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Chapter 10 Secured Transactions

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									Ch 10: UCC Secured Transactions                                                             Fall 2005


        Chapter 10: Secured Transactions
This chapter deals with the crucial topic of how most agricultural operations obtain their
operational financing. The chapter deals with the complex issue of how personal property, such
as crops, livestock, and other business inventory is used to finance the agricultural operation.
This is important to farmers, ranchers, agribusinesses who deal with farmers and ranchers and
agribusinesses and financial institutions who extend credit to farmers and ranchers. Major
topics are:

•      common loan terms ;
•      an overview of how the secured transaction process works;
•      how the borrower gives the lender/creditor a security interest (" creates a security
       interest ") during the loan process;
•      how the security interest is " perfected " or filed so that (1) other lenders who might lend
       on the loan collateral and (2) potential buyers of the loan collateral are put on notice of
       the new security interest;
•      how a revolving line of operating credit can be established;
•      what " purchase money security interests " are, and special rules for purchase money
       security interest in crops that have cost Nebraska cooperatives millions of dollars in
       unexpected loan losses;
•      priority disputes , or which creditor gets the collateral when there is more than one
       creditor, the borrower defaults, and there isn't enough collateral to go around;
•      what options are available to borrowers and lenders when the borrower defaults on the
       loan (i.e. can't pay);
•      loan foreclosure procedures; and
•      special rules regarding insolvent grain elevators and meatpackers .

loan terms: acceleration clause: with this clause, the entire loan balance is immediately due if
you miss one payment. This is a very common loan term; there is nothing wrong with it.
cognovit clause: with this clause, if you miss one payment, you authorize the creditor to bring a
lawyer into court in order to represent you without your knowledge and admit that you are in
loan default so the creditor can get a judgment to take possession of your property to satisfy
the debt. In other words the creditor can appoint a lawyer who is supposed to represent you
and will basically "plead you guilty" without consulting you first!! Not a good deal!! Don't sign a
loan agreement if it has a cognovit clause in it. Get the lender to take it out or else find
someone else to do business with.

overview: In the typical business lending situation, the lender (financial institution) needs loan
collateral in order to protect their depositors' assets (i.e. property to collect if the borrower can't
pay the bill. The borrower needs an operating loan (or other business loan). The borrower gives
the lender what is called a security interest (i.e. a lien) on the borrower's business property
(typically not land). Usually the farmer's inventory (unsold crops and livestock) is pledged as
loan collateral. The lender files a form called a financing statement (FS) to notify other lenders
and potential crop and livestock buyers of the security interest (SI). If lender's paperwork is
correct, the lender can take possession of and sell the loan collateral if the borrower defaults on
the loan. Significantly, the lender does not have to go to court in order to foreclose on loan. This
is an important advantage to the lender and one of the reasons they go through the security
interest process. However, in Nebraska the lender must notify farm borrowers before
foreclosing on a farm debt of $40,000 or more. This applies in Nebraska, and may not be a
requirement in other states. If the lender doesn't do the paperwork properly (and the farmer
objects to the foreclosure and the farmer's lawyer finds the lender's paperwork mistakes), the

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Ch 10: UCC Secured Transactions                                                          Fall 2005

lender must go to court in order to foreclose (delay & litigation expense). From the lender's
perspective, this defeats the purpose of the lender going through the security interest process,
so they don't make many mistakes.

There are several categories of ag creditors who need security interests: banks; input suppliers;
farmers selling crops or livestock on credit; and a cash rent landlord. The banks usually have
the paperwork done correctly; coops maybe; farmers selling on credit and cash-rent landlords
almost never do but should have!

security interest creation: The borrower must sign a security agreement (SA), which will be
part of the loan paperwork. In the SA the borrower says the creditor can seize the collateral if
the borrower defaults on the loan. The SA must be signed by borrower; and the SA must
describes collateral. The creditor is then secured (i.e. has loan collateral). Anunsecured creditor
has no loan collateral, and therefore must go to court to collect an unpaid debt. But an
unsecured creditor cannot get a court order to sell property for which a financing statement has
been filed (see below).

"perfecting" the SI [changed]: the financing statement (FS) is a summary of the SI. [changed]
FSs for everything except fixtures, including crops, livestock and farm equipment, etc. are filed
with the Nebraska Secretary of State. This is called “state filing” or “central filing” Formerly
crops, livestock and farm equipment were filed at the local county clerk where the borrower
lived. This was called “local filing.”

