A Quick Look at Revised Article Nine; Seven and a Half Years in.

Although the Revised Article Nine drafters were severely and justifiably criticized for increasing the complexity and length of the statute and for destroying the work of art that was Grant Gilmore’s Magnus Opus, their product has so far been very successful in meeting the drafters’ goal of increasing certainty for business lenders and borrowers. Their lightning fast and complete ratification by the fifty state legislatures was nothing short of miraculous. Their decision to abandon the general principles of the original version of Article Nine and replace them with a host of specific rules backed up by comments and, if necessary, commentaries or even phone calls from the drafters has made the rules clearer to borrowers, lenders and particularly to judges. This system of rules will, however, require that as new or unanticipated types of transactions or issues arise the Code must be amended rather than expecting these unanticipated  issues or transactions to be decided under the general principles of the Code. Let’s look briefly at two issues, the Code’s treatment of individual names and its effort to integrate agricultural statutory liens into Article Nine. 

1. Names of Individuals
The primary area that has generated problematic litigation and non uniform legislative fixes involves loans to individuals. This is not an easy problem to solve and perhaps the drafters simply ran out of time and energy after they had spent years thinking and drafting to regulate larger commercial transactions, and then at the last minute debating and implementing (and according to one Reporter  caving in to) the “consumer compromise.” Or perhaps they concluded that since underlying state law regarding legal names, on which the Article Nine system must operate was non uniform that they could do more harm than good by developing a specific approach. (Interestingly they made considerable progress with the treatment of perfection of security interests in motor vehicles, where Article Nine also rests upon non uniform state laws.) Or perhaps, since their primary focus was on large commercial transactions they felt that loans to individuals were not a weighty matter. The fact that they did not find a successful “fix” for this issue has led to litigation and commentary and has created uncertainty among those who lend to individuals and has resulted in incomplete and non uniform legislative statutes in at least two states.

The difficulty arises because it is hard to know the correct name to use for an individual; the problems occurs when the first secured creditor uses one name for the individual and a subsequent  searcher or subsequent secured creditor uses a different name or, more particularly if a bankruptcy judge determines that a secured creditor did not use the correct name. So far, Texas and Tennessee have enacted non uniform legislation. The joint guardians of the Code, ALI and NCCUSL, are likely considering the question of whether to convene an official committee to address this issue. It will be interesting to see what they decide and to watch the progress of the committee if they decide to go forward.

2. Agricultural Liens

The orchestrators and leaders of the Article Nine drafting process began that effort with a courageous determination to improve the fit of agricultural and agribusiness lending within Article Nine.  The plethora of cases that resulted from the ag depression of the 1980’s demonstrated that the fit was not a good one, and that there was considerable room for improvement. These leaders made sure to invite members of the American Bar Association  Sub Committee on Agricultural and Agribusiness Credit into that process at every stage, from the organization of the Study Committee to the work of the Drafting Committee.  The members of that ABA Committee worked with industry representatives to make sure that the final product reflected the best thinking of the secured lenders.

One of the key decisions was to have Article Nine include within its scope non possessory, statutory agricultural liens (“Ag Liens” or “Agricultural Liens”), including landlord’s liens against crops. Other examples include feeder’s liens against livestock and liens against crops in favor of suppliers of fertilizer and pesticides. (The author acknowledges a debt to the June 2008 edition of Clark’s Secured Transactions Monthly for some of the analysis in this post.)

Although Agricultural Liens are not security interests, Article Nine does establish certain of the rules for their enforcement and expressly provides that the Article Nine priority rules will apply unless the state statute that establishes the Agricultural lien expressly provides that such a lien prevails over an Article Nine security interest that is prior in time. In general, perfection of statutory ag liens is accomplished by a UCC filing although the place of filing is different from the place of filing for security interests. For security interests the place to file is the state where the debtor is located; for ag liens, the place to file is the state where the crops and livestock against which the lien is imposed are physically located. Another difference is that although a consensual security interest in most collateral automatically carries over to proceeds, unless the statute creating the ag lien states that the lien continues in proceeds from the disposition of farm product, the ag lien does not extend to the proceeds even if they are identifiable.  Finally, the rules for remaining perfected when collateral subject to an ag lien is moved to another state differ from those applicable to security interests in that same collateral.   

Recently the Montana Supreme Court faced a battle between an ag lienor and a secured creditor that had fully complied with Article Nine.  It is interesting to look at that decision and consider how well the drafting committee did its very difficult job of reconciling the rights of these competing parties.

In Stockman Bank of Montana v. Mon-Kota, Inc.  65 UCC Rep. Serv. 2d 174, 180 P. 3d 1125, 342 Mont. 115 (Sup Ct of Montana , 2008) the Bank had lent five  million dollars to the debtor and took as collateral a blanket security interest in all the debtor’s crops and crop revenues. The bank properly perfected by filing a financing statement with the Secretary of State of North Dakota where  the Debtor was incorporated.

