Food Security Act Doesn't Apply to Proceeds

The Food Security Act of 1995 is part of a matryoshka of statutes.   In the center is the general rule of 9-320(a) of the UCC, that a buyer in the ordinary course of business takes free of a security interest created by its seller.  The next doll is the Farm Products Exception, which I wrote about here:  except, most notably, in California, the buyer in the ordinary course rule does not apply to a buyer of farm products.  The next doll is the Food Security Act itself:  if you fail to comply with its terms, then the Farm Products Exception does not apply.  Finally, if you do comply, then the Farm Products Exception does apply. 

If that's not entirely clear, don't blame the messenger.

An interesting case out of the U.S. Bankruptcy Court for the Central District of Illinois asked this question:  does the Food Security Act apply to proceeds?  Here are the basic facts of CNH Capital America LLC v. Trainor Grain & Supply Co.:  Both CNH and Trainor had financed crops for farmers named Printz, who are now in bankruptcy.  CNH had the earlier filed financing statement.  Trainor was also the grain elevator which bought the crops.  CNH did not comply with the notice provisions of the Food Security Act.  Trainor had therefore, there was no dispute, purchased the crops free and clear of CNH's lien.  But what about the proceeds?  Trainor simply offset them against its debt and paid nothing to the Printzes.  Would it be able to walk away without paying, despite CNH's earlier filed financing statement?

Your ordinary buyer, when it pays for the crops, is concerned about double payment, which is why it will check the Food Security Act filings or notices of its seller.  In essence, Trainor wasn't making any payment at all; no cash was changing hands.  If it was wrong, it still had its debt.  That probably isn't worth much without collateral and with the farmers in bankruptcy, but also, as a secured party, it was clearly in second position behind another creditor. 

And that, in essence, is what the court held.  The Food Security Act protects a buyer.  If a secured creditor does not comply with its notice provisions (which, in some states like Idaho and Oregon, are essentially the same as for filing a financing statement, while in others, like Washington and, presumably, Illinois, involve actually sending notice to known prospective buyers of the farm products), then the buyer gets full title to the goods.  But what it does not get is priority in proceeds as well. 

Think of it this way:  if there were no Farm Products Exception--the rule that applies to purchasers of every kind of goods except farm products--would a buyer who also had a second security interest be able to take the goods by setting off its debt against the interests of a first priority secured creditor?  I think not, and that is what the court ruled here.

What if Trainor had paid the farmers and the farmers had turned around and paid Trainor in cash?  Under 9-332 of the UCC, unless Trainor and the farmers had been in collusion, Trainor would, outside of bankruptcy, have taken good title to the funds.  Of course, in bankruptcy, this was likely to be a preference and thus recoverable just as the setoff in the actual case was. 

The Missing Menu Item: the Farm Products Exception

I just got the latest issue of Business Law Today, published by the Business Law Section of the American Bar Association.  The cover has an intriguing title:  "Food and the Law."  The lead article has a title even closer to my heart:  "Le Menu: the UCC and Food", written by Steven O. Weise of Proskauer Rose LLP.  Steve is, in the interest of full disclosure, a friend, but in the interest of a full introduction, one of the most prolific writers and speakers on commercial law topics on the planet, someone who has been a mentor to many (myself included) and is engaging, witty and unbelievably smart.

Only he left out an item on his menu. 

In his discussion of Article 9 of the Uniform Commercial Code, he left out section 9-320(a), which is called the "Farm Products Exception."

I think I know why he left it out:  he practices in Los Angeles and California has never had the Farm Products Exception. 

After the jump, more on the Farm Products Exception.

For the rest of us, how the Farm Products Exception works is this:

The general rule is that when you buy something in the ordinary course of business, you own it free and clear, even if your seller had granted someone a security interest in what you bought.  If you walk into a hardware store and buy a wrench, you don't have to worry who Home Depot's lender is. 

The rule is turned around (twice, as we'll see in future entries) for farm products.  9-320(a) provides:

a buyer in ordinary course of business, other than a person buying farm products from a person engaged in farming operations, 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.

Thus, the general rule doesn't apply to a person buying farm products from a farmer.  And, as you read it more closely, you see that if it doesn't apply to a person buying farm products from a farmer, it never applies to those farm products at all. 

The easiest example is the farm stand.  If you buy strawberries at a farm stand, directly from the farmer, and the farmer has a secured lender, you are buying in violation of the rights of that lender.  This is just another reason to eat those farm-fresh products before you get back in your car.  They taste best that way, too, of course.

But the critical language, when applied to the Farm Products Exception is "created by the buyer's seller."  In the wrench example, you can usually assume that everyone in the chain of purchase, from supplier of raw materials to manufacturer to distributor to retailer, has purchased in the ordinary course of business.  So when farm products are not involved, you can also assume that you took free from the lenders to each of those persons.

With farm products, your assumption is turned on its head. 

Farmers have secured lenders.  Essentially all of them.  There may be a stray farmer out  there who can support operations without borrowing, but I've never encountered one.  There may be a lot of lenders who don't take the right steps to perfect their security interests (more on that in subsequent entries) but anyone dealing with farmers knows that you should assume that the farmer has a secured, perfected lender.

Returning then to the critical language, say you are a grocery store.  Unless you buy from farmers directly, you are not buying farm products, you are buying inventory from a processor or wholesaler (the definition of farm products makes it clear that only farmers sell them and the moment they leave the farmer's hands, they're not farm products anymore).  Since the safe harbor in 9-320(a) only applies to your direct seller ("created by the buyer's seller"), it doesn't cut off the claims of someone for whom the Farm Products Exception would have applied. 

The example that is often given is the steak sizzling on your plate.  The steak was cut from a cow, and the cow was farm products in the hands of the rancher, a person engaged in farming operations.  The rancher sold it to someone, who sold it to a slaughterhouse, who sold it to a meat wholesaler who sold it to your local grocery store, who sold it to you.  But the rancher had a secured, perfected lender, and that lender didn't get paid.  As a technical matter, the rancher's lender could snatch that steak right off your plate just before you stick your knife and fork into it.

The Farm Products Exception gets tied into the Federal Food Security Act., which is often said to preempt it, but actually only constitutes additional hurdles to its application.  There are also practical ways--mainly the issuance of joint checks to farmers and their lenders--by which grain elevators, processors and other buyers of farm products typically avoid complications of the Farm Products Exception.  Those will be dealt with at length in subsequent entries.  The Farm Products Exception has led to a lot of litigation, and in times of farm bankruptcies it becomes more and more critical for everyone to understand how it affects their rights.

Except in California.  Bon appetit, Mr. Weise.  As he says in the last line of his piece, "So where would we be without the UCC?  Hungry!"