Over the last two years, the world has grappled with the COVID-19 pandemic. In an effort to address the economic crisis following the arrival of COVID-19, the United States took a number of significant actions, including, among other things, infusing cash into the national economy, generally, and the agricultural industry, in particular. The introduction of liquidity into the agricultural industry altered many aspects of typical lender-borrower relationships.
For example, over the past two years many lenders have not initiated foreclosure or replevin actions because borrowers have often times had sufficient cash reserves to pay their financial obligations to their lenders. In like manner, during this timeframe we have not seen a significant number of farmerborrowers filing for Chapter 12 bankruptcy protection because these borrowers have been able to maintain their farming operations and pay their bills. That said, given economic uncertainties at home and abroad, lenders should be mindful that the agricultural economy could easily take a turn for the worse. If that were to happen, farmer-borrowers may find themselves cash-strapped and unable to pay their lenders. Given this possibility, it is advantageous for lenders to be mindful of the enforceability of their security interests in their collateral.
This article is intended to be a “refresher” regarding the enforceability of lenders’ security interests in their borrowers’ machinery and equipment. Depending upon the size of a borrower’s operation, this category of collateral can serve as a significant source of recovery for a lender in the event that a borrower is unable or unwilling to voluntarily pay his or her financial obligations to the lender. But machinery and equipment can be easily liquidated by a borrower without the lender’s knowledge or consent. This becomes a particular problem when the borrower does not voluntarily turn over the proceeds from the sale of this collateral to the lender. In these situations, in order to obtain a recovery, the lender may need to enforce its security interests against third parties who purchased the borrower’s machinery and equipment.
By way of example, a lender may run into a situation similar to the following: Lender has a blanket lien on a farmer debtor’s (Farmer) equipment, which includes a non-titled, four-wheel drive tractor. Farmer trades in the tractor to a dealership (Dealer), but Dealer does not obtain a release of the Lender’s lien. Dealer subsequently sells the subject tractor to a second farmer (Farmer 2) without authorization from Lender. Lender must then determine (1) whether Lender has any recourse against the Dealer and/or (2) whether Lender has any recourse against Farmer 2. As a threshold matter, the following statutes provide the primary basis for addressing the situation referenced above.
The general rule applicable to traded-in farm equipment subject to a security interest is that “[e]xcept as otherwise provided in this article and in section 336.2-403(2): (1) 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 agricultural lien; and (2) a security interest attaches to any identifiable proceeds of collateral.” Minn. Stat. § 336.9-315(a)(1)(2). Consequently, unless the buyer of traded-in farm equipment falls within an exception to Minn. Stat. § 336.9-315(a) (1)(2), the buyer buys traded-in farm equipment subject to the security interest.
However, there are two primary exceptions to this general rule which may apply to the above situation. First, [e]xcept as otherwise provided in subsection (e), a buyer, other than a secured party, of . . . goods . . . takes free of a security interest or agricultural lien if the buyer gives value and receives delivery of the collateral without knowledge of the security interest or agricultural lien and before it is perfected.” Minn. Stat. § 336.9-317(b) (emphasis added). Second, “[e]xcept as otherwise provided in subsection (e), 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.” Minn. Stat. § 336.9-320(a) (emphasis added).
With these principles in mind, a lender encountering a factpattern like the one mentioned above may run into one of the following scenarios:
On January 1, Lender loans $300,000 to Farmer, and Farmer grants Lender an enforceable security interest in all farm equipment, including but not limited to a non-titled, fourwheel drive tractor. On January 2, Lender files a properly completed financing statement describing the collateral as “all equipment.” On August 1, unbeknownst to Lender, Farmer trades the subject tractor in to Dealer as part payment of the purchase price for a new tractor. On August 10, Dealer sells the subject tractor to Farmer 2. Lender does not know about the sale, and hence did not authorize the sale. On October 1, Farmer defaults on his obligations to Lender. On November 1, Lender learns that Farmer 2 has the subject tractor and seeks replevin. Who wins between Lender and Farmer 2?
Lender should win because no exceptions exist to the general rule in Minn. Stat. § 336.9-315(a) that the security interest follows the subject tractor notwithstanding the sale. As a threshold matter, Lender did not know about the sale, and hence Lender did not authorize the sale. Second, none of the “buyer rules” in Minn. Stat. § 336.9-317(b) and Minn. Stat. § 336.9-320(a) protect Farmer 2.
The exception in Minn. Stat. § 336.9-317(b) does not apply in this hypothetical because Lender had a perfected security interest before Farmer 2 purchased the subject tractor. Furthermore, the exception in Minn. Stat. § 336.9-320(a) does not apply because although Farmer 2 is a buyer in the ordinary course because it bought from someone (the Dealer) in the business of selling goods of that kind, the Dealer (the seller in this case), did not create the security interest. Rather, Farmer created the underlying security interest. In order for the exception in Minn. Stat. § 336.9-320(a) to apply the (1) buyer must be a buyer in the ordinary course, and (2) Farmer 2’s seller must have created the security interest in the subject tractor.
On January 1, Lender loans $300,000 to Farmer who grants Lender an enforceable security interest in all farm equipment, including but not limited to a non-titled, four-wheel drive tractor. On January 2, Lender files a properly completed financing statement describing the collateral as “all equipment.” On August 1, unbeknownst to Lender, Farmer trades the subject tractor in to Dealer as part payment of the purchase price for a new tractor. On August 10, Dealer sells the subject tractor to Farmer 2. Lender does not know about the sale, and hence did not authorize the sale. On October 1, Farmer defaults on his obligations to Lender. On November 1, Lender learns that Dealer sold the subject tractor to Farmer 2, but Farmer 2 has himself since sold the tractor and Dealer cannot locate it. What remedy does Lender have against the Dealer?
Lender has a conversion claim against the Dealer because the Dealer purchased the subject tractor (by taking it on a trade) subject to Lender’s security interest.
In sum, under certain circumstances a lender may seek to recover its collateral or monetary damages from persons or entities other than the lender’s borrower. This is especially important to keep in mind in situations where a borrower may be judgment proof or file for bankruptcy after the lender commences a replevin action. In either case, recovering collateral from a cash-strapped borrower may not be an option, but the lender may be able to recover its collateral or obtain other relief from a third party who previously purchased the lender’s collateral. Of course, each case is different, and a lender’s collection options will vary depending upon the circumstances. Nonetheless, the “takeaway” from this article is that in many situations a lender’s security interest will continue in its collateral following a borrower’s disposition of that collateral. It may be worth pursuing that collateral from a third party in situations where a lender has limited options for recovering funds or collateral from a borrower who is unable or unwilling to honors its financial obligations to the lender.