interest. The court also held that the addition of the debtor's trade name to its registered organization name violated Rev. UCC 9-503. But, federal tax liens appear not to be subject to the same exact match standard. The test is whether a reasonable searcher would find the lien notwithstanding the use of on abbreviation. See, e.g., In re Spearing Tool and Manufacturing Co., 412 F.3d 653 (6th Cir. 2005), rev’g, 302 B.R. 351 (E.D. Mich. 2003), cert. den.sub nom, ,Crestmark Bank v. United States, 127 S. Ct. 41 (2006). Under UCC § 9-506, a financing statement is effective even if it has minor errors or omissions unless the errors or omissions make the financing statement seriously misleading. A financing statement containing an incorrect debtor’s name is not seriously misleading if a search of the records of the filing office under the debtor’s correct legal name, using the filing office’s standard search logic, if any, discloses the financing statement filed under the incorrect name. However, some states have regulations defining the search logic to be used and may require that the debtor’s name be listed correctly. See, e.g., In re Kinderknecht, 308 B.R. 47 (Bankr. 10th Cir. 2004), rev’g, 300 B.R. 47 (Bankr. D. Kan. 2003); Pankratz Implement Co. v. Citizens National Bank, 130 P.3d 57 (Kan. 2006), aff’g, 33 Kan. App. 2d 279, 102 P.3d 1165 (2004); In re Borden, 353 B.R. 886 (Bankr. D. Neb. 2006), aff’d, No. 4:07CV3048, 2007 U.S. Dist. LEXIS 61883 (D. Neb. Aug. 20, 2007); Corona Fruits & Veggies, Inc. v. Frozsun Foods, 143 Cal. App. 4th 319, 48 Cal. Rptr. 3d 868 (2006).
Theissue of the property identification of the debtor came up again in a recent case. In In re Pierce, No. 17060154, 2018 Bankr. LEXIS 287 (Bankr. S.D. Ga. Feb. 1, 2018), a bank financed a debtor’s purchase of a manure spreader. The bank properly filed a financing statement listing the debtor’s name as “Kenneth Pierce.” At the time of the filing, the debtor’s driver’s license identified him as “Kenneth Ray Pierce, but the debtor would always sign his licenses as either “Kenneth Pierce” or as “Kenneth Ray Pierce.” Approximately two years after the bank filed, the debtor filed Chapter 12 bankruptcy. The bank filed a proof of claim in the amount of $14,459.81 and attached the financing statement. The debtor filed an objection claiming that because the bank failed to correctly identify him as “Kenneth Ray Pierce” on the financing statement, the bank’s security interest was unsecured along with its claim. After determining that the debtor had standing to use the trustee’s avoidance powers and bring an action under 11 U.S.C. §544, the court found the bank’s interest to be unsecured. The court noted that Georgia Code §11-9-503(a)(1)-(4) required an individual debtor’s name on a financing statement to match the debtor’s name on the debtor’s driver’s license. The court noted that such imprecise match was seriously misleading and that Georgia law required that debtor’s name on the financing statement match the typed name on the debtor’s driver’s license. The court also pointed out that had the bank followed the Georgia UCC-1 Financing Statement Form which instructs the use of the debtor’s exact full name, the debtor would have been identified the same as the typed name on the debtor’s driver’s license.
Properly identifying the debtor on a filed financing statement is critical to ensuring that a creditor has perfected its interest in the collateral. An exact match is required. Lenders must be careful.
Monday, October 9, 2017
The farm economy continues to struggle. Of course, certain parts of the country are experiencing more financial trauma than are other parts of the country, but recent years have been particularly difficult in the Corn Belt and Great Plains. Aggregate U.S. net farm income has dropped by approximately 50 percent from its peak in 2011. It is estimated to increase slightly in 2017, but it has a long way to go to get back to the 2011 level. In addition, the value of farmland relative to the value of the crops produced on it has fallen to its lowest point ever. A dollar of farm real estate has never produced less value in farm production, and real net farm income relative to farm real estate values have not been as low as presently since 1980 to 1983.
A deeper dive on farm financial data indicates that after multiple years of declining debt-to-asset ratios, there was an uptick in 2015 and 2016. Relatedly, default risk remains low, but it also increased in 2015 and 2016. Also, there has been a decline in the ratio of working capital to assets, and a drop in the repayment capacity of ag loans. As a financial fitness indicator, repayment capacity is a key. At the beginning of the farm debt crisis in the early 1980s, it dropped precipitously due to a substantial increase in interest payments and a decline in farm production. That meant that land values could no longer be supported, and they dropped substantially. Consequently, many farmers found themselves with collateral value that was lower than the amount borrowed. Repayment capacity is currently a serious issue that could lead to additional borrowing.
While financial conditions may improve a bit in 2017 and on into 2018, working capital may continue to erode in 2017 which could lead to increased debt levels. That’s because average net farm income will remain at low levels. This could lead to some agricultural producers and lenders having to make difficult decisions before next spring. It also places a premium on understanding clause language in lending document and the associated rights and obligations of the parties.
Two clauses deserve close attention. One clause contains “cross collateralization” language. “Cross-collateralization” is a term that describes a situation when the collateral for one loan is also used as collateral for another loan. For example, if a farmer takes out multiple loans with the same lender, the security for one loan can be used as cross-collateral for all the loans. A second clause contains a “co-lessee” provision. That’s a transaction involving joint and several obligations of multiple parties.
Today’s post takes a deeper look at the implications of cross-collateral and co-lessee language in lending documents. My co-author for today’s post is Joe Peiffer of Peiffer Law Office in Hiawatha, Iowa. Joe brought the issues with cross-collateralization and co-lessee clause language to my attention. Joe has many years of experience working with farmers in situations involving lending and bankruptcy, and has valuable insights.
As noted above, clause language in lending and leasing documents should be carefully reviewed and understood for their implications. This is particularly true with respect to cross-collateralization language. For example, the following is an example of such a clause that appears to be common in John Deere security agreements. Here is how the language of one particular clause reads:
“Security Interest; Missing Information. You grant us and our affiliates a security interest in the Equipment (and all proceeds thereof) to secure all of your obligations under this Contract and any other obligations which you may have to us or any of our affiliates or assignees at any time and you agree that any security interest you have granted or hereafter grant to us or any of our affiliates shall also secure your obligations under this Contract. You agree that we may act as agent for our affiliates and our affiliates may as agent for us, in order to perfect and realize on any security interest described above. Upon receipt of all amounts due and to become due under this Contract, we will release our security interest in the Equipment (but not the security interest for amounts due an affiliate), provided no event of default has occurred and is continuing. You agree to keep the Equipment free and clear of all liens and encumbrances, except those in favor of us and our affiliates as described above, and to promptly notify us if a lien or encumbrance is placed or threated against the Equipment. You irrevocably authorize us, at any time, to (a) insert or correct information on this Contract, including your correct legal name, serial numbers and Equipment descriptions; (b) submit notices and proofs of loss for any required insurance; (c) endorse your name on remittances for insurance and Equipment sale or lease proceeds; and (d) file a financing statement(s) which describes either the Equipment or all equipment currently or in the future financed by us. Notwithstanding any other election you may make, you agree that (1) we can access any information regarding the location, maintenance, operation and condition of the Equipment; (2) you irrevocably authorize anyone in possession of that information to provide all of that information to us upon our request; (3) you will not disable or otherwise interfere with any information gathering or transmission device within or attached to the Equipment; and (4) we may reactivate such device.”
So, what does that clause language mean? Several points can be made:
- The clause grants Deere Financial and its affiliates a security interest in the equipment pledged as collateral to secure the obligations owed to it as well as its affiliates.
- When all obligations (including debt on the equipment purchased under the contract and all other debts for the purchase of equipment that Deere Financial finances) to Deere under the contract are paid, Deere Financial will release its security interest in the equipment. That appears to be straightforward and unsurprising. However, the release does not release the security interest of the Deere’s affiliates. This is the cross-collateral provision.
- The clause also makes Deere Financial the agent of its affiliates, and it makes the affiliates the agent of Deere Financial for purposes of perfection. What the clause appears to mean is that if a financing statement was not filed timely, perfection by possession could be pursued.
- The clause also irrevocably authorizes John Deere to insert or correct information on the contract.
- The clause allows John Deere to access any information regarding the location, maintenance, operation and condition of the collateral.
- The clause also irrevocably authorizes anyone in possession of that information to provide it to John Deere upon request.
- Also, under the clause, the purchaser agrees not to disable or interfere with any information gathering or transmission device in or attached to the Equipment and authorizes John Deere to reactivate any device.
Example. Consider the following example of the effect of cross-collateralization by machinery sellers and financiers:
Equity by Item
JD 4710 Sprayer 90' Boom
JD 333E Compact Track Loader
JD 8410T Crawler Tractor
JD 612C 12 Row Corn Head
Equity with Cross Collateralization
Equity without Cross Collateralization
The equity in the equipment without cross-collateralization is the sum of the equity in the Compact Track Loader, the Crawler Tractor and the Row Corn Head.
Sellers that finance the purchase price of the item(s) sold (termed a “purchase money” lender) seem to be using cross-collateralization provisions with some degree of frequency. As noted, the cross-collateralization provisions of the John Deere security agreement will allow John Deere to offset its under-secured status on some machinery by using the equity in other financed machines to make up the unsecured portion of its claims. Other machinery financiers (such as CNH and AgDirect) are utilizing similar cross-collateral provisions in their security agreements.
Can A “Dragnet” Lien Defeat a Cross-Collateralization Provision?
Would a bank’s properly filed financing statement and perfected blanket security agreement be sufficient to defeat a cross-collateralization provision? It would seem inequitable to allow an equipment financier’s subsequently filed financing statement to defeat the security interest of a bank. So far, it appears that when a purchase money security interest holder has sought to enforce a cross-collateralization clause, the purchase money security interest holder has always backed down. For example, in one recent scenario, John Deere Financial sought to enforce its cross-collateralization agreement against a Bank in a situation similar to the one set forth above. The Bank properly countered that its blanket security interest in farm equipment perfected before any of the Deere Financial purchase money security interests were perfected defeated the Deere Financial cross-collateralization. Deere Financial backed down thereby allowing the Bank to have all the equity in the equipment, $80,000, be paid to the Bank by the auctioneer after the liquidation auction.
A “Co-Lessee” Clause
When a guarantee on a loan cannot be obtained, a proposal may be made for “joint and several obligations.” In that situation, the lessor tries to compel one lessee to cover another lessee’s obligations or joint obligations. It’s a lease-sublease structure, with the original lessee becoming the sublessor. While the original lessee/sublessor has no rights to use the equipment (those rights are passed to the sublessee), the original lessee/sublessor remains legally obligated for performance. The sublease can then be assigned as collateral to the original lessor.
