From the Blog

July 9, 2012

Banks Beware: Federal Preemption of Security Interests on Farm Products

Written by: M. David Alexander

by M. David Alexander, Managing Shareholder, Peterson & Myers, Winter Haven

If you deal in farm products and are looking for a more level playing field between agribusiness and the banks, here’s a small, but bright spot to consider. If, on the other hand, you’re an “ag-lender,” forewarned is forearmed.

Imagine that Farmer John buys a Florida citrus grove in 2009, and the purchase is financed by Bank. All crops are pledged to Bank as collateral for the loan. Bank files a financing statement with the Secured Transaction Registry to perfect its lien on the crops. Later, in 2011, Farmer John sells the 2011-’12 citrus crop to Dealer, but Dealer gets no written notice of Bank’s lien on the crop from Farmer John or the Bank. Then, before harvest, Farmer John defaults on his loan and Bank forecloses, suing Dealer as well due to its competing claim of crop ownership. Bank maintains that Dealer’s right to the crop is inferior to Bank’s lien, and that Bank, not Dealer, is entitled to the crop. Who prevails?

Despite Bank’s record lien, Dealer owns the crop free and clear because Dealer received no written notice of Bank’s lien from either Bank or Farmer John before Dealer’s purchase, under Section 1324 of the federal Food Security Act of 1985 (7 USC 1631). The only exceptions to this rule do not apply in Florida, which has no lien registry approved by the United States Department of Agriculture.

Ordinarily, this scenario presents no significant problem to either Bank or Dealer. Bank simply asserts its right to the fruit proceeds and Dealer performs the contract (the farmer’s interest is eliminated). Bank, however, is on the horns of a dilemma if the contract price is less than the market at the time of default. Dealer wants his good deal and has probably committed the fruit to a processor. Bank, on the other hand, would rather have the increased profit to reduce its loan balance. To protect against such a situation, Bank has two mediocre options. Bank can attempt to monitor and restrict the sale of the crops so that it can give timely notice of its lien to Dealer. However, this cumbersome approach overly involves Bank in its customer’s daily business. Alternatively, Bank can assert a lien pursuant to Section 713.71, Florida Statutes, which exists where a loan is made to aid the farmer in the business of planting or farming. The farmer must consent to the lien in a writing recorded with the clerk of circuit court of the county in which the farmer’s business is conducted. Notwithstanding, Dealer can, and no doubt will, contest whether the loan proceeds actually aided the borrower in growing the purchased crop.

The federal Food Security Act extends to all farm products, not just citrus, and was enacted by Congress to protect a buyer, like Dealer, against paying twice for products, once at the time of purchase and again when a farmer defaults on his loan. Furthermore, the other options available to banks under Florida law offer no guaranty of protection. Thus, at least in Florida and in the particular situation presented, the risk of loss is shifted from the buyer to the bank, with little protection available to the bank. Banks beware!