When times are good, the farmer-lender relationship usually is positive or perhaps even an afterthought for most farmers. However, when times are tough, the relationship can quickly become strained, especially when there are misunderstandings about the legal obligations owed under the terms of the farmer’s loan. This article provides information to help avoid some of those basic misunderstandings and preserve a positive working relationship between farmers and their lenders.
1. The “Standard” Loan Package.
While many financing packages vary due to individual circumstances, most agricultural loans revolve around five documents: promissory notes, mortgages, security agreements, personal guaranties, and loan agreements.
Promissory notes are the documents through which borrowers promise to repay a loan under certain terms. Whoever signs the promissory notes assumes a personal legal obligation to repay the debt. Typical terms include the loan amount and structure (that is, whether the loan funds will be extended as a lump sum, a line of credit, or otherwise), interest rate, and maturity date. When a lender extends funds under a promissory note and those funds are not paid pursuant to the note’s terms, the lender can obtain a money judgment against the borrower who signed the note and any guarantor.
Mortgages are the documents through which borrowers or guarantors grant property interests in real estate to lenders. However, borrowers do not convey present ownership of real estate through mortgages. Instead, they convey a mortgage interest that pledges real estate as collateral for a loan. If the borrower defaults under the loan, the lender can foreclose on the mortgage and force a sale of the real estate pledged in order to pay down the loan. The foreclosure process is multi-faceted and governed by state law, but in short, a Minnesota foreclosure sale can be conducted with or without court involvement, requires various pre-sale notice periods, entails an auction conducted by the local sheriff’s office, and includes a post-sale redemption period during which the person who gave the mortgage retains possession of the pertinent property and can essentially buy the property back.
Security agreements are the documents through which borrowers or guarantors grant the lender a property interests in personal property that acts as collateral for a loan. In the agricultural context, security agreements often cover things like current and future crops, grain, livestock, equipment, and accounts receivable, but in many instances a security agreement will cover all personal property owned by the person signing the security agreement. Security agreements are governed by laws different than those governing mortgages, but security agreements are similar to mortgages in many respects. That is, when a borrower defaults under a loan secured by a security interest, the lender can force a sale of the personal property identified in the security agreement, and the proceeds from that sale will be applied to pay down the underlying loan.
A personal guaranty is a document through which someone other than the borrower promises to be jointly liable for the borrower’s debt. When a borrower is a business entity, the lender will almost always require the business entity’s owner(s) to sign a personal guaranty. A lender will also typically desire a personal guaranty if the borrower has insufficient collateral to pledge through a mortgage or security agreement but can identify a third party who is able and willing to sign a personal guaranty and, potentially, pledge additional collateral through a separate mortgage or security agreement. If a borrower defaults on his or her debt obligations, the lender can pursue collection against the borrower and/or any guarantor.
Finally, loan agreements are overarching documents that govern the financing extended to borrowers. Loan agreements typically reiterate the terms of various loan documents, impose further rights and obligations, and generally tie together all pieces of the financing arrangement. While loan agreements are common, they are not always entered into as part of the standard agricultural loan, and the absence of a loan agreement does not affect the validity of other executed loan documents.
2. Common Events of Default.
While the above documents convey different rights, the events constituting default under them are quite common. The most obvious event of default is the failure to make a payment on the promissory note when the payment is due. Other less obvious events of default include the following:
- False statements: the borrower makes a false statement or representation to the lender.
- Bankruptcy: the borrower files a bankruptcy petition.
- Judgments: a court enters a judgment against the borrower.
- Nonpayment of taxes: the borrower fails to pay his or her taxes when due.
- Impairment of collateral: the borrower’s collateral pledged to secure the loan is destroyed or otherwise impaired, including through the establishment of a statutory lien discussed below.
- Unauthorized sale of collateral: the borrower sells collateral pledged to secure the loan without remitting the resulting proceeds to the lender.
- Adverse change: a material adverse change occurs in the borrower’s financial condition or the lender believes that the borrower’s ability to repay the loan is impaired.
Loan documents usually have cross-default provisions stating that if the borrower defaults under one document, the borrower will be in default under all loan documents he or she executed. For example, if a borrower signs promissory notes A and B, keeps payment current under promissory note A, and fails to keep payment current under promissory note B, the borrower will be in default under both promissory notes A and B. Due to these provisions, it is important for borrowers to ensure that they satisfy the conditions of all loan documents they sign and not assume that their liability can be limited through compliance with some, but not all, of those documents.