While a co-borrower situation is not uncommon, a transaction involving co-lessees is different inasmuch as a lease involves the right to use and possess property along with the obligation to pay for the property. A loan document simply involves the repayment of debt. So, what if a co-lessee arrangement goes south and the lessor tries to compel one lessee to cover another lessee’s joint obligation? What is the outcome? That’s hard to say simply because there aren’t any litigated cases on the issue with published opinions. But, numerous legal (and (tax) issues would be involved. For instance, with a true lease (see an earlier post on the distinction between a true lease and a capital lease), what if the lessees argue over the use and possession of the equipment or the removal of liens or maintenance of the property or the rental or return of the property? What about the payment of taxes? Similar issues would arise in a lease/purchase situation that encounters problems. What is known is that in such a dispute numerous Uniform Commercial Code issues are likely to arise under both Article 2 and Article 9.
The following is an example of John Deere’s co-lessee clause when it has an additional party sign on a lease:
“By signing below, each of the co-lessees identified below (each, a “Co-Lessee”) acknowledges and agrees that (1) the Lessee indicated on the above referenced Master Lease Agreement (the “Master Agreement”) and EACH CO-LESSEE SHALL BE JOINTLY AND SEVERALLY LIABLE FOR ANY AND ALL OF THE OBLIGATIONS set forth in the Master Agreement and each Lease Schedule entered into from time to time thereunder including, but not limited to, the punctual payment of any periodic payments or any other amounts which may become due and payable under the terms of the Master Agreement, whether or not said Co-Lessee signs each Lease Schedule or receives a copy thereof, and (2) it has received a complete copy of the Master Agreement and understands the terms thereof.
In the event (a) any Co-Lessee fails to remit to the Lessor indicated above any Lease Payment or other payment when due, (b) any Co-Lessee breaches any other provision of the Master Agreement or any Lease Schedule and such default continues for 10 days; (c) any Co-Lessee removes any Equipment (as such term is more fully described in the applicable Lease Schedule) from the United States; (d) a petition is filed by or against any Co-Lessee or any guarantor under any bankruptcy or insolvency law; (e) a default occurs under any other agreement between any Co-Lessee (or any of Co-Lessee's affiliates) and Lessor (or any of Lessor's affiliates); (f) or any Co-Lessee or any guarantor merges with or consolidates into another entity, sells substantially all its assets, dissolves or terminates its existence, or (if an individual) dies; or (g) any Co-Lessee fails to maintain the Insurance required by Section 6 of the Master Agreement, Lessor may pursue any and all of the rights and remedies available to Lessor under the terms of the Master Agreement directly against any one or more of the Co-Lessees. Nothing contained in the Addendum shall require Lessor to first seek or exhaust any remedy against any one Co-Lessee prior to pursuing any remedy against any other Co-Lessee(s).
Capitalized terms not defined in this Addendum shall have the meaning provided to them in the Master Agreement.”
Clearly, a party signing on as a co-lessee on a John Deere lease is assuming a great deal of risk.
Times are tough for many involved in production agriculture. The same is true for many agribusiness and agricultural lenders. If a producer is presented with a lending transaction that involves either a cross-collateralization or a co-lessee clause, legal counsel with experience in such transactions should be consulted. Fully understanding the risks involved can pay big dividends. Failing to understand the terms of these clauses can lead to the financial failure of the farmer that signs the document.
Friday, September 1, 2017
When a farmer sells farm products such as crops and livestock in the normal course of the farming business, those products often are also serving as collateral for a lender’s security interest. So what are the rights of the buyer in that instance? Does the buyer take the goods subject to a pre-existing security interest created by the farmer-seller? That’s an important question for both farmer-sellers and buyers of farm products to know the answer to. Fortunately, there is a special rule that governs in such situations – the farm products rule.
The Farm Products Rule
Original rule. There is a long history behind the farm products rule. Prior to a change in the law that was contained in the 1985 Farm Bill, the majority rule was that a buyer in the ordinary course of business (BIOC) from a seller engaged in farming operations did not take free of a perfected security interest unless evidence existed of a course of past dealing between the secured party and the debtor from which it could be concluded that the secured party gave authority to the debtor to sell the collateral. UCC § 9-307(1). Thus, a farmer's sale of secured farm products did not cut off the creditor's right to follow farm products into the hands of buyers, such as grain elevators. This meant that when a farmer failed to settle with secured parties, buyers of farm products sometimes had to pay twice unless the buyer could show that the secured party gave the debtor authority to sell the collateral
Under the farm products rule, farm products were not considered “inventory” to a farmer. Instead, “farm products” were defined as crops, livestock (including, apparently, fowl) or supplies used or produced in farming operations and products of crops or livestock in their unmanufactured states if they were in the possession of a debtor engaged in the raising, fattening, or grazing of livestock or other farming operations. The holder of the perfected security interest could recover farm products subject to the interest from a bona fide purchaser purchasing watermelons from a roadside stand, steers in carload lots, or a load of corn, if the purchase was from a seller engaged in farming operations. However, crops, livestock, or the products of crops or livestock if in the possession of one not engaged in farming cease to be farm products and are inventory. Similarly, if farm products pass to one engaged in marketing for sale or a manufacturer or processor, they become inventory.
As can be surmised, the farm products rule was highly protective of secured parties. Purchasers of farm products had to be cautious in all transactions and were given strong incentive to always check the record for filed financing statements, and to have checks made payable jointly to the seller and the lender. However, creditors secured by farm products still needed to have a properly perfected security interest in the crops or livestock and include a specific provision in the security agreement specifying whether the debtor could sell the collateral. If sales were allowed, the lender needed to state clearly how payment was to be made, whether checks were to be sent directly to the lender, whether the debtor and lender were to be joint payees, or, whether a specified percentage of the proceeds was to be remitted directly to the lender. In any event, the provisions on sale and payment of proceeds had to be consistently enforced.
From the mid-1970s until the mid-1980s, several states amended the UCC farm products rule to allow, in various circumstances, purchasers of farm products from a person engaged in farming operations to take free of a perfected security interest. By the end of 1985, about 40% of the states had modified the general rule discussed above.
New rule. Effective December 23, 1986, the 1985 Farm Bill “federalized” the states' farm product rules. This gave the states two options - adopt a prescribed central filing system or follow an “actual notice” rule. Thus, under the federal rule, if a BIOC buys a farm product that has been “produced in a state” from a seller engaged in farming, the BIOC takes the farm product free of any security interest created by the seller unless:
- Within one year before the sale of the farm products, the buyer has received written notice of the security interest from the secured party (the direct notice exception);
- The buyer has failed to pay for the farm products; or
- In states which have established a central filing system (all states now have adopted central filing), the buyer has received notice from the Secretary of State of an effective filing of a financing statement (EFS) or notice of the security interest in the farm products and has not obtained a waiver or release of the security interest from the secured party (the central filing exception).
To comply with the direct notice exception, a secured creditor had to send the farm products purchaser a written notice listing (1) the secured creditor’s name and address; (2) the debtor’s name and address; (3) the debtor’s social security number or taxpayer identification number; (4) a description of the farm products covered by the security interest and a description of the property; and (5) any payment obligations conditioning the release of the security interest. The description of the farm products had to include the amount of the farm products subject to the security interest, the crop year, and the counties in which the farm products are located or produced.
Under central filing, the secured creditor must file a financing statement containing the same information as required in the written notice under the direct notice exception, except the secured creditor need not include crop year or payment obligation information. Also, notwithstanding errors contained in the financing statement, a financing statement in a central filing state remains effective so long as the errors “are not seriously misleading.” However, the general rule is that there is no “substantial compliance” rule with respect to the direct notice exception. A secured creditor must comply strictly with the requirements of the direct notice exception. See, e.g., State Bank of Cherry v. CGB Enterprises, Inc., 984 N.E.2d 449 (Ill. 2013), aff’g., 964 N.E.2d 604 (Ill. Ct. App. 2012). However, the Kansas Supreme Court has applied a substantial compliance rule to the direct notice exception. First National Bank & Trust v. Miami County Cooperative Assoc., 257 Kan. 989, 897 P.2d 144 (1995).
Key question. Under the farm products rule, a question arises as to whether a buyer in a direct notice state that buys farm products that were produced in a central filing state is subject to a filing in an EFS central notice state. 7 U.S.C. §1631 says the answer to that question is “yes” but does not define what “produced in” means. Is the phrase restricted in meaning only to production activities or does it also include marketing of the farm products? One court has held that “produced in” means “the location where farm products are furnished or made available for commerce.” The court believed that “such an interpretation allowed lenders to discern where they must file notice of their security interests and ensures a practical means for buyers to discover otherwise unknown security interests in farm products.” Great Plains National Bank v. Mount, 280 P.3d 670 (Colo. Ct. App. 2012).
2002 Farm Bill
The 2002 Farm Bill made several changes in the federal farm products rule. Under the legislation, a financing statement is effective if it is signed, authorized or otherwise authenticated by the debtor. A financing statement securing farm products needs to describe the farm products and specify each county or parish in which the farm products are produced or located. Also, the required information on the security agreement must include a description of the farm products subject to the security interest created by the debtor, including the amount of such products where applicable, crop year, and the name of each county or parish in which the farm products are produced or located.
Revised Article 9
Secured transactions under Article 9 of the Uniform Commercial Code (UCC) involve personal property and fixtures including loans on crops, livestock, inventories, consumer goods and accounts receivable. Effective in 2001, Article 9 was revised such that “farm products” means goods, other than standing timber, with respect to which the debtor is engaged in a farming operation and which are:
- Crops grown, growing or to be grown, including crops produced on trees, vines and bushes; and aquatic goods produced in aquacultural operations;
- Livestock, born or unborn, including aquatic goods produced in aquacultural operations;
- Supplies used or produced in a farming operation; or
- Products of crops or livestock in their unmanufactured states.
“Farming operation” means raising, cultivating, propagating, fattening, grazing or any other farming, livestock or acquacultural operation. As such, the revised definition of “farm products” eliminates the provision explicitly requiring the collateral to be in the possession of a person engaged in a farming operation.
In difficult financial times, understanding the rights of creditors of agricultural products is important. The specific rules surrounding the sale of farm products are important to understand.
Tuesday, August 22, 2017
On September 18, Washburn School of Law will be having its second annual CLE conference in conjunction with the Agricultural Economics Department at Kansas St. University. The conference, hosted by the Kansas Farm Bureau (KFB) in Manhattan, KS, will explore the legal, economic, tax and regulatory issue confronting agriculture. This year, the conference will also be simulcast over the web.
That’s my focus today – the September 18 conference in Manhattan, for practitioners, agribusiness professionals, agricultural producers, students and others.
Financial situation. Midwest agriculture has faced another difficult year financially. After greetings by Kansas Farm Bureau General Counsel Terry Holdren, Dr. Allen Featherstone, the chair of the ag econ department at KSU will lead off the day with a thorough discussion on the farm financial situation. While his focus will largely be on Kansas, he will also take a look at nationwide trends. What are the numbers for 2017? Where is the sector headed for 2018?
Regulation and the environment. Ryan Flickner, Senior Director, Advocacy Division, at the KFB will then follow up with a discussion on Kansas regulations and environmental laws of key importance to Kansas producers and agribusinesses.
Tax – part one. I will have a session on the tax and legal issues associated with the wildfire in southwest Kansas earlier this year – handling and reporting losses, government payments, gifts and related issues. I will also delve into the big problem in certain parts of Kansas this year with wheat streak mosaic and dicamba spray drift.
