May 12, 2021

Volume XI, Number 132

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Farm Lending Pitfalls For Urban Lawyers

OK, so you’re a sophisticated lending attorney in Metropolis who is comfortable with everything from aircraft financing to syndicated loans secured by casinos in Macau. Yet you feel a twinge of uncertainty when a business loan is to be secured by wine inventory made from grapes grown in both California and Washington. You know intuitively that anytime farmers, ranchers or food processors are in the mix, either as a borrower or a supplier to the borrower, the underwriting and documentation challenges are not uniform on a state-by-state basis, and are compounded by an overlay of federal laws designed to protect growers of perishable crops and providers of livestock. To get a reality check, you sometimes will secretly call your law school classmate who oddly returned to Smallville and now represents its one bank.

Your concerns are justified but can be reduced by understanding a handful of specific laws that should prompt discussion of documentation and collection risks. First and foremost, all 50 states have unique lien statutes designed to protect those who provide goods, services, land and labor to farmers, ranchers and food processors. Dealing with competing liens and quantifying risk is nothing new to lenders, but the problem posed by agricultural liens is that they often are not searchable (no public filing is required), yet they often are senior in lien priority to conventional Uniform Commercial Code (UCC) security interests. As a result, the number and size of such liens are unknowable except from reliance on the borrower’s own books and records, which hopefully are current and accurate.

To exemplify this risk, let’s return to the winery loan that made you uneasy. California law provides a Producers Lien (Cal. Food & Agric. Code 55631-55653) to unpaid grape producers in an unlimited amount without requiring any public or searchable filing. A Producer Lien’s priority is senior to all UCC security interests and other claims, except for UCC warehouse liens and laborers’ wage claims. Cal. Food & Agric. Code 55633; Frazier Nuts v. American AgCredit, 141 Cal. App. 4th 1263 (2006). The Producers Lien attaches not only to the wine sitting in the borrower’s inventory, but also to the accounts generated by the sale of wine. Frazier Nuts, supra, at 1270. Thus, the lender’s $10 million revolving line of credit, ostensibly well secured by wine inventory and accounts valued at $20 million, has a far different risk profile if the borrower did not fully disclose the amount of unpaid grower claims, an amount which varies during the winery’s business cycle. The full amount of these Producer Liens will prime the lender’s unpaid loan if collection remedies ever become necessary. Cal. Food & Agric. Code 55634.

Faced with this risk, a reasonable lender might attempt to identify likely holders of Producer Liens and obtain a waiver or subordination of the statutory liens. This solution is possible but not foolproof; waivers of Producer Liens laws have been overturned on grounds showing they were not knowingly and intentionally given. See, e.g., Silva Farms v. Wells Fargo Bank (In Re GVF Cannery, 202 B.R. 140 (N.D. Cal. 1996).

Before throwing in the towel, however, bear in mind that some statutory agricultural liens are searchable because of public filing requirements and are also governed by the UCC’s “first in time” priority rules. Seee.g., California’s Dairy Cattle Supply Lien, Food & Agric. Code 57401-57414; Agricultural Chemical and Seed Lien, Food & Agric. Code 57551-57595; and Poultry and Fish Supply Lien, Food & Agric. Code 57501-57545. These filing and priority rules resulted from efforts by the UCC’s Permanent Editorial Board to bring statutory liens within the UCC’s framework, but only with partial success. Thus, the lawyer’s analysis includes not only spotting the potential statutory lien, but knowing when its risk is manageable or mitigated by the specific lien’s UCC-like searchability and collection priority.

Moving beyond state lien laws, which by themselves are powerful tools in a priority dispute with a conventional UCC lender, federal laws sometimes provide an even more powerful tool. Growers of perishable fruits and vegetables, as well as providers of livestock and poultry, are afforded federal protections under the Perishable Agricultural Commodities Act (PACA), 7 U.S.C. 499, and the Packers and Stockyards Act (PASA), 7 U.S.C. 181. PACA and PASA do not simply create a lien that competes with a UCC security interest; they may actually impose a trust on the farm products, the inventory created from such products and all receivables and other proceeds generated by those perishable commodities and livestock. 7 U.S.C. 499e(c)(2). By placing these products and proceeds in a trust, any purported security interest in the same assets is limited to the residual value after the trust beneficiaries – the unpaid suppliers – are paid. And when assets are subject to a PACA or PASA trust, certain individuals are saddled with the legal duties of a trustee to pay those unpaid beneficiaries, creating strong incentives for the PACA or PASA trustee to do so to avoid personal liability.  Seee.g. Coosemans Specialties v. Gargiulo, 485 F. 3d 701 (2d Cir. 2007).

To quantify the risks posed by these federal statutory trusts, the limits of these statutes and common defenses to them must be understood. For example, the most common questions for the application and extent of the PACA trust include: (1) is the product a perishable agricultural commodity under 7 U.S.C. 499a(b)(4); (2) was the receiver of the produce licensed or otherwise subject to PACA under 7 U.S.C. 499a(b)(6); and (3) did the PACA claimant comply with, or waive the protections of, PACA? A common defense to a PACA claim is that the payment terms exceeded 30 days. 7 C.F.R. 46.46(e)(2). Other more technical disqualifying terms or deficiencies are numerous. But once the lender is aware of the possibility of a federal trust being imposed on the collateral in question, the lender cannot rely upon the prospect of the trust beneficiary’s mistakes to value its own collateral when making underwriting decisions.

In short, an agricultural loan backed by a UCC security interest must be underwritten, sized and subsequently monitored based on the risks posed both by these federal trust statutes and a host of non-uniform, state agricultural liens. A survey of state agricultural liens, PACA and PASA are the subject of entire treatises and beyond the scope of this overview.  (Excellent scholarly papers and 50 state surveys are available from the National Agricultural Law Center, https://nationalaglawcenter.org.) The key for the careful transactional lawyer is to identify the risks and ask the right questions. Because these statutory liens and federal trusts reflect strong public policies, most of these statutory liens and trust rights cannot easily be waived or avoided, but they can be understood and the associated risks managed. In few areas of commerce is this exercise more challenging than agricultural lending to farmers, ranchers and food processors of every type.

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Copyright © 2021, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume XI, Number 76
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Richard Brunette Bankruptcy Lawyer Sheppard Mullin Law Firm
Partner

Richard Brunette is a partner in the Finance and Bankruptcy Practice Group in the Los Angeles office of Sheppard Mullin.

Areas of Practice

Richard specializes in creditor rights, commercial litigation and business bankruptcy. He has extensive experience in creditors rights litigation and appellate work and has broad experience representing creditors in business and real estate workouts involving various industries, including commercial and industrial real estate, hospitality, technology companies, retailing and agribusiness.

Richard frequently lectures...

213.617.4174
Kenneth D. Fox Finance & Bankruptcy Attorney Sheppard Mullin Orange County, CA
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Kenneth Fox is a partner in the Finance and Bankruptcy Group in the firm's Orange County Office and Leader of the Real Estate Finance Team.

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Kenneth has experience in several types of commercial lending transactions, including unsecured loans and loans secured by real and/or personal property. His experience includes loan documentation, syndicated credit facilities and participations, loan workouts and foreclosures. Kenneth represents various lending clients, including national banks, local and regional banks and other institutional lenders...

714-424-2804
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