One of the challenges for secured lenders to farming operations is sorting out the variety of public record filings related to these transactions. Unless a secured party regularly engages in farm lending the differences between UCC1 Financing Statements, Effective Financing Statements and agricultural liens may not be clear. The issue is clouded further because the different types of records may be very similar in appearance. As a result, some secured lenders tend to blur the distinctions and assume they all have the same purpose or result.
Each of these “farm filings” has a distinct purpose and legal effect. Secured parties need to understand the role that each plays in farm lending to correctly interpret search reports and to file the correct records necessary to fully protect a security interest. This article helps cut through some of the misconceptions and explains the unique role that each of these records plays in farm-related secured transactions.
Security Interests in Farm Products
Lenders to farming operations often take a security interest in the debtor’s farm products. “Farm products,” as the term is defined by Article 9, include crops, livestock and the products of crops or livestock in their unmanufactured state. In general, a security interest in farm products is subject to the same creation, perfection and priority rules that apply to other types of tangible collateral.
The secured party ordinarily prefects its security interest in farm products by filing a UCC financing statement. The financing statement can describe the farm products specifically or by type, category or any other method permitted by Article 9, including the super-generic “All Assets” description.
Likewise, the general Article 9 priority rules apply to conflicting security interests in farm products. Priority ranks from the earlier time of filing or perfection. Even the normal purchase-money priority rules apply to farm products, although there are special perfection and notice requirements for a purchase-money security interest (“PMSI”) in livestock.
To obtain PMSI priority in livestock, the secured party must file its financing statement before the debtor receives possession of the collateral. In addition, the secured party must send a notice of its PMSI claim to the holder of any conflicting security interest. While these requirements are very similar to those for a PMSI in inventory, the livestock PMSI notice has a much shorter effective period, six months instead of five years for an inventory PMSI notice.
The most significant exception to the general Article 9 rules for farm products applies to a buyer in ordinary course of business (“BIOCOB”). A BIOCOB generally takes free of a security interest created by the seller, even if the security interest is perfected and the buyer is aware of its existence. However, the buyer of farm products from a person engaged in farming operations was specifically excluded from the BIOCOB provisions. As a result, Article 9 does not permit the BIOCOB of farm products to take free of a security interest created by the seller. However, law other than Article 9, specifically the federal Food Security Act, may enable the buyer to take free of the security interest.
An agricultural lien is a different legal concept than the UCC security interest but the two types of interests are often confused. Although they both secure payment or performance of an obligation, a security interest arises through the voluntary agreement of the parties, whereas an agricultural lien is created by the existence of certain conditions specified by statute. The consent of the debtor is not necessary for creation of an agricultural lien.
Generally, an agricultural lien arises by statute in favor of a party that, in the ordinary course of its business, furnishes certain goods or services for use in connection with the debtor’s farming operation. For example, the suppliers of seed, fertilizer or veterinary services may all be entitled to claim an agricultural lien for the unpaid amount owed by the debtor.
An “agricultural lien,” as defined in Article 9, does not depend on possession of the farm products. Like a security interest, an agricultural lien is often non-possessory. It would be a hidden lien without some type of public record filing. Perhaps for that reason, agricultural liens also fall within the scope of Article 9 for perfection and priority.
Unlike a security interest, the supplier may have to satisfy additional statutory requirements before it can claim an agricultural lien. These might include sending a notice to designated parties or filing a local notice, if the agricultural lien statute so provides. To perfect an agricultural lien, the claimant must both satisfy those additional requirements and comply with Article 9, typically by filing a UCC1 financing statement.
There is a significant difference between security interests and agricultural liens when it comes to governing law. The general rule under Article 9 is that the law of the jurisdiction where the debtor is located governs perfection and priority of a security interest in goods. However, the law governing perfection and priority of an agricultural lien is the law of the jurisdiction where the farm products are located.
This can lead to UCC records filed in different states that cover the same farm products. For example, if the debtor is located in Minnesota and the farm products are located in Iowa, a lender would file its financing statement with the Minnesota Secretary of State to perfect a security interest, but a claimant would have to file its financing statement with the Iowa Secretary of State to perfect an agricultural lien. Likewise, those who conduct UCC searches would have to look in both Iowa and Minnesota to find all the effective records.