Weather. Mary Knapp, the state climatologist for Kansas, will provide her insights on how weather can be understood as an aid to manage on-farm risks. Mary’s discussions are always informative and interesting.
Crop Insurance. Dr. Art Barnaby, with KSU’s ag econ department, certainly one of the nation’s leading experts on crop insurance, will address the specific situations where crop insurance does not cover crop loss. Does that include losses caused by wheat streak mosaic? What about losses from dicamba drift?
Washburn’s Rural Law Program. Prof. Shawn Leisinger, the Executive Director of the Centers for Excellence at the law school (among his other titles) will tell attendees and viewers what the law school is doing (and planning to do) with respect to repopulating rural Kansas with well-trained lawyers to represent the families and businesses of agriculture. He will also explain the law school’s vision concerning agricultural law and the keen focus that the law school has on agricultural legal issues.
Succession Planning. Dr. Gregg Hadley with the KSU ag econ department will discuss the interpersonal issues associated with transitioning the farm business from one generation to the next. While the technical tax and legal issues are important, so are the personal family relationships and how the members of the family interact with each other.
Tax – part two. I will return with a second session on tax issues. This time my focus will be on hot-button issues at both the state and national level. What are the big tax issues for agriculture at the present time? There’s always a lot to talk about for this session.
Water. Prof. Burke Griggs, another member of our “ag law team” at the law school, will share his expertise on water law with a discussion on interstate water disputes, the role of government in managing scarce water supplies, and what the relationship is between the two. What are the implications for Kansas and beyond?
Producer panel. We will close out the day with a panel consisting of ag producers from across the state. They will discuss how they use tax and legal professionals as well as agribusiness professionals in the conduct of their day-to-day business transactions.
The Symposium is a collaborative effort of Washburn law, the ag econ department at KSU and the KFB. For lawyers, CPAs and other tax professionals, application has been sought for continuing education credit. The symposium promises to be a great day to interact with others involved in agriculture, build relationships and connections and learn a bit in the process.
We hope to see you either in-person or online. For more information on the symposium and how to register, check out the following link: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
August 22, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Monday, July 31, 2017
Today's post is a deviation from my normal posting on an aspect of agricultural law and tax that you can use in your practice or business. That’s because I have a new book that is now available that you might find useful as a handbook or desk reference. Thanks to West Academic Publishing, my new book “Agricultural Law in a Nutshell,” is now available. Today’s post promotes the new book and provides you with the link to get more information on how to obtain you copy.
The Nutshell is taken from my larger textbook/casebook on agricultural law that is used in classrooms across the country. Ten of those 15 chapters are contained in the Nutshell, including some of the most requested chapters from my larger book – contracts, civil liabilities and real property. Also included are chapters on environmental law, water law and cooperatives. Bankruptcy, secured transactions, and regulatory law round out the content, along with an introductory chapter. Not included in this Nutshell are the income tax, as well as the estate and business planning topics. Those remain in my larger book, and are updated twice annually along with the other chapters found there.
The Nutshell is designed as a concise summary of the most important issues facing agricultural producers, agribusinesses and their professional advisors. Farmers, ranchers, agribusinesses, legal advisors and students will find it helpful. It’s soft cover and easy to carry.
Rural Law Program
The Nutshell is another aspect of Washburn Law School’s Rural Law Program. This summer, the Program placed numerous students as interns with law firms in western Kansas. The feedback has been tremendous and some lawyers have already requested to be on the list to get a student for next summer. Students at Washburn Law can take numerous classes dealing with agricultural issues. We are also looking forward to our upcoming Symposium with Kansas State University examining the business of agriculture and the legal and economic issues that are the major ones at this time. That conference is set for Sept. 18, and a future post will address the aspects of that upcoming event.
You can find out more information about the Nutshell by clicking here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/agriculturallawnutshell/index.html
Thursday, July 27, 2017
Low commodity prices over the past couple of years for many commodities, particularly in the Midwest and the Great Plains, have resulted in financial stress for many farmers. For example, 2015 farm income in Kansas was the lowest since 1985. Prices have dropped and are volatile and subject to economic conditions around the world. In addition, the cost of production has continued to rise. All of this have an impact on a farmer’s ability to repay debt. That repayment capacity has dropped dramatically over the past two-three years. All of this makes marketing important as well as the proper utilization of crop revenue insurance. Ultimately, continued low prices will also have an impact on land values and, in some areas, that impact is already being noticed.
An associated concern is the strain placed on grain elevators. If an elevator fails, what’s the impact on farmers that have deposited grain and on the agricultural community? What are the rights that a farmer has when an elevator fails? How much can be recovered, and when can it be recovered? Are there any legal remedies? These issues are the focus of today’s post.
A farmer that has stored grain at an elevator that files bankruptcy is not a creditor of the elevator. That’s because the grain in storage is the farmer’s property. The farmer’s ownership of the grain is evidenced by a warehouse receipt or a scale ticket. Both of those serve as prima facie evidence of the farmer’s ownership of the stored grain. So, the farmer’s relationship with the elevator is not a creditor/debtor relationship, but a bailee/bailor one. Uniform Commercial Code (U.C.C.) §7-102(a)(1). In addition, that relationship is not impacted just because the elevator will return to the farmer grain of like quality rather than the identical grain that the farmer delivered to the elevator. See 54 A.L.R. 1166 (1928).
Under the UCC, commingled grain that is stored in an elevator is owned in common by the persons storing the grain. U.C.C. §7-207(b); see also, United States v. Luther, 225 F.2d 499 (10th Cir. 1955), cert. den., 350 U.S. 947 (1956); In re Bucyrus Grain, Co., Inc., 78 B.R. 296 (Bankr. D. Kan. 1987). So, if there isn’t a grain shortage when an elevator fails, a farmer with grain stored at the elevator can get his grain in accordance with his warehouse receipt or scale ticket. The bankruptcy trustee can’t retain farmer-stored grain in the bankruptcy estate if there isn’t a shortage. The trustee only succeeds to the rights the that bankrupt elevator had and, as noted above, stored grain is not the elevator’s property. Under the Bankruptcy Code, the bankruptcy trustee, after notice and hearing, can dispose of property which an entity other than the bankruptcy estate has an interest in. 11 U.S.C. §725. This all means that once a farmer establishes ownership to the grain and pays the associated storage costs, the farmer is entitled to his grain.
But, what if there isn’t enough grain in the elevator to cover all of the claims of farmers that have warehouse receipts or scale tickets. If that is the case at the time the elevator files bankruptcy, the farmers holding those indicia of ownership share pro rata in the remaining grain. In this situation, what typically happens is that the bankruptcy trustee will sell all of the grain that is in storage and make a pro rata distribution of the proceeds of sale along with any bond money that the elevator’s bonding company might have. If, after the pro rata distribution, a famer has not been made whole, the famer becomes a general, unsecured creditor of the elevator to the extent of the shortfall.
Farmer Priority in Bankruptcy
In the shortfall situation, there is a bit of relief that the Bankruptcy Code provides. Under 11 U.S.C. §507(a)(6), an unsecured claim of a farmer (grain producer) in an amount of up to $6,325 against a grain storage facility (e.g., grain elevator) has priority. The priority is a sixth priority claim. It’s after domestic support obligations, administrative expenses, certain types of other specified unsecured claims, “allowed” unsecured claims, and unsecured claims for contributions to an employee benefit plan, but before certain unsecured claims of individuals and governmental units. For purposes of the priority provision, a “grain producer” is someone (“an entity”) that engages in the growing of wheat, corn flaxseed, grain sorghum, barley, oats, rye, soybeans, other dry edible beans, and rice. 11 U.S.C. §557(b)(1). “Grain storage facility” means a site or physical structure used to store grain for producers or to store grain acquired from producers for resale. 11 U.S.C. §557(b)(2).
While the $6,325 provision is likely to be of limited assistance, the Bankruptcy Court for the District of Kansas, affirmed by the Kansas Federal District Court, has held that the priority provision also gives priority status ahead of secured creditors with respect to grain owned by farmers that the elevator stores. In re Esbon Grain Co., 55 B.R. 308 (Bankr. D. Kan. 1985), aff’d., First National Bank v. Nugent, 72 B.R. 528 (D. Kan. 1987). That means that the financier of the elevator cannot participate in the pro rata distribution of the elevator’s remaining grain to the farmers that stored grain in the elevator at the time the elevator filed bankruptcy. The court reached its decision based on a Kansas statutory provision that gives grain depositors priority over a warehouse owner and the owner’s creditors in the grain stored in the elevator. Kan. Stat. Ann. §34-2,107. A different court in a different state could reach a different conclusion.
There is also another bankruptcy priority provision that can aid a farmer with grain stored in an elevator that fails. 11 U.S.C. §503(b)(9) includes as an administrative expense, entitled to first-tier priority, “the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.” If a farmer can qualify for this provision, it is much stronger that the sixth-priority claim under 11 U.S.C. §507(a)(6). That’s because it is an administrative expense under the definition of 11 U.S.C. §507(a)(1) which makes it a first-tier priority. It also is not subject to the limit of $6,325 noted above that applies to sixth-priority claims.
There is also an expedited procedure for determining ownership of the grain that is stored at an elevator at the time the elevator files bankruptcy. 11 U.S.C. §557(c).
Grain Sold on Contract
One of the perils of grain contracting is the financial instability of the buyer. For grain that has been sold on contract to an elevator that then files bankruptcy before the delivery date specified in the contract, the farmer-seller can refuse to deliver the grain if the elevator is insolvent. The only exception to that rule is if the elevator can make cash payment. U.C.C. §2-702. If delivery has already been made as specified in the contract (whether under a forward, deferred payment or deferred pricing contract) and then the elevator files bankruptcy, the farmer-seller is an unsecured creditor and also is ineligible to participate in state indemnity/insurance funds or elevator bonding protection. See e.g., Iowa Code §203D; In re Woods Farmers Co-op Elevator Co., 107 B.R. 678 (Bankr. N.D. 1989). While ownership of grain stored under a warehouse receipt or scale ticket remains with the farmer, delivery of grain that is sold under a contract causes title to the grain to pass to the elevator. As noted, that makes the outcome different.
As noted in my blogpost of July 19, co-op directors are subject to fiduciary duties of obedience, loyalty and care. If a breach of any of those duties can be tied to the elevator’s failure, that might provide a legal remedy for disaffected farmers. However, that could be a difficult connection to make, and take time and money to establish it.
Tough economic times can lead to numerous legal issues. The failure of a grain elevator can cause large problems for farmers and for the local community it serves. A farmer that knows their rights and where they stand if an elevator fails, can be in a better position than are those farmers that aren’t as well informed.
Thursday, July 13, 2017
The financial difficulties in agriculture have strained relationships between farmers and their creditors. Back in vogue are the Uniform Commercial Code (UCC) rules for the dispositions of collateral by a creditor when a debtor defaults. But, even when a creditor repossesses collateral and takes action to dispose of it, the debtor still has some rights. One of those rights involves the requirement that the disposition of the collateral be done in a reasonable manner
Commercially reasonable collateral sales – that’s the topic of today post.
