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Home , Pledge (law), Security interest

Agricultural Business Management

FARM LEGAL SERIES June 2015 Interests in Personal Phillip L. Kunkel, Jeffrey A. Peterson, Jason Thibodeaux Attorneys, Gray Plant Mooty Commercial Code (UCC). Article 9 was INTRODUCTION significantly revised in 2001, and then again in 2010, and the substantive revisions have The best protection a lender can have against been adopted in every state and govern potential is to deal with borrowers virtually all such transactions. It has who have solid reputations and have simplified the use of as demonstrated their ability to repay . by providing for an almost uniform However, even when dealing with the most set of rules nationwide. It does not, however, reputable borrower, lenders typically require apply to transactions. This fact borrowers to property (or collateral) sheet only summarizes the in the State of to secure the . Collateral is real or Minnesota. personal property owned by the borrower that is pledged to the lender as security for the repayment of the debt obligation. In the PERSONAL PROPERTY AS COLLATERAL event of default, the lender may look to the As previously mentioned, Article 9 governs collateral to satisfy the debt. For further the use of personal property as collateral for discussion, see Financing the Farm a loan. Article 9 classifies certain types of Operation; and see also, , Notes and personal property. For our purposes, we will Guaranties. Lenders who do not require discuss tangible personal property (or borrowers to pledge collateral make a much “goods”), which would include machinery, riskier investment and become unsecured equipment, livestock (and unborn young of , as discussed in Right of Unsecured animals), and crops (grown, growing, or to be Creditors. grown). This fact sheet considers general concepts Types of Goods and identifies various problem areas that Generally, goods fall into one of four arise with the use of personal property, such categories: (1) consumer goods; (2) as livestock, machinery, equipment, and equipment; (3) farm products; or (4) crops, as security for a loan. For a discussion inventory. on the use of , such as land and buildings, as security for a loan see fact Consumer Goods are goods used or bought sheet: Mortgages and Contracts for Deed. for personal, family, or household purposes. Farm Products include crops grown, growing, GOVERNING LAW or to be grown, livestock, born or unborn, The law governing the legal rights of lenders supplies used or produced in a farming and borrowers who use personal property as operation, or products of crops or livestock collateral is contained in Article 9 of Uniform

in their manufactured state, if the is There are two general situations when a engaged in a farming operation. is created: Inventory includes goods that are leased by a 1. When a farmer needs to borrow person as lessor, held by a person for sale or money but cannot obtain the funds lease or to be furnished under a of unless some collateral is put up for service, furnished by a person under a the loan. Funds may be needed to contract of service, or consist of raw plant crops, acquire livestock, or materials, work in process, or material used obtain machinery. In this situation, or consumed in a business. the borrower may grant a lender a security interest in his personal Equipment is essentially any good that is not property in order to obtain the a consumer good, farm product, or inventory. necessary money. It is important to note that a good can only 2. When a farmer does not have fall into one category at a time although at sufficient funds to pay the full price times it may be a close call. For example, a of a desired purchase. In this farmer’s truck might be either a consumer situation, the seller may provide the good or equipment depending on its primary necessary financing and retain an use. In addition, the category a good falls interest in the property. Such a into may change over time. For example, security interest is referred to as a farm products, such a livestock or crops, may “purchase money security interest”. become inventory when they are no longer part of the farming operation. Security Agreements and Attachment Lenders can also take security interests in The benefit of obtaining a security interest in proceeds from a sale or trade of collateral, a piece of collateral is that the lender may property acquired by the debtor after the repossess the collateral and utilize other creation of the security interest and deposit preferential rights upon a default by the accounts such as a checking or savings borrower. However, in order for the security account. interest to be enforceable by the lender the security interest must be “attached” to the CREATION OF SECURITY INTERESTS collateral. A security interest attaches to the Under the UCC, a lender may acquire a collateral when it becomes enforceable “security interest” in collateral. A security against the debtor. interest is a property interest over specific Generally, the process of attachment includes assets that secures performance of an three requirements: obligation, typically the payment of a debt. 1. The lender must give value for the The security interest is typically created attachment to occur. though a document known as a and signed in conjunction with 2. The debtor must have rights in the the execution of a promissory note or collateral or possess the power to another loan document. For a discussion on transfer rights in the collateral to a promissory notes see fact sheet Contracts, secured party. If the debtor does not Notes and Guaranties. have complete ownership of the collateral listed, the lender will take