3. The Impact of Statutory Liens.
The potential for imposition of a statutory lien further complicates many lending relationships. The term “lien” refers to a type of property right that allows a person (the “lienholder”) to take possession of certain property belonging to a debtor if an underlying debt is not paid. Mortgages and security interests are voluntary liens that are created by contracts. Statutory liens are involuntary and are created by operation of the law when certain debts are not paid. Minnesota law provides for various statutory liens in the agricultural context, including the following:
- Landlord’s lien: a landlord renting cropland to a farmer can obtain a lien on the crops grown on the landlord’s land if the farmer does not pay rent.
- Harvester’s lien: a person providing harvesting services can obtain a lien upon the crops being harvested equal to the amount charged for the harvesting services.
- Crop production input lien: a supplier furnishing crop production inputs can obtain a lien upon the crops being grown equal to the cost of the crop production inputs that are furnished.
- Veterinarian’s lien: a licensed veterinarian that provides emergency veterinary services can obtain a lien on the animals treated equal to the amount charged for the veterinary services.
- Breeder’s lien: a livestock owner whose livestock are used for breeding services can obtain a lien on the offspring.
- Livestock production input lien: a supplier furnishing livestock production inputs can obtain a lien upon the livestock being raised equal to the cost of the livestock production inputs that are furnished.
- Feeder’s lien: a person who stores or cares for another’s livestock can obtain a lien on the livestock equal to the amount of the value of the services provided.
Someone claiming one of these liens must take specific steps to ensure that the lien is enforceable, and while some of the liens can, in specific circumstances, take priority over a lender’s mortgage or security interest, many will not. Nonetheless, borrowers should take care to prevent a situation where a statutory lien is created and potentially impairs a lender’s collateral position.
4. (In)action Items that Farmers Should Understand.
With the above information in mind, here are some actions that farmers should avoid in order to maintain a positive farmer-lender relationship.
First, farmers should not sell property that constitutes a senior lender’s collateral without obtaining the lender’s consent or remitting the proceeds to that lender. This principle applies to both large parcels of farmland and smaller commodities such as grain and livestock. Agricultural loans are often provided to enable farmers to acquire or produce the property that constitutes collateral, and senior lenders usually are entitled to be paid first from the proceeds of the sales of such property.
Second, and related to the first, farmers should not remit collateral proceeds to junior lienholders. Some farmers will obtain loan proceeds from—and pledge collateral to—multiple lenders. Some farming operations will also purchase farm supplies on account rather than using money from an operating loan to pay for the supplies. If the account for the supplies is not paid, the supplier might file a statutory lien. As a result, multiple lenders and suppliers might claim the same property as collateral. But when collateral is sold, there will always be one senior creditor entitled to the proceeds until its account is paid in full, and oftentimes that senior creditor is the first financial institution that extended funds to the farmer. In stressed times, this could mean that some junior creditors, suppliers, vendors, and contractors cannot be paid in full or perhaps not paid at all.
Third, borrowers should not, intentionally or unintentionally, make inaccurate disclosures to their lenders. Accurate disclosures enable lenders to determine how to structure the loan, help ensure that a borrower can feasibly service the loan, and help ensure that there is sufficient collateral to cover the loan amount if the borrower is unable to service the loan. Inaccurate disclosures might be deemed fraudulent and can result in loans and judgments that can never be paid.
Fourth, borrowers should avoid creating circumstances in which a lender may need to make a “protective advance.” A protective advance essentially is the lender’s right to make certain payments to third parties when the borrower does not. Protective advances are perhaps most commonly made when a borrower fails to pay his or her taxes or rent. In such situations, the lender may pay the taxes or rent on the borrower’s behalf in order to prevent the filing of a tax or landlord’s lien and then add the payment amount to the principal balance of the borrower’s loan. A lender’s need to make a protective advance often signals a distressed loan and indicates that larger operational issues exist.
The various parts of lending arrangements and requirements are not always obvious to borrowers or simple to determine. Sometimes such arrangements and requirements are not given proper attention until it is too late. But when borrowers understand and give proper attention to their financing and their potential financial landscape, lenders are often much more willing to work with their borrowers in difficult times. An important component in all this is accurate, frank communication whenever financial conditions stress the famer-lender relationship.
This information is general in nature and should not be construed as tax or legal advice.
Co-written by Jeff Braegelmann and Chris Bowler