Right and Duty to Dispose of Collateral
In General. Upon a debtor's default, a secured party can repossess the collateral and may sell (either by public or private sale), lease or otherwise dispose of the collateral either in its existing condition or following any commercially reasonable preparation or processing.
Two rules on timing of collateral sales apply:
- If the debtor has paid 60 percent of the cash price of a purchase money security interest (PMSI) in consumer goods, or 60 percent of the loan in the case of another security interest in consumer goods and has not signed, after default, a statement renouncing or modifying the debtor's right, a secured party who has taken possession of the collateral must dispose of the collateral within 90 days after possession or suffer liability to the debtor. A PMSI is involved in situations where the lender provides the financing.
- In all other situations, the secured creditor may, after repossessing the collateral, retain the collateral in full satisfaction of the debt unless the debtor objects within 21 days of receipt of notice of the creditor's intent to retain the collateral. If the creditor does retain the collateral, the security interest is discharged along with any liens that are subordinate to such interest. If the collateral is not worth the amount that is owed against it, the creditor is not entitled to the deficiency.
Commercial Reasonableness. If the creditor disposes of the collateral, every aspect of the secured party’s disposition of the collateral, including the method, manner, time, place and other terms must be commercially reasonable. If collateral is not disposed of in a commercially reasonably manner, the liability of a debtor or a secondary obligor for a deficiency may be limited. See, e.g., Ford Motor Credit Co. v. Henson, 34 S.W.3d 448 (Mo. Ct. App. 2001).
Unless the collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the creditor must give the debtor reasonable notification of the time and place of any public sale, private sale or other intended disposition of the collateral unless the debtor, after default, has signed a waiver of notification of sale. For example, in In re Krug, 189 B.R. 948 (Bankr. D. Kan. 1995), the creditor repossessed registered shorthorn cattle without giving the debtor notice, and placed them under care of other ranchers while seeking foreclosure. The court held that repossession was proper because the security agreement allowed lack of notice; the creditor gave the debtor time to cure the default and did not intend to harm the debtor; however, debtor allowed an offset for damage to the cattle and calves against the creditor's claim because the caretakers failed to properly feed the cattle and bred them improperly.
When Article 9 of the UCC was revised, those revisions did not change existing law with respect to the statutory language for the recognized market exception. See Revised UCC § 9-611(b)-(d). Local livestock auctions cannot qualify for the recognized market exception to the notification requirement because livestock sold at auction are not tangible items and bidders by bidding are individually negotiating the price for the particular livestock in the ring.
If the repossessed collateral fails to bring enough at sale to cover the creditor’s claim, the creditor may bring a legal action against the debtor for the amount of the deficiency. But, again, to recover the deficiency, the sale of the collateral must have been made in a commercially reasonable manner. For instance, in Dallas County Implement, Inc. v. Harding, 439 N.W.2d 220 (Iowa 1989), the sale of repossessed collateral was held to not be reasonable where collateral the collateral (farm equipment) was sold at a private sale without notice to the debtor. As a result, the creditor was not entitled to a deficiency judgment. However, some courts hold that failure to send notice to the debtor may not invalidate a sale of repossessed property if the collateral is sold at a recognized market or for fair market value. See, e.g., First National Bank v. Ruttle, 108 N.M. 657, 778 P.2d 434 (1989). Proof that a greater amount could have been obtained for the collateral by its disposition at a different time or in a different method is not alone sufficient to preclude the secured party from establishing that the disposition was commercially reasonable. But, a low sales price suggests the court should scrutinize carefully all the aspects of the disposition to insure each aspect was commercially reasonable.
Ultimately, the issue of whether the disposition of collateral was commercially reasonable is one of fact. Courts consider a number of factors to evaluate whether collateral was disposed of in a commercially reasonable manner. These factors include whether the secured party tried to obtain the best price possible, whether the sale was private or public, the condition of the collateral and any efforts made to enhance its condition, the advertising undertaken, the number of bids received and the method used in soliciting bids.
The secured party may buy repossessed collateral at a public sale and may also buy the collateral at a private sale if the goods are of a type customarily sold in a recognized market or of a type which is the subject of widely distributed standard price quotations.
Revised Article 9
As noted above, a few years ago the UCC was revised. Under the Revisions to Article 9, in non-consumer deficiency cases, the secured party need not prove compliance with the default provisions unless compliance is placed in issue. If compliance is placed in issue, the secured party has the burden to show compliance. If the creditor cannot prove compliance, the rule is that the failure will reduce the secured party’s deficiency to the extent that the failure to comply affected the price received for the goods at the foreclosure sale. Under the revisions, the value of the collateral is deemed to equal the unpaid debt and the noncomplying creditor is not entitled to a deficiency, unless the creditor seeking a deficiency proves by independent evidence that the price produced at sale was reasonable. Thus, the creditor must prove what the collateral would have been sold for at a commercially reasonable sale and that this amount is less than the unpaid debt.
While Revised Article 9 does not define “commercially reasonable,” UCC §9-611(c) provides that in a commercial transaction notice must be given to debtors, secondary obligors, any person who has given the foreclosing creditor notice of a claim, and any other secured party that holds a perfected security interest in the collateral. When consumer goods are involved, notice need only be given to debtors and secondary obligors.
Times of financial distress always strain relationships between debtors and creditors. That’s a tough situation in agricultural settings because of the typical close relationship that many farmers and ranchers have with their lenders. But, the law establishes many rules that must be followed in financial transactions – including rules that govern how collateral dispositions are handled. The rule of “commercial reasonableness” is one of those rules.
Tuesday, January 24, 2017
The present economic conditions in agriculture are reminiscent of the 1980s. For those of you that attended the agribusiness symposium last September put on by Washburn University School of Law and Kansas State University, you saw the close parallels. One of the legislative attempts to assist farm producers during that time involved the creation of an agricultural supply dealer’s lien in those states that were experiencing an extraordinarily high number of agricultural bankruptcies.
For those farmers and ranchers, it was likely that all of their property was claimed subject to perfected security interests under Article 9 of the Uniform Commercial Code, leaving the supply dealer as an unsecured creditor with large unpaid bills. Thus, the theory behind an ag supply dealer lien is that parties who supply necessary inputs such as seed, feed, fertilizer, chemicals and petroleum products should have a method whereby they are assured of payment for the inputs supplied to agricultural producers.
Various Statutory Approaches; Various Issues
Agricultural supply dealer lien statutes are rather complex, but most follow a common procedure. One common type gives an ag commodity dealer that sells an ag product a lien on the ag product or its sale proceeds. But what if the input subject to the lien is feed that is consumed by livestock that are collateral for another lender’s security interest? The Idaho statute, for example, specifies that the lien only extends to an “agricultural product” or the “proceeds of the sale of the agricultural product.” As a result, one court has held that the lien was extinguished when it was consumed as feed by the livestock because “livestock” were not included in the statutory definition of “agricultural products.” Farmers National Bank v. Green River Dairy, LLC, 318 P.3d 622, 155 Idaho 853 (2014). But, another court, construing a different state statute has held that the ag supply dealer lien applied to the full amount of feed supplied and fully attached to the animals consuming it. In re Schley, No. 10-03252, 2017 Bankr. LEXIS 115 (Bankr. N.D. Iowa Jan. 13, 2017).
For crop input suppliers, when a farmer or rancher attempts to purchase supplies on credit or on open account, the supplier can obtain a lien on the crops produced with those inputs. But, there is typically a process the supplier must go through. For instance, under the Iowa statute (a statute that has been litigated frequently), the supplier must discover what other parties, if any, have a security interest in the purchaser's crops or livestock. Iowa Code §570A. The supplier is required to contact these creditors and inquire about the purchaser's financial abilities. This puts the creditors on notice that the supplier may be attempting to take a statutory lien. The creditors can either agree to finance the purchase or send the supply dealer the buyer's financial records. If the creditors refuse to extend credit, the supply dealer can make the sale and obtain a lien by filing in the appropriate office, usually the Secretary of State's office. The lien is effective at the time of the purchase and is “perfected” by the filing of a financing statement within 31 days of the purchase. The lien applies to crops related to the purchased supply or livestock consuming the feed sold to the farmer by the dealer. The amount of the lien is the amount owed to the dealer for the “retail cost of the agricultural supply, including labor.” Courts have determined that the lien is perfected for the amount of supplies that the debtor buys from the supplier within 31 days before the supplier files the financing statement. See, e.g., In re Shulista, 451 B.R. 867 (Bankr. N.D. Iowa 2011); In re Big Sky Farms, Inc., No. 12-01711, 2014 Bankr. LEXIS 1725 (Bankr. N.D. Iowa Apr. 18, 2014). The lien also extends to the proceeds of the input(s) supplied. In re Schley, 509 B.R. 901 (Bankr. N.D. Iowa 2014). The perfected lien does not continue nor does it cover future advances. If additional supplies are sold to a debtor after the initial 31-day period, another financing statement must be filed within 31 days of sale to perfect the lien for those additional supplies that are provided.
The Iowa ag supply dealer’s lien has been held to beat out a bank’s prior perfected security interest in hogs even though the supply dealer had not provided the statutory certified notice to the creditor (bank) before selling feed to the debtor on credit. In Oyens Feed Supply, Inc. v. Primebank, 808 N.W.2d 186 (Iowa 2011), the court reasoned that the state ag supply dealer lien statute did not provide for the certified notice affirmative defense in the context of a lien in livestock feed dealers. The court was persuaded by the feed dealer’s argument that requiring a feed dealer to comply with the certification requirement would result in a “windfall” for the prior perfected lender who would benefit from the increase in the collateral value (livestock) provided for by the feed supplier. Such “superpriority” status, however, only applies to the extent the acquisition value of the livestock is exceeded by the livestock’s value at the time the lien attaches or its ultimate sale price. The secured lender still has priority up to the livestock’s acquisition price.
Most state statutes provide that an agricultural supply dealer lien is superior to subsequently filed Article 9 security interests, and of equal priority to Article 9 interests already in existence. However, Minn. Stat. § 514.952 (1994) provides that upon a supplier providing a lender a lien notification statement and the lender refuses in writing within 10 days to issue a letter of commitment, the rights of the lender and supplier are unaffected. The statute was at issue in Underwood Grain Co. v. Harthun, 563 N.W.2d 278 (Minn. Ct. App. 1997), where a lender with a prior perfected interest in cattle was determined to have priority over an agricultural production input lien upon refusal to issue a letter of commitment. Also, it’s important to understand whether a state ag lien statute applies to crops “produced” with the supplier's inputs. There might be a time limit specified in the statute. See, e.g, In re Schlote, 177 B.R. 315 (Bankr. D. Neb. 1995).