an interest in the amount that the secured property is to pay the farmer, such debtor owns. as requiring that the lender’s name appear on any checks issued in payment for such 3. The debtor must authenticate a property. security agreement that contains a description of the collateral (unless the collateral is in the possession of OF SECURITY INTERESTS the lender, then no authentication is In order for the lender’s security interest to required). The collateral may be be valid against third parties such as another described individually or by the lender with a claim against the borrower, the defined types of collateral discussed lender must take action to notify such parties above. The security agreement does of the lender's interest in the collateral. If the not need to contain a detailed collateral is in the possession of the lender, description of each item of collateral. no additional steps are required. This For example, it is not necessary to process of giving public notice of a security include the serial numbers of each interest is called “perfection”. piece of farm equipment or the legal description of the land growing the Financing Statement crops subject to the security interest. The usual method for perfecting a security Broad terms such as “all personal interest is by filing a financing statement property” or “all assets” are not (UCC-1) in the proper place. The financing sufficient but stating “all farm statement is a brief and relatively simple products” or “all crops to be grown” is document. It must (1) provide the name and sufficient. However, proper address of the borrower, (2) provide the descriptions of the property may name and address of the lender (“secured allow the farmer to limit the breadth party”), and (3) describe the collateral. It of the security interest to certain must also include the identification parcels of land or pieces of number of the borrower. With respect to the equipment. In addition, property name of the debtor, if the debtor is a acquired after the security agreement registered organization (e.g., a corporation, has been signed may be subject to the limited liability , etc.), only the name security interest if the agreement that appears on an organization’s most included terms such as “all present recently filed public record which purports to and future inventory.” state, amend or restate the name of the organization is deemed sufficient. If the Restrictions debtor is an individual and possess a state Besides the required terms, the security issued driver’s license or identification card, agreement generally will have additional the name must be as indicated on the driver’s terms that deal with the borrower's right to license or identification card. If the debtor is sell the collateral. Most farm security an individual but does not possess a state agreements provide restrictions on the issued driver’s license or an identification farmer's ability to sell the secured property. card, the debtor’s surname and first personal Some agreements may completely prohibit name is sufficient. The borrower’s signature any sales without the written consent of the is not required but he must authorize the lender. Others may allow such sales subject filing of the statement. Similar to the security to restrictions as to how the buyer of the

agreement, the description of the collateral already had made a loan on the same contained in a financing statement need not collateral. be exhaustive and need only to mention the types of collateral covered. Purchase Money Security Interest Despite the general rule stated above, the Filing priority of a perfected security interest in The financing statement must, in most after-acquired property can be overcome by a circumstances, be filed with the Secretary of purchase money security interest. A purchase State in the state where the debtor’s principle money security interest arises in a situation residence is located, likely the Minnesota when a party loans the debtor the money Secretary of State. This can be accomplished necessary to the purchase of goods, by filing with the Minnesota Secretary of and the same goods are used as collateral to State directly, online, or with one of the secure repayment of the loan. In order for a designated satellite offices of the Secretary of purchase money security interest to attach State. If the debtor is a corporation, limited the new lender must file a financing partnership, or limited liability company, the statement within 20 days from the time the financing statement must be filed in the state borrower takes possession of the goods. If where the debtor is registered. The filed this is done, the purchase money security financing statement is valid for five years interest will be given priority over the unless it is terminated. Within the five year original with an after-acquired period, a continuation statement must be property clause in his security agreement. A filed to extend the filing for another 5 years. typical example of such a purchase money For example, if an initial financing statement financing is the financing provided by the is filed on January 1, 2015, and a financing affiliates of farm machinery continuation statement is subsequently filed manufacturers. Often such financing is on December 1, 2019, the financing offered directly by agricultural equipment statement has a renewed lapse date of dealers. January 1, 2020. Special rules apply to lenders who anticipate obtaining a purchase money security interest PRIORITY OF SECURITY INTERESTS in livestock. These lenders must not only file In many cases, two or more creditors may a financing statement in order to trump an have security interests in the same collateral. earlier filed financing statement, but must This raises the question of who has the first provide written notice to the other creditors claim to the collateral. If one of the holding conflicting security interests stating competing creditors has failed to file a that new lender expects to acquire a financing statement, the holder of a purchase money security interest in the perfected security interest will prevail. When livestock. The notice must be received by the two or more creditors file a financing other creditors within six months before the statement covering the same collateral, the debtor receives possession of the livestock. general rule under the UCC is that the first to file prevails, regardless of who actually Statutory loaned money first. It makes no difference A second exception to the first to file rule is whether the party who filed first knew when provided for certain liens. If a person the money was advanced that another lender furnishes services for materials with respect to goods subject to a security interest and