When the SI is perfected/filed, this allows other lenders, or potential purchasers, to check the
FSs (on computer) to determine whether the crops etc. they are either going to lend on or
purchase are subject to a SI before lending or buying. The lenders avoid lending on property
that has already pledged as loan collateral, while the buyers make their check jointly payable to
lender and to seller (this important topic is discussed in ch 11).

For crops and livestock, ag equipment and supplies, and consumer products: the FS is filed by
the creditor (usually a lender) with the Nebraska Secretary of State. For fixtures: the FS is filed
with county recorder of deeds where the fixture is located. A fixture is a permanent buildings,
e.g. a grain bin set in concrete. Property that can be moved like irrigation systems and
non-permanent buildings (like a grain bin not set in concrete) are not buildings but are personal
property. For non-ag inventory and equipment, the FS filed with the Secretary of State (SOS).

Anyone can obtain a FS info by contacting the SOS (check their website by going to
www.nol.org and click on state agencies). The FS contains information regarding the type of
collateral, the borrower, and the lender, but not the loan amount, interest rate, etc. A buyer
needs to check for FSs before buying crops or livestock from a farmer (see ch 11). You should
also check FSs before extending credit (e.g. credit grain sales to feedlot). The SOS UCC
webpage is http://www.nol.org/home/SOS/UCC/ucctran.htm

p. 93: refers to Farm Credit Services (FCS). The FCS is the new entity replacing the old Federal
Land Banks (FLBs) and Production Credit Associations (PCAs). You will see references to the
FLBs and PCAs in the next several chapters. Those references would now be to the FCS.

In addition, the Farmers’ Home Administration (FmHA) no longer exists and has been replaced
by the Farm Services Agency (FSA). The FSA also includes the former Agricultural Stabilization
& Conservation Services (ASCS). So the local FSA offices where farmers go to sign up for
federal farm programs used to be the called local ASCS offices.



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Ch 10: UCC Secured Transactions                                                             Fall 2005

SIs in crops: the typical ag operating loan includes: (1) an after acquired property clause
(AAPC) and (2) a future advances clause. With the AAPC, any new property of same type
covered by the SI is automatically covered by current SI. For example, new farm equipment
purchased would automatically be covered by the AAPC if the SI covers farm equipment. New
crops grown on same land would automatically be covered by the AAPC if the current crops
from that field are pledged in the SI. So, an AAPC on farm equipment covers all the farm
equipment you own now and any additional equipment you acquire in the future, not just what
you own now. Similarly, an AAPC on crops includes not just the crops grown this year but the
crops grown next year and the year after and the year after and so on, on that particular field
(unless the SI covers all your land). Under the future advances clause (FAC) the lender can
lend to you in the future at the lender's option. A FAC does not obligate the lender to lend if the
loan is in trouble, however.

The combination of an AAPC + a FAC equals a revolving line of credit. This is the standard
business operating financing arrangement. Land may also be used as production loan
collateral: but the lender would take a trust deed or mortgage [if you own the bank :-)] as
discussed in ch 9.

purchase money security interests (PMSIs): A PMSI is a special SI where the credit provided
allows the borrower to acquire the new asset. That is, you are not pledging an existing asset
(tractor, stored grain, existing livestock, etc.) as loan collateral. Instead you are getting credit in
order to acquire a new asset that you do not already own. The credit can come from the e.g.
equipment dealer (i.e. the seller) or the lender. The general rule is that a PMSI defeats AAPCs.
For example, you buy a 1995 tractor from the local John Deere dealer, who takes a 1995 PMSI.
The bank has your operating loan, and has a 1990 AAPC on your farm equipment. If you go
broke and both the John Deere dealer and the bank want your tractor, who wins? The dealer
wins because the dealer's PMSI allowed you to buy the tractor. If it weren't for this rule (PMSI
defeats an AAPC), it would be impossible for you to buy the tractor with dealer financing
because the dealer would be financing the tractor for the bank's AAPC. In other words, this rule
allows the borrower to get dealer financing despitethe existing AAPC. Otherwise the 1995 John
Deer dealer would never have made the PMSI loan because the bank would have the first lien
on the new equipment with its 1990 AAPC even though the dealer financed the equipment

