Do Not Leave the Gate Open, All Your Cattle (Collateral) Will Disappear!
You have been warned!
At first glance, the Federal Food Security Act of 1985 appears to severely disadvantage perfected parties with security interests in farm products. But the Act’s primary aim is to establish a framework of enhanced notice for buyers, sellers, and secured parties of farm products. Nevertheless, secured creditors of farm products may find themselves without recourse against buyers of farm products in the ordinary course of business if they are not adequately informed of the various pitfalls within the Act.
For the most part, senior perfected secured parties reign supreme under Article 9 of the Uniform Commercial Code. A senior perfected party, for instance, will prevail over a conflicting security interest perfected in the same collateral. See U.C.C. §§ 9-317; 9-322(a). This policy is sensible because it permits lenders to extend credit at fair interest rates in exchange for security. However, a significant deviation from this rule involves “buyers in the ordinary course of business” (“BIOCOB”). Under Article 9, a BIOCOB, “takes free of a security interest created by the buyer’s seller, even if the security interest is perfected and the buyer knows of its existence.” See U.C.C. §§ 9-320(a), 1-201(b)(9). Here, the policy varies from the general rule– that is, such a buyer needs protection from a secured party’s enforcement of a security interest.
Nonetheless, even the BIOCOB exception includes an exception. A person buying farm products, such as livestock and crops, from a person engaged in farming operations does not take free of a security interest created by their sellers. See U.C.C. § 9-320(a). For example, suppose Farmer, grants a security interest in all his cattle to Bank, in exchange for a loan. Farmer who is experiencing financial difficulties, then sells all his cattle to Joe in the ordinary course of business. Under Article 9, Joe is not protected by the BIOCOB principle. Instead, Joe’s purchase of the cattle is subject to Bank’s security interest in the cattle. Therefore, Bank will be able to enforce its security interest in the cattle against Joe.
Buyers of farm products undoubtedly despised this result, and in 1985, convinced Congress to protect them under the Federal Food Security Act. Section 1631(d) of the Act effectively eliminated the exception to the BIOCOB rule relating to buyers of farm products. Now, “a buyer who in the ordinary course of business buys a farm product from a seller engaged in farming operations shall take free of a security interest created by the seller, even though the security interest is perfected; and the buyer knows of the existence of such interest.” See 7 U.S.C.S. §1631(d).
In their congressional findings, Congress noted that certain State laws permitting secured lenders to enforce liens against purchasers of farm products even if the purchaser did not know that the sale of products violated the lender’s security interest in the products exposed purchasers of farm products to double payment for the products; once at the time of purchase, and again when the seller fails to repay the lender. This exposure to double payment, Congress said, “inhibits free competition in the market for farm products” and “constitutes a burden on and an obstruction to interstate commerce in farm products.” See 7 U.S.C.S. §1631(a). Therefore, “notwithstanding any other provision of Federal, State, or local law”, buyers of farm products benefit from the same rights as other BIOCOB.
The Federal Food Security Act, however, affords two procedures for perfected secured parties to reclaim priority status over BIOCOB of farm products. Under the first mechanism, the State where the farm product is produced must have established a “central filing system.” This type of filing system is intended to provide heightened notice to prospective buyers of farm products. Currently, all fifty states have public filing systems for U.C.C. Article 9 financing statements. However, only nineteen (19) states have set up a central filing system under the Act. Here is a link showing which States have central filing systems certified by the U.S. Department of Agriculture as meeting the requirements of Section 1631 of the Food Security Act of 1985: https://www.gipsa.usda.gov/laws/cleartitle.aspx. Notably, Texas has not established a central filing system complying with the Act.
The second mechanism (applicable to Texas) of providing secured parties priority status over BIOCOB of farm products involves a seldom followed and impracticable notice procedure. Under the Act, a buyer of farm products takes subject to a security interest created by the seller if within one year before the sale of the farm products, the buyer receives from the secured party or the seller written notice of the security interest in the relevant farm products. The written notice must be an original or reproduced copy thereof, containing the name and address of the secured party and person indebted to the secured party, describing the farm products subject to the security interest, and noting “any payment obligations imposed on the buyer by the secured party as conditions for the waiver or release of the security interest.” See 7 U.S.C. §1631(e).
As noted above, only nineteen States have certified central filing systems, which leaves secured parties of farm products in most States with limited options in protecting their security interests. In the previous example above highlighting the exception to the BIOCOB rule, Bank is entitled to enforce its security interest in the cattle against Joe, the purchaser of the cattle from Farmer under Article 9. Under the Federal Food Security Act in most states, however, Bank would lose its priority status with regards to the cattle and would be unable to enforce its security interest against Joe, unless Bank complies with either one of the Acts two mechanisms for reclaiming priority status.
In Texas, the legislature adopted Article 9 of the U.C.C. but has not established a certified central filing system under the Federal Food Security Act. As a result, a scenario much like the one where the Bank loses its priority status to Joe is almost certain to occur. Therefore, creditors have two main options when dealing with farm products as security in Texas: 1) a creditor could accept farm products as collateral under a security agreement and comply with the second mechanism under the Act for reclaiming priority status; or 2) the creditor could reject farm products as security all together. The first option is clearly the riskier choice for a creditor because complying with the second mechanism hinges entirely on the seller of farm products notifying the secured creditor of the sale. Oftentimes, debtors are forgetful or in financial distress and will fail to notify a secured party of a sale on secured collateral. Either way, creditors and buyers of farm products should proceed with caution when dealing with farm products as security in Texas.