The Under-Used Effective Financing Statement — Protection Against Unauthorized Sales of Farm Products
As the farm economy tightens, the chances increase that your farm borrower may sell his or her grain without paying you the proceeds. Your borrower might have several reasons for doing so, but none of them are sufficient. For example, farmers may want to pay their input providers first, or they may have other creditors pressuring them for payment. Unauthorized sales of grain can leave lenders with a much smaller source of repayment than they anticipated.
If the lender gave a sufficient direct notice to the buyer or, in Nebraska and some other “central filing states” if the lender filed an effective financing statement (“EFS”) and if the lender did not consent to the borrower’s sale of its collateral, it can demand payment from not only the borrower, but also from the buyer of those farm products. It can sue the buyer to recover, if necessary, but in order to prevail as to the buyer, the notice or EFS must have been was properly prepared and sent or filed. Nebraska allows a filed EFS, while Iowa and Kansas are direct notice only states. Of course, there can be situations when lenders feels they have adequate safeguards against conversion of proceeds and do not wish to file an EFS or send direct notice. Nothing in the law mandates either of these procedures.
Some Basics About an EFS and Direct Notice
The EFS and the direct notice are not a substitutes for a security agreement and a UCC financing statement. Both are intended to provide notice of the lender’s claimed farm products, preserving the lender’s rights against buyers of farm products. If the lender has complied with the EFS or direct notice rules, and a buyer does not obtain the lender’s consent to pay the borrower for the farm products, the buyer could end up paying for them twice-once to the buyer and again to the lender.
For the lender, attention to the details of an EFS or direct notice is crucial. For an EFS or a direct notice to be effective, it must include all of the following:
- The name and address of the secured party;
- The name and address of the secured party’s borrower;
- The Social Security number, tax identification number, or approved unique identifier (number approved by the Secretary of State) of the borrower; and
- A description of the farm products, including farm product name, amount, crop year, and the name of each county in which the products are produced or located.
One disadvantage of the direct notice is that in order to be effective, the lender must have sent the notice to the buyer within a year before the sale to the buyer. As a result, the direct notice will not provide protection against other, previously undisclosed buyers that the farmer might choose when he decides to sell his products. On the other hand, the EFS, when properly filed an a central filing state, is effective as to all buyers who purchase farm products produced in that state. Like a UCC financing statement, an EFS is filed with the Secretary of State (in the state where the farm products are produced or located if that state has central filing) but the form is altogether different. Note that the EFS does not apply to farm equipment—only farm products, such as grain and livestock.
the Food Security Act
This legal protection for buyers and lenders is set forth in a 1985 law known as the Food Security Act (“FSA”). It puts agricultural lenders in a better position than other lenders who have non-agricultural inventories as their collateral (for example, the lender to a furniture store cannot recover from the customer who purchased a recliner from the store in the ordinary course, even though the seller pledged that recliner as collateral to the lender.) Buyers are also better protected under the FSA because they either receive a direct notice or they can search a special state filing system just for farm products without having to wade through dozens of UCC financing statements. Buyers can also subscribe to services that provide a periodic list of sellers who have pledged their farm products.
Court Decisions that Affect the Lender’s Rights
In the cases where lenders have sued buyers of farm products, courts have ruled against the lenders when their notice or EFS filing left out required information like the county or tax ID of the borrower.
In the Eighth Circuit (which includes Nebraska and Iowa), the courts have a “substantial compliance” standard for EFS financing statements—if your EFS is correct in most respects, it may be sufficient. But the courts have a tougher standard for the direct notices—any missing or incorrect piece of information in the notice could be fatal to enforcement.
Filing an EFS or sending a direct notice is easy and inexpensive. It’s cheap insurance against a financially-stressed farmer who chooses to ignore his or her obligation to pay over crop proceeds to his secured lender, and may provide you with a basis for a claim against your borrower based on an unauthorized sale of farm products.