crop PMSI exception [very important!]: a PMSI in crops defeats an AAPC only if (1) the PMSI
credit was extended up to 3 months before crops planted and, and (2) the AAPC is more than 6
months overdue when new crop is planted. This rule cost co-ops millions during 1980s when
the coop thought it had first SI on the new crop but the prior lender did! The coop (or any other
lender) lending operating money to farmer is PMSI lender because the credit allows the farmer
to acquire the new crop by planting and harvesting it. case 10-1 [crop PMSI example]: the bank
has a 1987 AAPC, with the payment due on December 1 of each year. The bank cuts the
borrower off for the 1990 crop year (which the lender legally can do) because the farmer has
gotten behind on his loan. The co-op steps in, finances the 1990 crop, and gets a PMSI on the
1990 crop. Who gets the 1990 crop, the co-op or the bank? The bank gets 1990 crop (even
though the co-op financed the 1990 crop): the bank loan was not 6 months overdue until June
1, 1990. The 1990 crop normally would be planted well before that. So the co-op financed the
1990 crop for the bank!! Not a smart thing for the co-op (or anyone else) to do!!

If the bank is smart, it will extend loan due on 12-1-90 to 12-1-91. Then the co-op can't get
PMSI on a crop until after 6-1-91! (i.e. not until the 1992 crop!!) Many co-ops thought they had
first priority on new crop, but were wrong if the original operating lender had a valid AAPC (as
most of them did).



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Ch 10: UCC Secured Transactions                                                             Fall 2005

If the co-op wants first priority on the new crop, the co-op will have to get the bank to
subordinate its SI to the co-op. Subordinate: the bank agrees to let co-op get paid first out of
the proceeds of the new crop. More likely the bank says "we get first $25,000, then you get your
$50,000, then we get the rest" or something similar. Ask yourself: who benefits from crop lien
rule? Banks? Or the co-ops? Do you think that is why the law was written that way? Hint: it
didn't just happen by itself!! It never does.

security interest priority disputes: When more than one creditor wants the same collateral:
who wins? Rules: (1) a secured (SI) creditor always defeats an unsecured creditor (no
collateral). (2) A perfected (SI + FS) creditor always defeats an unperfected (SI only) creditor.
(3) Between perfected creditors: generally the earliest date wins ("senior" creditor v. "junior"
creditor). (4) However, PMSI defeats AAPC (except for crops). (5) In addition, PMSIs have a 10
day grace period to file; if they do so their date is the sale date not the date the FS was filed.

UCC loan default: Under the UCC a lender can (1) require additional collateral or (2)
accelerate the loan if the borrower is behind on the loan (or otherwise in loan default). You
should always think twice about giving the lender more collateral: you may be better off to let
lender foreclose on the existing collateral this year rather than giving the lender more collateral
and having the lender foreclose on everything (new and old collateral) the following year. What
often happens is that wife doesn't sign the SI; then the lender can't foreclose on her share of
the farm without her signature. So the lender gets the wife's signature and doesn't foreclose this
year, but lender forecloses on both the husband and the wife's share next year. The farmer may
be better off to give the lender the husband's share and call it good! After the loan losses of the
1980s farm crisis, lenders get both signatures on all their loans now :-)

A lender can foreclose if it deems itself "insecure" even if default has not yet occurred (e.g. low
crop prices mean farmer can't make the loan payment). Ag loans usually are set up with one
annual payment rather than monthly payments. So if the lender thinks it is a good bet that the
farmer is going to be short this year, the lender can under the UCC legally go ahead and
foreclose without waiting for the farmer to miss the payment, even if the farmer hasn't missed a
payment yet. The borrower can go to court if lender decision that the loan is "insecure" is not
made in good faith