receives a against the goods by law provided that a financing statement is filed (“possessory lien”), that lien will take priority by the custom harvester within 15 days after over a perfected security interest. A common the harvesting. example in the farm setting is the case of a farm machinery repair business. So long as Crop Production Input Lien the repaired equipment remains in the A crop production input lien grants a lien in possession of the repairman, he will retain a favor of a supplier of crop production inputs priority lien for storage charges, (chemicals, fertilizer, seeds, labor, fuel etc.) transportation, , labor, and other for the unpaid cost of the inputs. The charges necessary for protecting the lien attaches to the crops produced by the equipment. input and their products and proceeds. However, the supplier must notify any Agricultural Liens creditor who has filed a financing statement The UCC carves out state statutory prior to providing the crop production input. agricultural liens that secure payment or The creditor may either decide to extend performance of an obligation for goods or to the farmer (for the purchase of the services furnished or rent on real property inputs) or notify the input supplier of its leased by a farmer in connection with a unwillingness to extend additional credit. If farming operation. The perfection and the creditor fails to respond within 10 days priority of these liens are governed by the of the notice, the input supplier may assert a specific state lien statute; and not the UCC. first and priority lien in the crops by filing a These liens can be enforced when the farmer financing statement. fails to perform any obligation owed to the Similar liens are provided for veterinarians, lienholder. livestock breeders, livestock production Under Minnesota law, agricultural liens apply inputs and livestock feeders. to both crops and livestock. These liens are typically limited to those who supply goods or services in the ordinary course of At times, if a new creditor cannot obtain business. priority through a purchase money security interest or a statutory lien, they may require Landlord’s Lien a subordination agreement. A subordination A landlord’s lien is granted in favor of a agreement is a voluntary agreement in which landlord leasing real property for agricultural a creditor voluntary gives up its position of production a lien for unpaid rent on the priority for that of a new creditor. These crops produced and their products and agreements may be necessary for a new proceeds on the land provided that a creditor to extend financing to a farmer. financing statement is filed by the landlord within 30 days after the crops begin growing. SPECIAL PROBLEMS FOR FARMERS AND This lien takes priority over other secured THEIR LENDERS creditors. Farmers and lenders who take security Harvester’s Lien interests in farm products receive special treatment under the UCC. In addition, the A harvester’s lien is granted in favor of a very nature of a farming operation raises person who combines, picks, harvests, hauls, bales, dries, or stores crops for a farmer

special problems for agricultural lenders and lender may not have financed the planting their customers. and harvesting of such crops. It is not necessary for a farmer to sign a new security Farm Program Payments agreement or for the lender to file a new Farmers may participate in any number of financing statement for each crop year. farm programs. Many of them result in program payments to the farmer from the Products and Proceeds government. These rights to payment may be Besides covering property that may come a source of security for the agricultural into existence at a later date, the security lender. Such payments are covered by a interest under the UCC remains intact even proper security interest in crops or in general though the collateral itself may change intangibles, a catch all category of collateral through the stages of production. A lien on under the UCC. Most courts which have crops continues as the crop matures in the addressed the question have determined that field, is harvested, and stored. A lien on government program payments are included livestock, including all after-acquired in this classification. However, unfortunately livestock, creates a valid security interest in the law in this area is less than clear. In offspring, whether or not they were addition to pledging these payments in a conceived at the time the agreement was security agreement, the farmer may be asked signed. Finally, the security interest of a to sign other documents with the lender extends to proceeds of the collateral. government. To perfect its security interest Thus, if a farmer sells farm products, the lien the Lender will need to file a financing holder is entitled to the sales proceeds by statement. virtue of his security interest in the farm products themselves. After‐Acquired Property If a farmer sells farm products, the purchaser Once a lender obtains a security interest of such products takes the farm products under the UCC it is a durable lien. By means free of the prior perfected security interest in of an after-acquired property clause, a lender the products unless the lender has filed may be given a security interest in property second notice called an “effective financing that will be obtained or acquired after the statement” with the Minnesota Secretary of signing of the security agreement. Thus, State under the provisions of a federal livestock, crops, or other goods acquired by statute. If the lender complies with the the farmer in the future may be included as federal act, and the farmer sells the crops collateral for the present loan. without the permission of the lender, the lender can sue either the farmer or the Future Advances purchaser of farm products to either In addition, the UCC allows the parties to repossess the goods or get damages for the agree that future advances of money may be farmer's unauthorized sale. given when needed without making a new agreement. Such provisions are important CONCLUSION since a lender who has been granted a security interest in all crops, including crops The rules of the UCC with respect to security to be grown at a future date, will possess a interests in personal property are of critical security interest in crops that are planted importance for the farm operator and lender and harvested in later years even though the alike. The farmer must be aware of the

significance of each of the documents he is remains in place until terminated by the asked to sign. The lender must take all steps lender or until five years pass.

necessary to obtain a perfected security interest in the collateral that has been For more information: extension.umn.edu/agriculture/business promised for the loan. Once a perfected security interest has been obtained, it

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