UCC Expert’s Corner: Court Finds UCC Security Interest Superior to Set-Off Rights of Farm Products Buyer
June 1, 2016
Sorting out UCC security interests, agricultural liens, and Effective Financing Statements (“EFS”) filed under the Food Security Act (“FSA”) can be a challenge for both lenders and buyers of farm products. These three distinct but overlapping concepts all were issues in the recent case of Guaranty Bank & Trust Company v. Agrex, Incorporated, 2016 WL 1720105 (5th Cir. Apr. 28, 2016).
To understand the issues in the case, a little background on agricultural liens and interests might be helpful. There are three public records that might affect interests in farm products. Security interests in farm products are governed by UCC Article 9. A secured party generally perfects its security interest in farm products by filing a financing statement.
Non-possessory statutory liens on farm products may arise under state agricultural laws. However, perfection of these agricultural liens is typically also governed by Article 9. In general, the lienholder must file a financing statement in compliance with Article 9 to perfect its agricultural lien.
Although they appear similar, an EFS record differs from a UCC financing statement. Normally, the buyer of goods in ordinary course of business takes free of a security interest created by the seller. However, Article 9 has an exception for the buyers of farm products. Buyers of farm products generally take subject to security interests created by the farmer.
In response to concerns about this exception expressed by some large buyers of farm products, Congress passed the FSA. The FSA preempted the UCC and eliminated the farm products exception for buyers in ordinary course. However, the FSA did allow secured parties to prevent buyers from taking free of the security interest either through direct notice or, in states that created a central indexing system, by filing an EFS record.
Some states created a separate database for EFS records. A few, including Mississippi, simply commingled UCC and EFS records in one searchable index. An EFS record alone, however, does not necessarily perfect a security interest. Nor does a UCC financing statement necessarily serve as notice for FSA purposes. The requirements for each type of record are similar, but there are differences.
Returning to the Guaranty case, Murtaugh-Walker Farms (“MWF”) was a farming partnership in Mississippi. The partnership entered into multiple commodities futures contracts with Agrex, Incorporated, DBA FGDI (“FGDI”) to deliver corn and soybeans in 2010. However, MWF dissolved shortly after entering into the agreements.
Following the dissolution of MWF, FGDI agreed to assign the commodities futures contracts to Walker, one of the original MWF partners, and to delay delivery of the corn and soybeans until 2012. In 2012, Walker entered into three additional corn commodity contracts with FGDI for delivery of agricultural goods later that year.
In April 2012, Walker took out a production money loan with Guaranty Bank & Trust Company (“Guaranty”) to finance his 2012 crops. To secure the debt, Walker granted Guaranty a security interest in his 2012 crops, other farm products, equipment and accounts. Guaranty promptly perfected its security interest by filing a financing statement with the Mississippi Secretary of State. On the same day, Guaranty filed a Mississippi UCC-1F, which is designed to satisfy the FSA requirements for an EFS record. Walker later drew more than $400,000 on the Guaranty loan to finance the 2012 crops.
Late in 2012, Walker delivered his crops and FGDI then sold the grain. The crops were sufficient to satisfy all of Walker’s obligations under the commodities futures contracts, with the exception of one soybean contract. FGDI calculated that it owed Walker $417,033 for the grain it sold, but had suffered a loss of $359,853 as a result of the unfulfilled soybean contract.
Guaranty sent a demand letter to FGDI requesting the proceeds from the sale of Walker’s 2012 crops. FGDI issued Guaranty a check for only $57,179, the difference between the sum it owed Walker and the loss it suffered on the soybean contract.
Guaranty filed suit against FGDI, seeking to recover the full amount of the crop sale proceeds FGDI owed to Walker. Guaranty claimed that its security interest was superior to any right that FGDI might have to apply its right of set-off.
The court first addressed the nature of Guaranty’s security interest. Because the loan was intended to be used to produce crops and was in fact used for that purpose, the court concluded that the secured party held a “production-money security interest” under Mississippi law. Unlike other states, Mississippi enacted a non-uniform provision for production-money security interests in its version of Article 9 rather than within the state’s agricultural lien statutes. The Mississippi production-money security interest has priority over most preexisting claims, much like the priority accorded a purchase-money security interest.
Next, the court determined that the financing statement filed by Guaranty properly perfected its security interest. Moreover, the UCC-1F included the information required to comply with the FSA requirements for an EFS record. The court therefore concluded that Guaranty had a perfected security interest and was secured the protection of the FSA.
The court also noted that FGDI had not registered with the secretary of state to receive EFS notices as required by the FSA. Consequently, FGDI took Walker’s crops subject to Guaranty’s security interest. As a result, the court held that Guaranty’s security interest was superior to FGDI’s set-off rights and that Guaranty was entitled to the full proceeds of the crops.
The important thing to take away from this case is that a secured party might need to file an EFS record in addition to a UCC financing statement to fully protect its security interest when the collateral includes farm products. If the state where the debtor and/or farm products are located has a central notification system under the FSA, the secured party should file an EFS record in addition to its UCC financing statements.
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Paul Hodnefield is associate general counsel for Corporation Service Company® and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at firstname.lastname@example.org or 800-927-9801, ext. 61730.