A question can arise concerning the total amount of inputs a supply dealer's lien secures. For instance, in Tracy State Bank v. Tracy-Garvin Cooperative, 573 N.W.2d 393 (Minn. Ct. App. 1998), a farmer borrowed money from a bank and granted the bank a security interest in the farmer's property. The bank perfected the interest. The farmer obtained feed on credit from a supplier and the supplier filed with the bank a notification of agricultural input lien, listing the lien amount at $65,000. The bank received the notification, but did not respond to it, thus giving the supplier a priority lien for $65,000 under Minnesota law. The supplier, however, actually provided the farmer with $73,748 in feed during the dates listed and the farmer paid on the account during that period such that the debt stood at $44,682 when the farmer liquidated the farm. The supplier argued that the lien protected a revolving line of credit of up to $65,000 regardless of the payments made by the farmer so that the entire $44,682 was covered by the lien. The bank argued that only $65,000 of the total amount supplied on credit, less the amounts paid by the farmer, was subject to the lien. The court held that, under Minnesota law, the notification stated the retail cost of the anticipated production inputs to be provided. Therefore, the notification statement's listing of $65,000 established the total limit on the inputs covered by the lien. The court also noted that if a supplier provides more than the notification amount, Minnesota law allows the notification to be amended to provide for priority for the additional amount. Because the plaintiff did not file an amended notification, the lien covered only $65,000 of the feed less the amounts the farmer actually paid on the debt.
Because statutory liens grant “super priority” status only to the extent that they are perfected, it is important that a party seeking to gain super priority status understand the particulars of the statutory lien and follow the requirements to perfect the lien as intended. It is also important to clearly understand the type of lien obtained because nuances exist amongst state statutory liens. For example, in First National Bank v. Profit Pork, LLC, et al., 820 N.W.2d 592 (Minn. Ct. App. 2012), a feed supplier was found to have a production-input lien rather than a superior feeder’s lien under a different statutory provision because the supplier also provided nutritional advice, feed and labor to produce custom-made feed for the debtor. As previously noted, the Iowa ag supply dealer’s lien statute is perfected only for the amount of supplies that are purchased from the supplier within 31 days before the supplier files the financing statement. The perfected lien does not continue, nor does it cover future advances. Thus, if additional supplies are sold to a debtor after the initial 31-day period, another financing statement must be filed within 31 days of the sale to perfect the lien for those additional supplies that are provided. In re Shulista, 451 B.R. 867 (Bankr. N.D. Iowa 2011). But, there is no limit on the amount that is purchased from the supplier, even if it is for future periods.
There remain some unanswered questions about ag supply dealer liens. For example, where must an ag supply dealer’s lien be filed? Is it to be filed in the state where feed is supplied, or in the state of incorporation of the owner of the livestock, if that is different? Clearly, the safest course of action would be to file in both states as it is relatively inexpensive to do so and avoids the necessity of litigation to determine whether the lien was properly filed. Also, what about a feedlot owner that provides feed to cattle in the feedlot? Can the feedlot owner file an ag supply dealer’s lien to secure the value of the feed supplied to the cattle? Some feedlot owners have filed these liens seeking to assert a lien prior to the lien of the bank. Will that work?
This is just one of the topics that will be discussed at next weeks’ farm financial distress seminar at Washburn law school. If you can’t attend in person, the seminar will be simulcast live over the web. If you work with farm/ranch clients that are dealing with a difficult economic situation, this seminar and the accompanying materials is what you need. Here’s registration information: http://washburnlaw.edu/employers/cle/farmersandranchers.html
Friday, January 6, 2017
Today we continue our look this week at the biggest developments in agricultural law and taxation during 2016. Out of all of the court rulings, IRS developments and regulatory issues, we are down to the top five developments in terms of their impact on ag producers, rural landowners and agribusinesses.
So, here are the top five (as I see them) in reverse order:
(5) Pasture Chiseling Activity Constituted Discharge of “Pollutant” That Violated the CWA. The plaintiff bought approximately 2,000 acres in northern California in 2012. Of that 2,000 acres, the plaintiff sold approximately 1,500 acres. The plaintiff retained an environmental consulting firm to provide a report and delineation map for the remaining acres and requested that appropriate buffers be mapped around all wetlands. The firm suggested that the plaintiff have the U.S. Army Corps of Engineers (COE) verify the delineations before conducting any grading activities. Before buying the 2,000 acres, the consulting firm had provided a delineation of the entire tract, noting that there were approximately 40 acres of pre-jurisdictional wetlands. The delineation on the remaining 450 acres of pasture after the sale noted the presence of intact vernal and seasonal swales on the property along with several intermittent and ephemeral drainages. A total of just over 16 acres of pre-jurisdictional waters of the United States were on the 450 acres – having the presence of hydric soils, hydrophytic vegetation and hydrology (1.07 acres of vernal pools; 4.02 acres of vernal swales; .82 acres of seasonal wetlands; 2.86 acres of seasonal swales and 7.40 acres of other waters of the United States). In preparation to plant wheat on the tract, the property was tilled at a depth of 4-6 inches to loosen the soil for plowing with care taken to avoid the areas delineated as wetlands. However, an officer with the (COE) drove past the tract and thought he saw ripping activity that required a permit. The COE sent a cease and desist letter and the plaintiff responded through legal counsel requesting documentation supporting the COE’s allegation and seeking clarification as to whether the COE’s letter was an enforcement action and pointing out that agricultural activities were exempted from the CWA permit requirement. The COE then provided a copy of a 1994 delineation and requested responses to numerous questions. The plaintiff did not respond. The COE then referred the matter to EPA for enforcement. The plaintiff sued the COE claiming a violation of his Fifth Amendment right to due process and his First Amendment right against retaliatory prosecution. The EPA refused the referral due to the pending lawsuit so the COE referred the matter to the U.S. Department of Justice (DOJ). The DOJ filed a counterclaim against the plaintiff for CWA violations.
The court granted the government’s motion on the due process claim because the cease and desist letter did not initiate any enforcement that triggered due process rights. The court also dismissed the plaintiff’s retaliatory prosecution claim. On the CWA claim brought by the defendant, the court determined that the plaintiff’s owner could be held liable as a responsible party. The court noted that the CWA is a strict liability statute and that the intent of the plaintiff’s owner was immaterial. The court then determined that the tillage of the soil causes it to be “redeposited” into delineated wetlands. The redeposit of soil, the court determined, constituted the discharge of a “pollutant” requiring a national pollution discharge elimination system (NPDES) permit. The court reached that conclusion because it found that the “waters” on the property were navigable waters under the CWA due to a hydrological connection to a creek that was a tributary of Sacramento River and also supported the federally listed vernal pool fairy shrimp and tadpole shrimp. Thus, a significant nexus with the Sacramento River was present. The court also determined that the farming equipment, a tractor with a ripper attachment constituted a point source pollutant under the CWA. The discharge was not exempt under the “established farming operation” exemption of 33 U.S.C. §1344(f)(1) because farming activities on the tract had not been established and ongoing, but had been grazed since 1988. Thus, the planting of wheat could not be considered a continuation of established and ongoing farming activities. Duarte Nursery, Inc. v. United States Army Corps of Engineers, No. 2:13-cv-02095-KJM-AC, 2016 U.S. Dist. LEXIS 76037 (E.D. Cal. Jun. 10, 2016).
(4) Prison Sentences Upheld For Egg Company Executives Even Though Government Conceded They Had No Knowledge of Salmonella Contamination. The defendant, an executive of a large-scale egg production company (trustee of the trust that owned the company), and his son (the Chief Operating Officer of the company) pled guilty as “responsible corporate officers” to misdemeanor violations of 21 U.S.C. §331(a) for introducing eggs that had been adulterated with salmonella into interstate commerce from the beginning of 2010 until approximately August of 2010. They each were fined $100,000 and sentenced to three months in prison. They appealed their sentences as unconstitutional on the basis that they had no knowledge that the eggs at issue were contaminated at the time they were shipped. They also claimed that their sentences violated Due Process and the Eighth Amendment insomuch as the sentences were not proportional to their “crimes.” They also claimed that incarceration for a misdemeanor offense would violate substantive due process.
The trial court determined that the poultry facilities were in poor condition, had not been appropriately cleaned, had the presence of rats and other rodents and frogs and, as a result, the defendant and his son either “knew or should have known” that additional salmonella testing was needed and that remedial and preventative measures were necessary to reduce the presence of salmonella. The appellate court agreed, finding that the evidence showed that the defendant and son were liable for negligently failing to prevent the salmonella outbreak and that 21 U.S.C. §331(a) did not have a knowledge requirement. The appellate court also did not find a due process violation. The defendant and son claimed that because they did not personally commit wrongful acts, and that due process is violated when prison terms are imposed for vicarious liability felonies where the sentence of imprisonment is only for misdemeanors. However, the court held that vicarious liability was not involved, and that 21 U.S.C. §331(a) holds a corporate officer accountable for failure to prevent or remedy “the conditions which gave rise to the charges against him.” Thus, the appellate court determined, the defendant and son were liable for negligently failing to prevent the salmonella outbreak. The court determined that the lack of criminal intent does not violate the Due Process Clause for a “public welfare offense” where the penalty is relatively small (the court believed it was), the defendant’s reputation was not “gravely” damaged (the court believed that it was not) and congressional intent supported the penalty (the court believed it did). The court also determined that there was no Eighth Amendment violation because “helpless” consumers of eggs were involved. The court also found no procedural or substantive due process violation with respect to the sentences because the court believed that the facts showed that the defendant and son “had reason to suspect contamination” and should have taken action to address the problem at that time (even though law didn’t require it).
The dissent pointed out that the government stipulated at trial that its investigation did not identify any corporate personnel (including the defendant and son) who had any knowledge that eggs sold during the relevant timeframe were contaminated with salmonella. The dissent also noted that the government conceded that there was no legal requirement for the defendant or corporation to comply with stricter regulations during the timeframe in issue. As such, the convictions imposed and related sentences were based on wholly nonculpable conduct and there was no legal precedent supporting imprisonment in such a situation. The dissent noted that the corporation “immediately, and at great expense, voluntarily recalled hundreds of millions of shell eggs produced” at its facilities when first alerted to the problem. As such, according to the dissent, due process was violated and the sentences were unconstitutional. United States v. Decoster, 828 F.3d 626 (8th Cir. 2016).
(3) The IRS and Self-Employment Tax. Two self-employment tax issues affecting farmers and ranchers have been in the forefront in recent years – the self-employment tax treatment of Conservation Reserve Program (CRP) payments and the self-employment tax implications of purchased livestock that had their purchase price deducted under the de minimis safe harbor of the capitalization and repair regulations. On the CRP issue, in 2014 the U.S. Court of Appeals ruled that CRP payments in the hands of a non-farmer are not subject to self-employment tax. The court, in Morehouse v. Comr., 769 F.3d 616 (8th Cir. 2014), rev’g, 140 T.C. 350 (2013), held the IRS to its historic position staked out in Rev. Rul. 60-32 that government payments attributable to idling farmland are not subject to self-employment tax when received by a person who is not a farmer. The court refused to give deference to an IRS announcement of proposed rulemaking involving the creation of a new Rev. Rul. that would obsolete the 1960 revenue ruling. The IRS never wrote the new rule, but continued to assert their new position on audit. The court essentially told the IRS to follow appropriate procedure and write a new rule reflecting their change of mind. In addition, the court determined that CRP payments are “rental payments” statutorily excluded from self-employment tax under I.R.C. §1402(a). Instead of following the court’s invitation to write a new rule, the IRS issued a non-acquiescence with the Eighth Circuit’s opinion. O.D. 2015-02, IRB 2015-41. IRS said that it would continue audits asserting their judicially rejected position, even inside the Eighth Circuit (AR, IA, MN, MO, NE, ND and SD).