UCC foreclosure: A secured creditor can take possession of collateral without the borrower's
permission (i.e. the creditor is not trespassing) and without going to court. But the creditor can't
break a lock to get the collateral, etc. The ease of foreclosing is the main reason for creditors to
get and file their SI. In Nebraska, a creditor must give 30 day mediation notice of foreclosure for
farm debts of $40,000 or more. In other words, the lender must give the farmer 30 days notice that
the lender is going to foreclose, and must also notify the farmer that farm credit mediation (ch 12)
is available to the farmer. This important borrower protection was adopted in 1986. However, there
is no right to cure default: if farmer can make up the missed payment the lender is not required to
reinstate the loan (but I expect that most would be delighted to do so). Under the UCC the borrower
can redeem the collateral prior to the foreclosure sale only by paying the entire balance due (unless
the lender agrees to take less than the full amount). There is no grace period beyond the 30 days
mediation notice of foreclosure. Contrast this with the mortgage, trust deed 60 day "right to cure
default" provision. The creditor of course can agree to call off the sale if the creditor receives less
than the entire loan balance due but that is up to the creditor.

p. 100: in the mediation notice paragraph, please note that the sunset for the farm credit mediation
statutes is now June 30, 2009.

personal property exemptions: see book p. 101. Both spouses can claim most of them (except the

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Ch 10: UCC Secured Transactions                                                              Fall 2005

head of household homestead exemption). The wife can get $2500 wildcard exemption if husband
gets the homestead exemption. If neither spouse can claim homestead exemption, both would get
the $2500 wildcard exemption. However, if you don't claim your exemptions you don't get them! So
you have to know about them to get them. Filing bankruptcy stops foreclosure: this is a critically
important consumer protection law.

conversion: selling property that is subject to a SI and not paying the lender is a crime, and can
result in imprisonment. E.g. the farmer sells the crop which is subject to a Local Bank SI in order
to feed his livestock without the Bank's permission. This is conversion--the money from selling the
crops should be paid to the lender rather than being used to feed livestock In this situation the
lender's permission is needed to sell crops to feed the livestock. If the lender's permission is not
granted, the farmer basically has to sell the livestock and pay the creditor (if the livestock are loan
collateral). If you raise livestock, you (and your attorney) should consider adding a clause in your
loan security agreement giving the farmer the legal authority to sell collateral in order to feed
livestock without violating the security agreement. The lender may want prior notification as part
of the deal, but it would be worth it to get this in your loan agreement.

involuntary liens: certain input suppliers can file a SI, FS without the borrower's signature. That is
why they are called "involuntary" liens: they can be filed without the borrower's permission or
signature. The normal SI's are signed by the borrower. The input supplier with an involuntary lien
gets a crop SI; but the priority date is date input lien is filed. This means that the input supplier is
almost always a junior creditor, and the operating lender would be the senior creditor.

failed elevators :case 10-2: Grain elevator goes bankrupt. The claimants for the elevator's
assets include: (1) the elevator's lender (the bank, who has a perfected SI), (2) farmers storing
unsold grain, (3) farmers storing grain sold on forward contract, and (4) farmers whose grain
checks have bounced. When the elevator is liquidated (i.e. sold at auction) and the cash
distributed, the order of payment is: (1) farmers storing unsold grain (they are co-owners of the
remaining grain); (2) the elevator's lender; and (3) farmers who forward contracted and/or
whose grain checks bounced.

insolvent meatpackers: case 10-3: Meat packer goes bankrupt. The claimants for the packer's
assets include: (1) the farmers whose meat checks bounced, and (2) the packer's lender (bank,
who has a perfected SI). The farmers whose meat checks bounced get paid first! Why?
Nebraska Congressman (and former governor) Charles Thone had the federal bankruptcy law
changed in 1976, when the national meat packing chain American Beef went broke. The law
was changed so that farmers/livestock sellers would get paid before the banks. This law applies
only to meat packers, not to grain elevators (should it apply to grain elevators? what do you
think?) Livestock sellers must notify USDA within 15 days of the bad check or within 30 days of
nonpayment in order to get paid first before the lender. Otherwise the lender as the secured
creditor gets paid first.

political action question: why do farmers with rubber meat checks get paid first while farmers
with rubber grain checks get paid last? Answer: the meat sellers got the law changed; the grain
sellers haven't gotten the law changed for them yet. Moral:if you don't like the law, try to get it
changed. There is no guarantee of success, but you won't find out until you try. If you don't try
to change the law, then you (and the interest groups that you belong to) have no one to blame
but yourself for the way things are.