One other significant difference between a security interest and agricultural lien is that the Article 9 priority rules do not always apply to an agricultural lien. If the statute that created the agricultural lien so provides, a perfected agricultural lien may take priority over prior perfected security interests in the same collateral. In a sense, the agricultural lien is the rough equivalent of a PMSI. After all, the debtor often could not produce the crops or livestock without the goods or services that third parties provided on credit. Therefore, an agricultural lien statute may give the lien claimant first priority in the goods it enabled the debtor to produce.
Because agricultural liens are designed to protect those who supply inputs to farming operations, banks and other lenders to farming operations would rarely, if ever, have a need to file one. More commonly, a lender would run across an agricultural lien when conducting a UCC search on a debtor engaged in farming operations. In that case, the lender must consult the agricultural lien statute to determine the priority of the claim in relation to other UCC security interests.
The Food Security Act and Effective Financing Statements
As previously noted, Article 9 does not permit a BIOCOB of farm products to take free of a security interest created by the seller. Some large national buyers of farm products were not happy that they faced the risk of buying farm products subject to a security interest. They took their concerns to Congress and the result was the Food Security Act (“FSA”). As federal law, the FSA preempts Article 9.
The FSA provides that a buyer, commission merchant or selling agent (collectively “buyer”) in the ordinary course may buy farm products without being subject to a security interest created by the seller. However, the FSA allows a secured party to take action to prevent a buyer from taking clear of the security interest.
The action available to the secured party depends on whether the state involved has established a central notification system (“CNS”) that has been certified by the Secretary of Agriculture. Under the FSA, if the state has a certified CNS system, then the secured party can file an effective financing statement (“EFS”) with the secretary of state to notify buyers of the claimed security interest. Buyers of farm products in a CNS state must subscribe to lists of filed EFS records provided on a regular basis by the secretary of state, or conduct their own searches of EFS records. If the seller appears on the published list or search of EFS records, the buyer knows it must take steps to ensure the proceeds reach the secured party.
The content requirements for an EFS record are similar to those for a UCC financing statement, but with some notable differences. In addition to the party name and address, an EFS must include the debtor’s Social Security number (or unique identifier), description of the farm products, location of the farm products and, in the case of written EFS records, the debtor’s signature.
Each state with a CNS system has its own EFS forms. Because of the similarity between EFS and UCC requirements, some CNS states use EFS forms that follow the same basic design as UCC forms. As a result, the EFS and UCC forms in some states are quite similar and can be easily confused. In fact, some states even name the forms after the comparable UCC record. The EFS form in some states, for example, is titled “UCC-1F” even though it is not a UCC record.
A secured party should be careful not to confuse EFS and UCC forms. The purpose of the EFS is to prevent a buyer from taking free of the perfected security interest. It is not a substitute for a UCC financing statement. The secured party must still perfect its security interest by filing a UCC financing statement that covers the farm products. (Although one could argue that an EFS record would perfect the security interest if it were commingled in the UCC searchable index and satisfied the requirements for sufficiency of a financing statement under UCC § 9-502(a).)
Only about 16 states have established a CNS system. The FSA provides for direct notice to potential buyers in the other states. In those states the secured party must send notice directly to potential buyers of the debtor’s farm products within one year prior to the sale. The notice has very specific content requirements, but does not require a filing in the public record. The FSA compels the debtor to cooperate with the direct notice process by providing a list of past and potential buyers.
Depending on the state or states involved, a secured lender may have to file an EFS record or send notice directly to potential buyers. However, failure to file an EFS or send notice only allows a BIOCOB to take free of the security interest. It does not leave the secured party unperfected.
UCC financing statements, agricultural lien financing statements and EFS records all have different uses and legal effects. Secured lenders to farming operations are likely to encounter all three types of records sooner or later, either as part of due diligence searches or during the perfection process. Understanding the meaning and proper use of these records can give secured lenders more confidence and reduce risk when they take farm products as collateral.
Paul Hodnefield is Associate General Counsel for Corporation Service Company and a frequent speaker/writer on UCC search and filing issues. Please feel free to contact him with questions or comments at firstname.lastname@example.org, or 800-927-9801, ext. 62375.
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