In 2016, the IRS had the opportunity to show just how strong its opposition to the Morehouse decision is. A Nebraska non-farmer investor in real estate received a CP2000 Notice from the IRS, indicating CRP income had been omitted from their 2014 return. The CP2000 Notice assessed the income tax and SE Tax on the alleged omitted income. The CRP rental income was in fact included on the return, but it was included on Schedule E along with cash rents, where it was not subject to self-employment tax. The practitioner responded to the IRS Notice by explaining that the CRP rents were properly reported on Schedule E because the taxpayer was not a farmer. This put the matter squarely before the IRS to reject the taxpayer’s position based on the non-acquiescence. But, the IRS replied to the taxpayer’s response with a letter informing the taxpayer that the IRS inquiry was being closed with no change from the taxpayer’s initial position that reported the CRP rents for the non-farmer on Schedule E.
On the capitalization and repair issue, taxpayers can make a de minimis safe harbor election that allows amounts otherwise required to be capitalized to be claimed as an I.R.C. §162 ordinary and necessary business expense. This de minimis expensing election has a limit of $5,000 for taxpayers with an Applicable Financial Statement (AFS) and $2,500 for those without an AFS. Farmers will fall in the latter category. In both cases, the limit is applied either per the total on the invoice, or per item as substantiated by the invoice. One big issue for farmers and ranchers is how to report the income from the sale of purchased livestock that are held for productive use, such as breeding or dairy animals for which the de minimis safe harbor election was made allowing the full cost of the livestock to be deducted. It had been believed that because the repair regulations specify when the safe harbor is used, the sale amount is reported fully as ordinary income that is reported on Schedule F where it is subject to self-employment tax for a taxpayer who is sole proprietor farmer or a member of a farm partnership. In that event, the use of the safe harbor election would produce a worse tax result that would claiming I.R.C. §179 on the livestock.
An alternative interpretation of the repair regulations is that the self-employment tax treatment of the gain or loss on sale of assets for which the purchase price was deducted under the de minimis safe harbor is governed by Treas. Reg. §1.1402(a)-6(a). That regulation states that the sale of property is not subject to selfemployment tax unless at least one of two conditions are satisfied: (1) the property is stock in trade or other property of a kind which would properly be includible in inventory if on-hand at the close of the tax year; or (2) the property is held primarily for sale to customers in the ordinary course of a trade or business. Because purchased livestock held for dairy or breeding purposes do not satisfy the first condition, the question comes down to whether condition two is satisfied – are the livestock held primarily for sale to customers in the ordinary course of a trade or business? The answer to that question is highly fact-dependent. If the livestock whose purchase costs have been deducted under the de minimis rule are not held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business, the effect of the regulation is to report the gain on sale on Part II of Form 4797. This follows Treas. Reg. §1.1402(a)-6(a) which bars Sec. 1231 treatment (which would result in the sale being reported on Part I of Form 4797). In that event, the income received on sale would not be subject to self-employment tax.
In 2016, the IRS, in an unofficial communication, said that the alternative interpretation is the correct approach. However, the IRS was careful to point out that the alternative approach is based on the assumptions that the livestock were neither inventoriable nor held for sale, and that those assumptions are highly fact dependent on a case-by case basis. The IRS is considering adding clarifying language to the Farmers’ Tax Guide (IRS Pub. 225) and/or the Schedule F Instructions.
(2) TMDLs and the Regulation of Ag Runoff. Diffused surface runoff of agricultural fertilizer and other chemicals into water sources as well as irrigation return flows are classic examples of nonpoint source pollution that isn’t discharged from a particular, identifiable source. A primary source of nonpoint source pollution is agricultural runoff. As nonpoint source pollution, the Clean Water Act (CWA) leaves regulation of it up to the states rather than the federal government. The CWA sets-up a “states-first” approach to regulating water quality when it comes to nonpoint source pollution. Two key court opinions were issued in 2016 where the courts denied attempts by environmental groups to force the EPA to create additional federal regulations involving Total Maximum Daily Loads (TMDLs). The states are to establish total maximum daily TMDLs for watercourses that fail to meet water quality standards after the application of controls on point sources. A TMDL establishes the maximum amount of a pollutant that can be discharged or “loaded” into the water at issue from all combined sources on a daily basis and still permit that water to meet water quality standards. A TMDL must be set “at a level necessary to implement water quality standards.” The purpose of a TMDL is to limit the amount of pollutants in a watercourse on any particular date. Two federal court opinions in 2016 reaffirmed the principle that regulation of nonpoint source pollution is left to the states and not the federal government.
In Conservation Law Foundation v. United States Environmental Protection Agency, No. 15-165-ML, 2016 U.S. Dist. LEXIS 172117 (D. R.I. Dec. 13, 2016), the plaintiff claimed that the EPA’s approval of the state TMDL for a waterbody constituted a determination that particular stormwater discharges were contributing to the TMDL being exceeded and that federal permits were thus necessary. The court, however, determined that the EPA’s approval of the TMDL did not mean that EPA had concluded that stormwater discharges required permits. The court noted that there was nothing in the EPA’s approval of the TMDL indicating that the EPA had done its own fact finding or that EPA had independently determined that stormwater discharges contributed to a violation of state water quality standards. The regulations simply do not require an NPDES permit for stormwater discharges to waters of the United States for which a TMDL has been established. A permit is only required when, after a TMDL is established, the EPA makes a determination that further controls on stormwater are needed.
In the other case, Gulf Restoration Network v. Jackson, No. 12-677 Section: “A” (3), 2016 U.S. Dist. LEXIS 173459 (E.D. La. Dec. 15, 2016), numerous environmental groups sued the EPA to force them to impose limits on fertilizer runoff from farm fields. The groups claimed that many states hadn’t done enough to control nitrogen and phosphorous pollution from agricultural runoff, and that the EPA was required to mandate federal limits under the Administrative Procedure Act – in particular, 5 U.S.C. §553(e) via §303(c)(4) of the CWA. Initially, the groups told the EPA that they would sue if the EPA did not write the rules setting the limits as requested. The EPA essentially ignored the groups’ petition by declining to make a “necessity determination. The groups sued and the trial court determined that the EPA had to make the determination based on a 2007 U.S. Supreme Court decision involving the Clean Air Act (CAA). That decision was reversed on appeal on the basis that the EPA has discretion under §303(c)(4)(B) of the CWA to decide not to make a necessity determination as long as the EPA gave a “reasonable explanation” based on the statute why it chose not to make any determination. The appellate court noted that the CWA differed from the CAA on this point. On remand, the trial court noted upheld the EPA’s decision not to make a necessity determination. The court noted that the CWA gives the EPA “great discretion” when it comes to regulating nutrients, and that the Congressional policy was to leave regulation of diffused surface runoff up to the states. The court gave deference to the EPA’s “comprehensive strategy of bringing the states along without the use of federal rule making…”.
Also, in 2016 the U.S. Supreme Court declined to review a decision of the U.S. Court of Appeals for the Third Circuit which had determined in 2015 that the EPA had acted within its authority under 33 U.S.C. §1251(d) in developing a TMDL for the discharge of nonpoint sources pollutants into the Chesapeake Bay watershed. American Farm Bureau, et al. v. United States Environmental Protection Agency, et al., 792 F.3d 281 (3d Cir. 2015), cert. den., 136 S. Ct. 1246 (2016).
(1) The Election of Donald Trump as President and the Potential Impact on Agricultural and Tax Policy. Rural America voted overwhelmingly for President-elect Trump, and he will be the President largely because of the sea of red all across the country in the non-urban areas. So, what can farmers, ranchers and agribusinesses anticipate the big issues to be in the coming months and next few years and the policy responses? It’s probably reasonable to expect that same approach will be applied to regulations impacting agriculture. Those with minimal benefit and high cost could be eliminated or retooled such that they are cost effective. Overall, the pace of the generation of additional regulation will be slowed. Indeed, the President-elect has stated that for every new regulation, two existing regulations have to be eliminated.
Ag policy. As for trade, it is likely that trade agreements will be negotiated on a much more bi-lateral basis – the U.S. negotiating with one other country at a time rather than numerous countries. The President-elect is largely against government hand-outs and is big on economic efficiency. That bodes well for the oil and gas industry (and perhaps nuclear energy). But, what about less efficient forms of energy that are heavily reliant on taxpayer support? Numerous agricultural states are heavily into subsidized forms of energy with their state budgets littered with numerous tax “goodies” for “renewable” energy.” However, the President-elect won those states. So, does that mean that the federal subsidies for ethanol and biodiesel will continue. Probably. The Renewable Fuels Standard will be debated in 2017, but will anything significant happen? Doubtful. It will continue to be supported, but I expect it to be reviewed to make sure that it fits the market. Indeed, one of the reasons that bio-mass ethanol was reduced so dramatically in the EPA rules was that it couldn’t be produced in adequate supplies. What about the wind energy production tax credit? What about the various energy credits in the tax code? Time will tell, but agricultural interests should pay close attention.
The head of the Senate Ag Committee will be Sen. Roberts from Kansas. As chair, he will influence the tone of the debate of the next farm bill. I suspect that means that the farm bill will have provisions dealing with livestock disease and biosecurity issues. Also, I suspect that it will contain significant provisions crop insurance programs and reforms of existing programs. The House Ag Committee head will be Rep. Conaway from Texas. That could mean that cottonseed will become an eligible commodity for Agricultural Risk Coverage (ARC) and Price Loss Coverage (PLC). It may also be safe to assume that for the significant Midwest crops (and maybe some additional crops) their reference prices will go up. Also, it now looks as if the I.R.C. §179 issue involving the income limitation for qualification for farm program payments (i.e., the discrepancy of the treatment between S corporations and C corporations) will be straightened out. Other federal agencies that impact agriculture (EPA, Interior, FDA, Energy, OSHA) can be expected to be more friendly to agriculture in a Trump Administration.
Tax policy. As for income taxes, it looks at this time that the Alternative Minimum Tax might be eliminated, as will the net investment income tax that is contained in Obamacare. Individual tax rates will likely drop, and it might be possible that depreciable assets will be fully deductible in the year of their purchase. Also, it looks like the corporate tax rate will be cut as will the rate applicable to pass-through income. As for transfer taxes, President-elect Trump has proposed a full repeal of the federal estate tax as well as the federal gift tax. Perhaps repeal will be effective January 1, 2017, or perhaps it will be put off until the beginning of 2018. Or, it could be phased-in over a certain period of time. Also, while it appears at the present time that any repeal would be “permanent,” that’s not necessarily a certainty. Similarly, it’s not known whether the current basis “step-up” rule would be retained if the estate tax is repealed. That’s particularly a big issue for farmers and ranchers. It will probably come down to a cost analysis as to whether step-up basis is allowed. The President-elect has already proposed a capital gains tax at death applicable to transfers that exceed $10 million (with certain exemptions for farms and other family businesses). Repeal of gift tax along with repeal of estate tax has important planning implications. There are numerous scenarios that could play out. Stay tuned, and be ready to modify existing plans based on what happens. Any repeal bill would require 60 votes in the Senate to avoid a filibuster unless repeal is done as part of a reconciliation bill. Also, without being part of a reconciliation bill, any repeal of the federal estate tax would have to “sunset” in ten years.
