By Paul Hodnefield, Esq.

Being the first to file a UCC financing statement does not always guarantee that the secured party will have the superior interest in collateral. Statutory liens may take priority even over prior perfected security interests. How a court determines the relative priorities of a statutory possessory lien and a UCC security interest recently was demonstrated in the case of J & M Cattle Company, LLC, v. Farmer’s National Bank, 2014 Ida. LEXIS 198 (Idaho Aug. 1, 2014).

Farmer’s National Bank (“FNB”) made secured loans to Green River Dairy, LLC (“Green River”) in 2006 and 2008. The loans were secured by Green River’s dairy cattle and other assets. FNB perfected its security interest by filing a financing statement with the Idaho Secretary of State in 2006.

Beginning in June 2011, Green River delivered some of the cattle subject to FNB’s security interest to J&M Cattle Company (“J&M”). J&M provided food, care and other services necessary to raise the dairy cattle for Green River.

Later in 2011, Green River defaulted on its obligation to FNB. Green River also failed to pay J&M for the services it provided to raise Green River’s dairy cattle.  However, J&M remained in possession of the cattle.

FNB filed suit against Green River to collect on the outstanding obligation and obtained a judgment. Although J&M was not a party to the suit, it argued that it was entitled to an agister’s lien for the amount J&M still owed for care of the cattle.

Idaho law recognizes a possessory agister’s lien in favor of persons who care for, board, feed or pasture livestock. J&M claimed its agister’s lien was superior to FNB’s security interest based on an Idaho statute that gives a possessory lien on goods priority over a security interest in the same goods unless the lien is created by a statute that expressly provides otherwise.

FNB and J&M entered into an agreement for sale of the cattle and the proceeds went into escrow, pending resolution of the parties’ competing claims. The sale proceeds were not enough to pay either claim in full.

After the sale, J&M filed a complaint against FNB seeking a declaratory judgment that its agister’s lien claim took priority over FNB’s prior security interest. FNB answered and counter-claimed that its interest was superior to the agister’s lien.

The dispute made it all the way to the Idaho Supreme Court. The issue before the court was whether the statute that created the agister’s lien “expressly provides otherwise.” The relevant portion of the agister’s lien statute provides:

… The proceeds of the sale must be applied to the discharge of any prior perfected security interest, the lien created by this section and costs; the remainder, if any, must be paid over to the owner.

FNB claimed that the plain text of this statute expressly provides that the proceeds from sale of the dairy cattle must be paid to it first because of FNB’s prior perfected security interest. The Court, however, disagreed.

According to the Court, the statute could be interpreted a couple of different ways. It could be a priority rule for the precise order that each claimant is paid from the sale proceeds. On the other hand, the text could be interpreted to simply offer a list of potential interests to be paid from the sale proceeds without regard for priority. The Court concluded that the statute was ambiguous because it had more than one reasonable interpretation.

The Court ruled that the ambiguity prevented the statute that created the agister’s lien from expressly providing otherwise with respect to priority. Consequently, the court held that J&M was entitled to the proceeds from the sale of the dairy cattle despite FNB’s prior perfected security interest.

The takeaway from this case is that state statutory liens may take priority over prior perfected security interests. The types of liens and the priority afforded each by statute is not uniform from state to state. The effect in a particular case will depend on the specific priority provisions of the statute that created the lien.

Generally, giving higher priority to statutory liens, especially agricultural liens or possessory liens in favor of those who repair, maintain or otherwise improve goods, does no harm to the secured party. These liens are similar in concept to a purchase-money security interest.

Without the input from those who provide seed, fertilizer, land or other services, it would be nearly impossible to produce crops, livestock and other farm products. Likewise, without the services of a person who repairs equipment, the value of the goods as collateral could be substantially diminished or even extinguished. Statutory liens encourage suppliers to provide essential inputs by reducing the risk of non-payment. Secured parties often benefit from the increased value of the collateral made possible by third-party inputs.

Nevertheless, secured parties may want to take action to avoid unpleasant priority surprises. That may require a secured party to track which parties are providing inputs to produce, repair or maintain the collateral and ensure the debtor is paying the resulting bills.

Paul Hodnefield is Associate General Counsel for CSC and a frequent speaker/writer on UCC due diligence issues. Please feel free to contact him with questions or comments at phodnefi@cscinfo.com or 800-927-9801, ext. 62375.

Expert’s Corner: Court Finds Statutory Lien Entitled to Priority over Prior Perfected Security Interest