In the world of agricultural commodities (including livestock and grain), as uncomfortable as it may be, volatility is becoming a way of life. That volatility can wreak havoc on participants in the pork production chain if they find themselves on the wrong side of price movements. Increased input costs result in increased finished pig costs or squeezed margins or both. Producers, processors and creditors alike feel the stress. In more stable economic times, creditors would secure their interest and not worry about their priority position because the hogs tended to be profitable enough to pay all creditors. In today’s climate, one day creditors can feel comfortable about producers’ margins covering all debts, only to watch skyrocketing input prices without corresponding increases in the finished hog prices surface the next day.
When producers get squeezed there may not be enough money to pay all of the creditors, so the priority of a creditor’s lien can be the difference in getting paid in full or not paid at all. In the pork industry, lien priority can be a fairly complicated issue, and while it’s always wise to understand the creditor priority issue, in times like this it’s even more important.
Let’s review several types of creditor interests that may compete for an interest in hogs.
Consensual Security Interests
Most farmers rely on secured credit. A bank lends a farmer money; the farmer gives the bank a note and grants it a security interest in his hogs to secure payment of the note. Lawyers, bankers and many farmers know that granting and enforcing such consensual security interests is governed by Article 9 of the Uniform Commercial Code.
Often a bank will be the only creditor holding a consensual security interest. However, sometimes a farmer will grant security interests in the same hogs to multiple parties. For example, a farmer may obtain a general revolving line of credit from a bank, secured by a security interest in essentially all of the farmer’s assets. However, if the farmer runs out of that credit line when he needs to buy hogs, he may find another lender that will lend money specifically for that purchase.
The second lender will attempt to document his interest in the hogs as a purchase-money security interest. The details of purchase-money financing of livestock are beyond the scope of this article, but if successful, the second lender will have priority over the bank financer involving the hogs purchased with his funds.
Interests in hogs and other livestock are complicated by the existence of statutory liens created by state law to benefit parties that contribute to the livestock. Statutory lienholders could include veterinarians, breeders, feed suppliers, contract producers, packers and such.
Statutory liens vary widely from state to state, so you must consult state law to determine whether it has liens for feed suppliers, veterinarians and others; how those liens are perfected (for example, by filing a financing statement); and their priority.
Let’s look at an example. Suppose that a producer borrows money from an agricultural lender to purchase weaned pigs. The lender then takes a consensual purchase-money security interest in the hogs and fulfills its obligations under the UCC by filing and perfecting its interest with the Secretary of State in the state where the producer is located. If no one has filed a financing statement before the lender, he will likely feel comfortable that his interest in the hogs is superior to other creditors.
Next, the producer secures a local farmer to raise his hogs on contract. In many states that farmer is now entitled to a statutory lien to secure payment for his services; in some states that lien ranks ahead of the lender’s lien.
Let’s continue with this example. Suppose the farmer buys feed on credit. Once again, in some states the feed provider is entitled to a statutory lien against the hogs that supersedes the lender in order to secure payment.
Next, the hogs get sick so the farmer calls his veterinarian, who provides services on credit. In some states the veterinarian is now entitled to a lien against hogs, assuming he follows the perfection requirements. In fact, some states go as far as to give the veterinarian priority ahead of all other lienholders, including other statutory lienholders.
In short, states have created statutory liens for nearly every person in the pork production value chain, but the liens created by each state are different in scope and enforcement.
The final complication to be discussed here arises from the hog buyer’s rights. Before 1985, a person who buys hogs (or other farm products) was always subject to security interests created by the seller. To mitigate the risk that a buyer might have to pay twice, regular buyers routinely conducted searches against their sellers and cut checks payable to both the seller and the seller’s secured creditors.
The Federal Food Security Act of 1985 shifted the burden somewhat in the buyer’s favor. The act provides that farm product buyers take free-of-security interests that sellers create unless the security interest holders comply with certain statutory requirements.
Under the act, states may be certified as having an adequate “central-filing system.” These states are referred to as “central-filing states” or “clear-title states.” States that do not have a central-filing system are known as “notice states.” Unless USDA has certified a state’s central-filing system, the state is a notice state. As of this writing, 19 states have been certified as clear-title states for some or all farm products. The list can be found at USDA’s website or at http://tinyurl.com/3jr8t2n. It reveals, for example, that Minnesota and Nebraska are clear-title states, but Iowa and Kansas are not.
In clear-title states with an approved central-filing system, secured parties must file an “effective financing statement” covering their security interest in the filing system of the state where the hogs are produced. Hog buyers must search the central filing before buying hogs. If any secured parties have filed against the hogs being purchased, the buyer should obtain a release from the secured parties or at least cut any checks payable to both the farmer and the secured parties.
Contents of the filing required in clear-title states is different from those required under the UCC, but a secured party must file both to be protected. Matters become particularly difficult when multiple states are involved. Under the Food Security Act, the correct state in which to file is the state where the product is produced. Under the UCC, the correct state in which to file is the state where the debtor is located, not where the product is produced. If a hog is grown in multiple states, creditors will generally file an effective financing statement in all of the states to which the hog is shipped.
In notice states, a buyer of farm products (including hogs) in the ordinary course of business takes free-of-security interests created by the seller unless the secured parties have given the buyer notice of their security interests. For this reason, lenders in notice states often require farm debtors to provide a list of buyers to whom they will sell hogs. That list should be updated periodically, and the lender should send notices of its interest to the buyers on the list. Still, the lender retains a risk that the producer will sell hogs to a buyer that is not on its list. In that case, the lender may have a misrepresentation claim against the producer, but his security interest may be lost.
The ways that statutory liens, the UCC and Food Security Act interact to determine priority vary from state to state. Pork industry participants would be well served to fully understand lien priority under the states in which they operate.
Jacob Bylund is a partner at Faegre & Benson in the Des Moines office. He can be reached at email@example.com. Adam Hertzke is an associate at Faegre & Benson in the Des Moines office and can be contacted at firstname.lastname@example.org.