January 6, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, January 4, 2017
This week we are looking at the biggest developments in agricultural law and taxation for 2016. On Monday, we highlighted the important developments that just missed being in the top ten. Today we take a look at developments 10 through six. On Friday, we will look at the top five.
- Court Obscures Rational Basis Test To Eliminate Ag Exemption From Workers' Compensation Law. While this is a state Supreme Court decision, its implications are significant. Most, if not all, states have a statutory exemption from workers’ compensation for employers that are engaged in agriculture. The statutory exemption varies in scope from state to state and, of course, an employer that is otherwise exempt can choose to be covered by the statute and offer workers’ compensation benefits to employees. In this case, the plaintiffs claimed that their on-the-job injuries should be covered under the state (NM) workers' compensation law. One plaintiff tripped while picking chile and fractured her left wrist. The other plaintiff was injured while working in a dairy when he was head-butted by a cow and pushed up against a metal door causing him to fall face-first into a concrete floor and sustain neurological damage. The plaintiffs' claims for workers' compensation benefits were dismissed via the exclusion from the workers' compensation system for employers. On appeal, the appellate court reversed. Using rational basis review (the standard most deferential to the constitutionality of the provision at issue), the court interpreted Sec. 52-1-6(A) of the New Mexico Code as applying to the primary job duties of the employees (as opposed to the business of the employer and the predominant type of employees hired), and concluded the distinction was irrational and lacked any rational purpose. The appellate court noted that the purpose of the law was to provide "quick and efficient delivery" of medical benefits to injured and disabled workers. Thus, the court determined that the exclusion violated the constitutional equal protection guarantee. The court further believed that the exclusion for workers that cultivate and harvest (pick) crops, but the inclusion of workers that perform tasks associated with the processing of crops was a distinction without a difference. The appellate court made no mention that the highest court in numerous other states had upheld a similar exclusion for agriculture from an equal protection constitutional challenge. On further review, the state Supreme Court affirmed. The Court determined that there was nothing to distinguish farm and ranch laborers from other ag employees and that the government interest of cost savings, administrative convenience and similar interests unique to agriculture were not rationally related to a legitimate government interest. The court determined that the exclusion that it construed as applying to ag laborers was arbitrary discrimination. A dissenting judge pointed out that the legislature’s decision to allow employers of farm and ranch laborers to decide for themselves whether to be subject to workers’ compensation or opt out and face tort liability did not violate any constitutionally-protected right. The dissent noted that such ability to opt out was a legitimate statutory scheme that rationally controlled costs for New Mexico farms and ranches, and that 29 percent of state farms and ranches had elected to be covered by workers’ compensation. The dissent also noted that the majority’s opinion would have a detrimental economic impact on small, economically fragile farms in New Mexico by imposing an additional economic cost of $10.5 million annually (as projected by the state Workers’ Compensation Administration). On this point, the dissent further pointed out that the average cost of a claim was $16,876 while the average net farm income for the same year studied was $19,373. The dissent further concluded that the exemption for farming operations was legitimately related to insulating New Mexico farm and ranches from additional costs. In addition, the dissent reasoned that the majority misapplied the rational basis analysis to hold the act unconstitutional as many other state courts and the U.S. Supreme Court had held comparable state statutes to satisfy the rational basis test. The dissent pointed out forcefully that the exclusion applied to employers and that the choice to be covered or not resided with employers who predominately hired ag employees. As such there was no disparate treatment between ag laborers and other agricultural workers. Rodriguez, et al. v. Brand West Dairy, et al., 378 P.3d 13 (N.M. Sup. Ct. 2016), aff’g., 356 P.3d 546 (N.M. Ct. App. 2015).
- 9. COE Jurisdictional Determination Subject to Court Review. The plaintiff, a peat moss mining company, sought the approval of the Corps of Engineers (COE) to harvest a swamp (wetland) for peat moss to use in landscaping projects. The COE issued a jurisdictional determination that the swamp was a wetland subject to the permit requirements of the Clean Water Act (CWA). The plaintiff sought to challenge the COE determination, but the trial court ruled for the COE, holding that the plaintiff had three options: (1) abandon the project; (2) seek a federal permit costing over $270,000; or (3) proceed with the project and risk fines of up to $75,000 daily and/or criminal sanctions including imprisonment. On appeal, the court unanimously reversed, strongly criticizing the trial court's opinion. Based on Sackett v. Environmental Protection Agency, 132 S. Ct. 1367 (2012), the court held that COE Jurisdictional Determinations constitute final agency actions that are immediately appealable in court. The court noted that to hold elsewise would allow the COE to effectively kill the project without any determination of whether it's position as to jurisdiction over the wetland at issue was correct in light of Rapanos v. United States, 547 U.S. 715 (U.S. 2006). The court noted that the COE had deliberately left vague the "definitions used to make jurisdictional determinations" so as to expand its regulatory reach. While the COE claimed that the jurisdictional determination was merely advisory and that the plaintiff had adequate ways to contest the determination, the court determined that such alternatives were cost prohibitive and futile. The court stated that the COE's assertion that the jurisdictional determination (and the trial court's opinion) was merely advisory ignored reality and had a powerful coercive effect. The court held that the Fifth Circuit, which reached the opposition conclusion with respect to a COE Jurisdictional Determination in Belle Co., LLC v. United States Army Corps. of Engineers, 761 F.3d 383 (5th Cir. 2014), cert. den., 83 U.S.L.W. 3291 (U.S. Mar. 23, 2015), misapplied the Supreme Court's decision in Sackett. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, 782 F.3d 984 (8th Cir. 2015), rev'g., 963 F. Supp. 2d 868 (D. Minn. 2013). In a later decision, the court denied a petition to rehear the case en banc and by the panel. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, No. 13-3067, 2015 U.S. App. LEXIS 11697 (8th Cir. Jul. 7, 2015). In December of 2015, the U.S. Supreme Court agreed to hear the case and affirmed the Eighth Circuit on May 31, 2016. The Court, in a unanimous opinion, noted that the memorandum of agreement between the EPA and the Corps established that jurisdictional determinations are “final actions” that represent the Government’s position, are binding on the Government in any subsequent Federal action or litigation involving the position taken in the jurisdictional determination. When the landowners received an “approved determination” that meant that the Government had determined that jurisdictional waters were present on the property due to a “nexus” with the Red River of the North, located 120 miles away. As such, the landowners had the right to appeal in Court after exhausting administrative remedies and the Government’s position take in the jurisdictional determination was judicially reviewable. Not only did the jurisdictional determination constitute final agency action under the Administrative Procedure Act, it also determined rights or obligations from which legal consequences would flow. That made the determination judicially reviewable. United States Army Corps of Engineers v. Hawkes Company, 136 S. Ct. 1807 (2016).
- 8. Proposed Regulations Under I.R.C. §2704. In early August, the IRS issued new I.R.C. §2704 regulations that could seriously impact the ability to generate minority interest discounts for the transfer of family-owned entities. Prop. Reg. – 163113-02 (Aug. 2, 2016). The proposed regulations, if adopted in their present form, will impose significant restrictions on the availability of valuation discounts for gift and estate tax purposes in a family-controlled environment. Prop. Treas. Regs. §§25.2704-1; 25.2704-4; REG- 163113-02 (Aug. 2, 2016). They also redefine via regulation and thereby overturn decades of court decisions honoring the well-established willing-buyer/willing-seller approach to determining fair market value (FMV) of entity interests at death or via gift of closely-held entities, including farms and ranches. The proposed regulations would have a significant impact on estate, business and succession planning in the agricultural context for many agricultural producers across the country and will make it more difficult for family farm and ranch businesses to survive when a family business partner dies. Specifically, the proposed regulations treat transfer within three years of death as death-bed transfers, create new “disregarded restrictions” and move entirely away from examining only those restrictions that are more restrictive than state law. As such, the proposed regulations appear to exceed the authority granted to the Treasury by Congress to promulgate regulations under I.R.C. §2704 and should be withdrawn. A hearing on the regulations was held in early December.
- 7. Capitalization Required For Interest and Real Property Taxes Associated with Crops Having More Than Two-Year Preproductive Period. The petitioner (three partnerships) bought land that they planned to use for growing almonds. They financed the purchase by borrowing money and paying interest on the debt. They then began planting almond trees. They deducted the interest and property taxes on their returns. The IRS objected to the deduction on the basis that the interest and taxes were indirect costs of the “production of real property” (i.e., the almonds trees that were growing on the land. The Tax Court agreed with the IRS noting that I.R.C. §263A requires the capitalization of certain costs and that those costs include the interest paid to buy the land and the property taxes paid on the land attributable to growing crops and plants where the preproductive period of the crop or plant exceeds two years. I.R.C. §263A(f)(1) states that “interest is capitalized where (1) the interest is paid during the production period and (2) the interest is allocable to real property that the taxpayer produced and that has a long useful life, an estimated production period exceeding two years, or an estimated production period exceeding one year and a cost exceeding $1 million.” The corresponding regulation, the court noted, requires that the interest be capitalized under the avoided cost method. The court also noted that the definition of “real property produced by the taxpayer for the taxpayer’s use in a trade or business or in an activity conducted for profit” included “land” and “unsevered natural products of the land” and that “unsevered natural products of the land” general includes growing crops and plants where the preproductive period of the crop or plant exceeds two years. Because almond trees have a preproductive period exceeding two years in accordance with IRS Notice 2000-45, and because the land was “necessarily intertwined” with the growing of the almond trees, the interest and tax cost of the land is a necessary and indispensable part of the growing of the almond trees and must be capitalized. Wasco Real Properties I, LLC, et al. v. Comr., T.C. Memo. 2016-224.
6. No Recapture of Prepaid Expenses Deducted in Prior Year When Surviving Spouse Claims Same Deduction in Later Year. The decedent, a materially participating Nebraska farmer, bought farm inputs in 2010 and deducted their cost on his 2010 Schedule F. He died in the spring of 2011 before using the inputs to put the spring 2011 crop in the ground. Upon his death, the inputs were included in the decedent’s estate at their purchase price value and then passed to a testamentary trust for the benefit of his wife. The surviving spouse took over the farming operation, and in the spring of 2011, took a distribution of the inputs from the trust to plant the 2011 crops. For 2011, two Schedule Fs were filed. A Schedule F was filed for the decedent to report the crop sales deferred to 2011, and a Schedule F was filed for the wife to report the crops sold by her in 2011 and claim the expenses of producing the crop which included the amount of the inputs (at their date-of-death value which equaled their purchase price) that had been previously deducted as prepaid inputs by the husband on the couple’s joint 2010 return. The IRS denied the deduction on the basis that the farming expense deduction by the surviving spouse was inconsistent with the deduction for prepaid inputs taken in the prior year by the decedent and, as a result, the “tax benefit rule” applied. The court disagreed, noting that the basis step-up rule of I.R.C. §1014 allowed the deduction by the surviving spouse which was not inconsistent with the deduction for the same inputs in her deceased husband’s separate farming business. The court also noted that inherited property is not recognized as income by the recipient, which meant that another requisite for application of the tax benefit rule did not apply. Estate of Backemeyer v. Comr., 147 T.C. No. 17 (2016).