                                                 10-5
Ch 10: UCC Secured Transactions                                                            Fall 2005


                            Review Questions
Briefly define, describe or illustrate the following:

1. acceleration clause

2. after-acquired property clause

3. future advances clause

4. involuntary lien

5. perfected security interest

6. purchase money security interest

7. secured creditor

8. subordinate (UCC)

9. unsecured creditor

10. perfected creditor

11. unperfected creditor

12. senior creditor

13. junior creditor

14. non-judicial foreclosure (UCC)

15. AAPC

16. SI

17. FS

18. FAC

19. PMSI

20. UCC

___ 21. If the farmer/rancher defaults on the loan, a secured creditor with a properly filed
security interest is always required to go to court in order to repossess the collateral. (A) true
(B) false

___ 22. If a landowner files a copy of a cash lease with the county recorder of deeds, the
landlord automatically has a rent lien on the tenant's crop. (A) true (B) false EXPLAIN.


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Ch 10: UCC Secured Transactions                                                            Fall 2005

23. List two common agricultural situations in which secured interests should be taken but
typically are not.

___ 24. On November 1, 1987 Frank Farmer pledged all his crops, livestock and farm
equipment to Local Bank, Bank properly filing all security interests and taking a security interest
in all Frank's after acquired property. On December 1, 1988 Frank purchased a 1988 John Deer
combine, borrowing the money from the PCA. PCA received a security interest in the combine
and filed all the required documents December 5, 1988. On January 1, 1990 Frank defaults on
his loans to Local Bank and to the PCA. In a contest between Local Bank and the PCA to
recover the 1988 John Deer combine, Local Bank will win. (A) true (B) false EXPLAIN.

___ 25. The Bank has a 1987 perfected crop lien on Farmer Jones' crops with both future
advances and AAPCs. The 1989 production loan payment was due January 15, 1990 but
Farmer Jones does not pay his production loan in full. Consequently the Bank refuses to lend
for the 1990 crop production on year. Farmer Jones receives operating credit from the local
co-op which agrees to sell Jones seed, fuel and ag chemicals on credit. The co-op properly
perfects a security interest in the 1990 crop on March 1, 1990. Jones plants his crop April 25,
1990. The co-op's crop lien takes priority over the Bank's crop lien. (A) true (B) false EXPLAIN.

26. The combination of the AAPC and the future advances clause make it possible for farm
lenders (and other business lenders) to make a __________________ available to their
customers.

27. Cash rent landlords should require a tenant's operating lender to ________________
____________ its security interest to the landlord where the operating lender (bank, FCS, etc.)
has the first lien on the crop.

___ 28. PMSIs are given priority over prior recorded security interests (including an AAPC) in
order to prevent a single creditor from closing off alternative sources of credit to the debtor. (A)
true (B) false

29. Financial institutions (banks, insurance companies, FSA, etc.) are a major source of
agricultural credit. List three other sources of agricultural credit.

30. In Nebraska, creditors must give borrowers ____________________________ before they
foreclose on an agricultural debt of $_____________ or more.

___ 31. Farmers can go to jail for selling crops subject to perfected security interests and not
using the sale proceeds to repay the loan. (A) true (B) false

32. Briefly discuss what a cash rent landlord needs to do (1) to obtain a security interest in the
crop for payment of the cash rent and (2) to have priority over the tenant's operating lender.

33. Livestock producers have __________ days after nonpayment from meat packers for
animals delivered to notify USDA of the nonpayment and _________ days after the packer's
check has bounced to notify USDA of nonpayment in order to have priority over the meat
packer's creditors in foreclosure and bankruptcy proceedings.

34a. Local Elevator is insolvent and its assets are being distributed to its creditors and other
claimants by the Nebraska Public Service Commission. There are three groups of creditors and
claimants: (1) Local Bank, who has provided operating credit to Elevator and has perfected
security interests in Elevator's inventory; (2) farmers who are storing grain with Elevator and (3)


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Ch 10: UCC Secured Transactions                                                           Fall 2005

farmers whose grain checks from Local have been dishonored (i.e. bounced). List the order in
which the three groups of creditors and claimants will be paid.

34b. Nebraska Beef Packers is insolvent and its assets are being distributed to its creditors and
other claimants. There are two groups of claimants: (1) perfected secured creditors and (2)
livestock sellers whose meat checks have been dishonored (i.e. bounced). List the order in
which the two creditors and claimants will be paid.

34c. Briefly discuss why, despite their factual similarity, situations 33a and 33b are legally
different.




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