Updated: Jul 2, 2020
This post should not be construed as legal advice.
Many of you realize that the agricultural industry relies on financing to operate. Producers often take out operating loans annually to purchase necessary inputs, and the lenders in return often secure these operating loans with the crops the producers grow. What happens if a producer fails to pay the lender back for the operating loan but sells the crop to a third party? Could that third party have to pay twice, once to the producer and once to the lender who had a security interest in the crop?
Before we answer this question, let’s discuss a term. A security interest is a property interest in assets, created by an agreement or by a law to secure an obligation. This obligation is typically the payment of a debt. If the borrower does not repay the debt, then the creditor will typically have first rights to control of the secured asset. For example, Cindy takes out a loan to finance her new farm and the lender requests a security interest in Cindy’s farmland. If Cindy fails to pay the loan back, the lender would be able to sell Cindy’s farmland in order recoup the money loaned.
Looking back at the original question of whether a third party might have to pay twice for an asset, the answer will depend not on state law but on the application of federal law. In most cases, secured transactions, where a creditor takes a security interest in property to secure repayment of a loan, is governed by Title 9 of the Uniform Commercial Code (UCC), which has been adopted in all 50 states. The 1985 Farm Bill contained a provision which preempts the UCC from applying to certain situations involving farm products.
The UCC is preempted when the buyer of the farm products is a buyer in ordinary course. While a buyer in ordinary course may have different definitions, in this case it means a person or business purchasing farm products from someone engaged in a farming operation which sells farm products. For example, Grain Elevator purchases grain from Cindy’s farm, making Grain Elevator a buyer in ordinary course. In my example, if Cindy’s lender has taken a security interest in her growing crops in exchange for a loan. When Cindy sells her grain to Grain Elevator, then the Grain Elevator will take free of Cindy’s lender’s security interest unless: 1) a financing statement is properly filed with a USDA-approved central filing system or 2) the lender provides direct notice to potential buyers, in states without a USDA-approved central filing system.
With a USDA-certified central filing system, the 1985 Farm Bill allowed states to develop their own central filing systems which could be approved by USDA. To date, only 19 states have done so. For a complete list, see https://www.gipsa.usda.gov/laws/cleartitle.aspx. In these 19 states, the lender or party with the secured interest sends an “effective filing statement” which includes name of borrower, party with the security interest, farm product with the security interest, social security number or tax ID number of borrower, and legal description of where the crop is being grown. Buyers would need to register with the state’s secretary of state, who then compiles a list of farm products subject to security interests and counties where the products are grown. This list is periodically sent to registered buyers, who then have notice of the security interest. Registered buyers would purchase the farm products with the security interest, unless the buyer can get the lender to extinguish the lender’s security interest.
For example, Grain Elevator purchases grain with a lender’s security interest from Cindy. Lender has properly filed a financing statement with the secretary of state, who sends that information out each week to registered buyers. Grain Elevator has not registered with the secretary of state and so did not know of the security interest. Grain Elevator would potentially have to pay for the grain twice (once to Cindy and once to lender), although Grain Elevator may be able to recover the money paid to Cindy.
In states without a USDA-approved central filing system such as Maryland and Delaware, a buyer in ordinary course could be put on notice if the borrower or the lender notifies buyer within one year before the purchase that the farm product is subject to a security interest. This notice must be in writing and include names and addresses of borrower and lender, social security number or tax id number of borrower, description of farm products and the crop year, and a reasonable description of the property the crops are grown on, including the county.
In states such as Maryland or Delaware without USDA-approved central filing systems, the lender has to question the borrower on all possible potential buyers and notify those potential buyers of the security interest. In these states, the lender will typically ask the borrower for a list of potential buyers and lender will provide the required notice to the potential buyers.