Those were developments ten through six, at least as I see it for 2016. On Friday, we will list the five biggest developments for 2016.
January 4, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Monday, January 2, 2017
This week we will be taking a look at what I view as the most significant developments in agricultural law and agricultural taxation during 2016. There were many important happenings in the courts, the IRS and with administrative agencies that have an impact on farm and ranch operations, rural landowners and agribusinesses. What I am writing about this week are those developments that will have the biggest impact nationally. Certainly, there were significant state developments, but they typically will not have the national impact of those that result from federal courts, the IRS and federal agencies.
It’s tough to get it down to the ten biggest developments of the year, and I do spend considerable time going sorting through the cases and rulings get to the final cut. Today we take a quick look at those developments that I felt were close to the top ten, but didn’t quite make the list. Later this week we will look at those that I feel were worthy of the top ten. Again, the measuring stick is the impact that the development has on the ag sector as a whole.
Almost, But Not Quite
Those developments that were the last ones on the chopping block before the final “top ten” are always the most difficult to determine. But, as I see it, here they are (in no particular order):
- HRA Relief for Small Businesses. Late in 2016, the President signed into law H.R. 6, the 21st Century Cures Act. Section 18001 of the legislation repeals the restrictions included in Obamacare that hindered the ability of small businesses (including farming operations) to use health reimbursement arrangements (HRAs). The provision allows a "small employer" (defined as one with less than 50 full-time employees who does not offer a group health plan to any employees) to offer a health reimbursement arrangement (HRA) that the employer funds to reimburse employees for qualified medical expenses, including health insurance premiums. If various technical rules are satisfied, the basic effect of the provision is that, effective for plan years beginning after December 31, 2016, such HRAs will no longer be a violation of Obamacare's market "reforms" that would subject the employer to a penalty of $100/day per affected person). It appears that the relief also applies to any plan year beginning before 2017, but that is less clear. Of course, all of this becomes moot if Obamacare is repealed in its entirety in 2017.
- More Obamacare litigation. In a somewhat related development, in May the U.S. District Court for the District of Columbia ruled in United States House of Representatives v. Burwell, No. 14-1967 (RMC), 2016 U.S. Dist. LEXIS 62646 (D. D.C. May, 12, 2016), that the Obama Administration did not have the power under the Constitution to spend taxpayer dollars on "cost sharing reduction payments" to insurers without a congressional appropriation. The Obama Administration had argued that congressional approval was unnecessary because the funds were guaranteed by the same section of Obamacare that provides for the premium assistance tax credit that is designed to help offset the higher cost of health insurance as a result of the law. However, the court rejected that argument and enjoined the use of unappropriated funds due insurers under the law. The court ruled that the section at issue only appropriated funds for tax credits and that the insurer payments required a separate congressional appropriation. The court stayed its opinion pending appeal. A decision on appeal is expected in early 2017, but would, of course, be mooted by a repeal of Obamacare.
- Veterinary Feed Directive Rule. The Food and Drug Administration revised existing regulations involving the animal use of antibiotics that are also provided to humans. The new rules arose out of a belief of bacterial resistance in humans to antibiotics even though there is no scientific proof that antibiotic resistant bacterial infections in humans are related to antibiotic use in livestock. As a result, at the beginning of 2017, veterinarians will be required to provide a “directive” to livestock owners seeking to use or obtain animal feed products containing medically important antimicrobials as additives. A “directive” is the functional equivalent of receiving a veterinarian’s prescription to use antibiotics that are injected in animals. 21 C.F.R. Part 558.
- Final Drone Rules. The Federal Aviation Administration (FAA) issued a Final Rule on UASs (“drones”) on June 21, 2016. The Final Rule largely follows the Notice of Proposed Rulemaking issued in early 2015 (80 Fed. Reg. 9544 (Feb. 23, 2015)) and allows for greater commercial operation of drones in the National Airspace System. At its core, the Final Rule allows for increased routine commercial operation of drones which prior regulations required commercial users of drones to make application to the FAA for permission to use drones - applications the FAA would review on a case-by-case basis. The Final Rule (FAA-2015-0150 at 10 (2016)) adds Part 107 to Title 14 of the Code of Federal Regulations and applies to unmanned “aircraft” that weigh less than 55 pounds (that are not model aircraft and weigh more than 0.5 pounds). The Final Rule became effective on August 29, 2016.
- County Bans on GMO Crops Struck Down. A federal appellate court struck down county ordinances in Hawaii that banned the cultivation and testing of genetically modified (engineered) organisms. The court decisions note that either the state (HI) had regulated the matter sufficiently to remove the ability of counties to enact their own rules, or that federal law preempted the county rules. Shaka Movement v. County of Maui, 842 F.3d 688 (9th Cir. 2016) and Syngenta Seeds, Inc. v. County of Kauai, No. 14-16833, 2016 U.S. App. LEXIS 20689 (9th Cir. Nov. 18, 2016).
- Insecticide-Coated Seeds Exempt from EPA Regulation Under FIFRA. A federal court held that an existing exemption for registered pesticides applied to exempt insecticide-coated seeds from separate regulation under the Federal Insecticide, Rodenticide Act which would require their separate registration before usage. Anderson v. McCarthy, No. C16-00068, WHA, 2016 U.S. Dist. LEXIS 162124 (N.D. Cal. Nov. 21, 2016).
- Appellate Court to Decide Fate of EPA’s “Waters of the United States” Final Rule. The U.S. Court of Appeals for the Sixth Circuit ruled that it had jurisdiction to hear a challenge to the EPA’s final rule involving the scope and effect of the rule defining what waters the federal government can regulate under the Clean Water Act. Murray Energy Corp. v. United States Department of Defense, 817 F.3d 261 (6th Cir. 2016).
- California Proposition Involving Egg Production Safe From Challenge. California enacted legislation making it a crime to sell shelled eggs in the state (regardless of where they were produced) that came from a laying hen that was confined in a cage not allowing the hen to “lie down, stand up, fully extend its limbs, and turn around freely.” The law was challenged by other states as an unconstitutional violation of the Commerce Clause by “conditioning the flow of goods across its state lines on the method of their production” and as being preempted by the Federal Egg Products Inspection Act. The trial court determined that the plaintiffs lacked standing and the appellate court affirmed. Missouri v. Harris, 842 F.3d 658 (9th Cir. 2016).
- NRCS Properly Determined Wetland Status of Farmland. The Natural Resource Conservation Service (NRCS) determined that a 0.8-acre area of a farm field was a prairie pothole that was a wetland that could not be farmed without the plaintiffs losing farm program eligibility. The NRCS made its determination based on “color tone” differences in photographs, wetland signatures and a comparison site that was 40 miles away. The court upheld the NRCS determination as satisfying regulatory criteria for identifying a wetland and was not arbitrary, capricious or contrary to the law. Certiorari has been filed with the U.S. Supreme Court asking the court to clear up a conflict between the circuit courts of appeal on the level of deference to be given federal government agency interpretive manuals. Foster v. Vilsack, 820 F.3d 330 (8th Cir. 2016).
- Family Limited Partnerships (FLPs) and the “Business Purpose” Requirement. In 2016, there were two cases involving FLPs and the retained interest section of the Code. That follows one case late in 2015 which was the first one in over two years. In Estate of Holliday v. Comr., T.C. Memo. 2016-51, the court held that the transfers of marketable securities to an FLP two years before the transferor’s death was not a bona fide sale, with the result that the decedent (transferor) was held to have retained an interest under I.R.C. §2036(a) and the FLP interest was included in the estate at no discount. Transferring marketable securities to an FLP always seems to trigger issues with the IRS. In Estate of Beyer v. Comr., T.C. Memo. 2016-183, the court upheld the assessment of gift and estate tax (and gift tax penalties) with respect to transfers to an FLP because the court determined that every benefit allegedly springing from the FLP could have been accomplished by trusts and other arrangements. There needs to be a separate non-tax business purpose to the FLP structure. A deeper dive into the court opinions also points out that the application of the “business purpose” requirement with respect to I.R.C. §2036 is very subjective. It’s important to treat the FLP as a business entity, not put personal assets in the FLP, or at least pay rent for their use, and follow all formalities of state law.
These are the developments that were important, but just not big enough in terms of their overall impact on the ag sector to make the list of the “top ten.” The next post will take a look at developments ten through six.
January 2, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, August 3, 2016
A common arrangement between cattlemen and feedlots generated a court case recently involving the rights to the proceeds of the sale of the cattle. Under the facts of the case, a cattle feedlot financed the debtor’s purchase of cattle from a third party (cattle seller) through a lender. The debtor placed the cattle in the feedlot where the cattle would be feed and care for the cattle until selling them. The sale proceeds would then be first used to repay the feedlot for the amount financed, with the balance going to the debtor. After checking public records, the feedlot confirmed that the cattle were free and clear of liens and encumbrances and no records showed that the seller had any interest in the cattle. The feedlot loaned the debtor almost $600,000 for finance the purchase of the cattle. The promissory notes and security agreements that the parties executed were assigned to the lender, and the lender wired the funds directly to the debtor. Unfortunately, several of the debtor’s checks for the purchase of the cattle were not honored, resulting in the seller receiving only partial payment for the cattle. The debtor filed Chapter 11 bankruptcy, and the feedlot, cattle seller and lender battled over priority rights in the proceeds of the sale of the cattle. In a prior proceeding, the court found that the cattle seller had reclaimed the cattle for which he had not been paid via a replevin action that was unaffected by the debtor’s bankruptcy. The remaining cattle were eventually sold for a gross proceeds amount of $883,073.25. $215,119.87 of that amount was paid to the feedlot for its care and feeding of the cattle. The balance was placed in escrow pending the outcome of the litigation.
The feedlot claimed that it had superior rights to the proceeds of the cattle sale because the seller gave up possession to the feedlot and the feedlot was a purchaser in good faith in that title had been transferred to the buyer who then transferred it to the feedlot. The seller claimed it had prior rights because title to the cattle didn’t transfer to the feedlot, and because the feedlot’s interest in the cattle didn’t attach due to the feedlot not being a good faith purchaser because the feedlot should have first determined that it had a valid bill of sale showing that the debtor owned the cattle. The court agreed with the feedlot based on U.C.C. §2-401 which deals with title transfer and does not provide for a revesting of title in the seller when the buyer fails to pay for the goods. The court noted that the seller could have protected himself rather than simply relying on the buyer’s word. Accordingly, the feedlot was a good faith purchaser of the cattle that relied on the legal documents of ownership that were presented with the cattle. The court noted that cattlemen generally consider the bill of sale and brand inspection report (which the feedlot relied on) to be valid documentation of ownership.
So, industry custom played a key role in determining the priority rights to the sale proceeds of the cattle. Also, unfortunately, simply relying on another party's word often isn't good enough to protect your rights.
The case is In re Leonard, No. BK15-82016, 2016 Bankr. LEXIS 2681 (Bankr. D. Neb. Jul. 22, 2016).