Subsequently Capital Harvest (the financing arm of the chemical seller) financed the sale of $500,000 of ag chemicals to that same borrower. Capital Harvest filed an ag lien statement with the Montana Secretary of State under the Montana statute which created the lien against crops to suppliers of chemicals used on those crops. The borrower sold its crop to two buyers who paid with checks made payable to the bank and the chemical supplier. The suit was filed by the bank to determine whether the bank or the chemical supplier/financer had priority in those funds. 

The Court held:

The supplier did not need to perfect its ag lien by filing in North Dakota even though the borrower was a North Dakota corporation. The normal  UCC filing requirement  applicable to consensual security interests did not apply to statutory ag liens. The crop was located in Montana and that is where Article Nine requires the filing for ag lien interests.

Although the supplier had not filed a UCC financing statement, its filing of a lien statement required by the Ag lien statute had all of the information that was required for a UCC financing statement and was filed into the same database with the Secretary of State as a financing statement. The statutory lien statement thus sufficed as its filing for perfection since requiring a separate financing statement would have been an unnecessary duplication.   

The Montana statute that created the ag lien expressly gave priority to the supplier’s lien over an earlier filed security interest in that same collateral. 

Article Nine leaves to the statute creating the ag lien the question of whether that lien extends to proceeds. The Montana statute creating the lien in favor of the chemical suppliers did not extend to revenues generated by the sale of the treated crops and thus those revenues were not captured as proceeds under Article Nine. The Court noted that although the agricultural lien statute does not extend the lien to proceeds of the collateral, Article Nine does provide that a ‘security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest or the agricultural lien. ‘ Thus, an agricultural lien remains attached to the collateral even after its sale or transfer.  Consistent with the UCC rules, the Montana ag lien statute provides that a buyer of farm products takes free of any lien unless a lien statement has been filed with the secretary of state. In short, since the Ag lienor had  complied with the Montana statutes, the supplier’s lien continued on the crops even though and after there were purchased by the buyers. That was the situation at the moment the buyer paid for the crops. 

As part of its decision to rationalize the relationship among Article Nine security interests in agricultural collateral with ag liens created by other state law, the drafters decided to provide parallel treatment for the enforcement of agricultural liens and security interests. Thus, the ag lien holder had the right to “reduce a claim to judgment, foreclose, or otherwise enforce the claim, security interest, or agricultural lien by any available judicial procedure.”  As the court stated “Title 71 also recognizes the right of an agricultural lien holder to pursue judicial enforcement and requires an ‘owner of property against which a lien is filed’ to also pay the lienholder’s costs, and attorneys fees even if the owner’ pays the underlying claim before an action is filed on that claim or to foreclose the lien.‘ (citation omitted. ) Thus, the right to judicially enforce or foreclosure an agricultural lien is not lost upon sale or transfer of the products.”

As this is the most troublesome portion of the courts holding it is important to quote their exact language. “In apparent recognition of these principles, Holly Sugar and Sidney Sugars, Inc. (the buyers) issued checks which were made jointly payable to Stockman Bank and Appelees, including the lienholder here, Capital Harvest. In so doing the buyers honored Capital Harvest’s agricultural lien, and Capital Harvest’s unconditional negotiation of the check acknowledged satisfaction and release of its lien.” Thus the ag lienholder was able to keep the $500,000. (Note: there was no mention in the opinion regarding what effect, if any, the Food Security Act would have on this decision.) 

Most of the opinion and decision up to this point are grounded on wise judicial reasoning interpreting a well thought out statute and a change in Article Nine that makes sense. This portion of the analysis impicates other articles of the Uniform Commercial Code and other provisions of state law and  is a bit forced although it seems to come to a generally appropriate conclusion. If the fight were soly about priority in the crops before they were sold it is clear that the holder of the ag lien would prevail; if the fight were soly about priority in the proceeds of the crops it seems clear that the holder of the security interest would prevail since the ag lien holder’s property interest does not transfer from the crops to the proceeds. Here the court seems to infer that the payment was made to the ag lien holder specifically or expressly in consideration of the need of the buyer to have the ag lienor’s property interest in the crops extinguished. If that is the case, then indeed, the first dollars paid by the purchaser to satisfy those interests would seem to belong to the ag lien holder since it had a first priority position on those crops. However, the path the court takes to reach this conclusion is not a smooth one and perhaps there are a few missing steps. (One wonders if the crops in then hands of the buyers are still subject to the Bank’s lien.) 

3. Conclusion

The drafters were wise and courageous to try to subsume within Article Nine the reconciliation of these important interests of agricultural and agribusiness  borrowers and lenders; it is a complex job but looking at the first case to examine the treatment carefully it appears the Article Nine treatment of ag liens is on the right track although there are still some wrinkles that will need to be ironed out.