Summary of a Recent
Judicial Development in
Bankruptcy

Disaster Payments Property of the Estate

Harrison M. Pittman
Center Research Attorney

The United States District Court for the District of North Dakota has affirmed a decision that held that crop disaster payments received post-petition by two Chapter 12 debtors were "property of the estate" because the payments were proceeds of the estate property that were in the debtors' possession at the time debtors filed their bankruptcy petition. FarmPro Services, Inc. v. Brown, 276 B.R. 620, 622 (Bankr. D.N.D. 2002)).

William and Gayle Brown, co-debtors, filed a Chapter 12 bankruptcy petition on February 18, 1999. See id. at 622. While the Browns' Chapter 12 case was pending, they obtained an operating loan from the Ag Acceptance Corporation ("Ag Acceptance"). See id. In exchange for this loan, Ag Acceptance "took a security interest in, inter alia, existing and future crops, government agricultural program payments, and their proceeds." Id. (emphasis supplied). On May 17, 1999, Ag Acceptance perfected its security interest by filing a financing statement. See id.

The Browns obtained another operating loan from FarmPro Services, Inc. ("FarmPro") on May 17, 2000. Id. The bankruptcy court approved this loan "and authorized FarmPro to take a security interest in, inter alia, existing future crops, government agricultural program payments, and their proceeds." Id. (emphasis supplied). The bankruptcy court stated in its order, however, that "'[a]ny security interest granted in favor of FarmPro Service under the terms of this Order shall be secondary to any previously granted security interest to Ag Acceptance Corporation covering the same security.'" Id. FarmPro perfected its security interest on June 12, 2000, when it filed a financing statement. See id.

On September 29, 2000, the Browns filed a Chapter 13 bankruptcy petition that was converted to a Chapter 11 bankruptcy in December, 2000, and to a Chapter 12 bankruptcy on June 4, 2001. Id. at 623. On October 28, 2000, Congress appropriated funds for disaster relief payments for the 2000 crop year. See id. In July, 2001, the Browns received $80,000.00 in disaster relief payments from the Department of Agriculture. See id.

FarmPro and Ag Acceptance each claimed a right to the $80,000.00 in disaster payments. See id. FarmPro brought an adversary hearing against the Browns and WSB Trucking, a creditor unrelated to the present case, "to determine whether it had a first priority lien in the debtors' 2000 crop disaster program payments." Id. The Browns brought a second adversary proceeding against Ag Acceptance "to determine the validity of the claim of Ag Acceptance to the debtors' 2000 crop disaster program payments." Id.

The bankruptcy court ruled that both Ag Acceptance and FarmPro held valid security interests in the disaster payments and that Ag Acceptance held a first priority in the disaster payments. See id. FarmPro filed a motion to alter or amend the bankruptcy court's order and judgment soon thereafter. See id. The bankruptcy court denied FarmPro's motion. See id. FarmPro appealed the bankruptcy court's decision to the district court. See id. The Browns originally appealed the bankruptcy court's decision to the Bankruptcy Appellate Panel for the Eighth Circuit, but the matter was transferred to the district court. See id.

The district court first examined the Browns' argument that "the disaster payments are not part of the bankruptcy estate and thus are not subject to the pre-petition liens of Ag Acceptance and FarmPro." Id. at 623-24. "Property of the estate" includes "'all legal or equitable interests of the debtor in property as of the commencement of the case' and 'proceeds . . . of the estate.'" Id. at 624 (quoting 11 U.S.C. §§ 541(a)(1) & (a)(6)). Bankruptcy Code § 522 states that "a creditor's lien acquired by a pre-petition security agreement may extend to post-petition proceeds of secured property if the security agreement extends to proceeds of such property." Id. (citing 11 U.S.C. § 552).

The district court examined two cases that discussed the issue of how disaster payments are to be classified under §§ 541(a)(1) and (6), In re Vote, 261 B.R. 439 (8th Cir. BAP 2001) and In re Lemos, 243 B.R. 96 (Bankr.D. Idaho 1999). See id. In In re Vote the Bankruptcy Appellate Panel for the Eight Circuit determined that the disaster relief payments at issue were not considered to be "property of the estate" under § 541(a)(1). Id. In In re Lemos the United States Bankruptcy Court for the District of Idaho determined that the disaster payments at issue were "property of the estate" under § 541(a)(6), rather than under § 541(a)(1). See id. In the present case, the bankruptcy court relied on In re Lemos and In re Vote "finding that while Vote mandates that such payments do not constitute property of the estate under 541(a)(1), Lemos indicates that such property constitutes proceeds of the estate under 541(a)(6), and thus the creditors' security interests extend to these proceeds." Id.

The Browns urged the district court to adopt the holding in In re Vote and to reject the holding in In re Lemos because it was no longer applicable and because In re Vote was "now the controlling law in the Eighth Circuit and in Lemos the rights to the payments arose pre-petition rather than post-petition, as they do here." Id. The district court rejected each of these arguments. See id. The court stated that "[t]he debtors' first argument, that Lemos is no longer applicable, is incorrect. The Court agrees with the bankruptcy court's analysis and finds that the two cases are complementary and may be read together to form one rule." Id.

The court explained that in In re Vote the panel neither explicitly or implicitly decided not to follow the holding in In re Lemos. See id. The court also explained that in In re Vote the panel did not discuss whether the disaster payments at issue were proceeds because the bankruptcy trustee did not raise the issue in the bankruptcy court. See id. Instead, the panel "limited its holding to a determination that the crop disaster benefits did not constitute property of the estate under 541(a)(1), since the rights to the payments arose [pre]-petition." Id. Therefore, the district court determined that In re Lemos and In re Vote did not conflict and that In re Lemos was instructive to the case at hand. See id.

The district court also rejected the Browns' argument that because the disaster payments at issue in In re Lemos arose pre-petition, then In re Lemos does not apply to the present case where the rights to the disaster payments arose post-petition. See id. The court stated that in In re Lemos, the court's decision that the payments were proceeds "did not turn on when the rights to the payments arose. Instead, the court's characterization of the payments as proceeds was based on the nature of the payments. Thus, Lemos is directly applicable here." Id. The district court concluded that:

The Court finds the decision in Lemos, in which the court determined crop disaster benefits to be proceeds, to be sound and well-reasoned, and the Court hereby adopts this decision and the reasoning that precedes its decision. Accordingly, this Court finds correct the judgment of the bankruptcy court decreeing that the bankruptcy filing did not defeat the security interests of the creditors in the crop disaster payments.

Id.

Next, the district court examined FarmPro's argument that the bankruptcy court incorrectly determined that Ag Acceptance held a first priority lien in the Browns' existing and future crops, government agricultural program payments, and their proceeds. The general rule under North Dakota law is that "the first to file or otherwise perfect a security interest maintains a superior claim among conflicting security interests." Id. at 625 (citing N.D. Cent. Code § 41-09-33(5)). This general rule can be circumvented if one of the exceptions set forth in § 41-09-33 of the North Dakota Century Code applies. Id. The court explained that "Ag Acceptance perfected its security interest first, and FarmPro does not seem to dispute this point. Thus, Ag Acceptance has a first priority in the crop disaster benefits unless one of the exceptions set forth in section 41-09-33 . . . applies." Id.

FarmPro contended that the exceptions found under §§ 41-09-33(2) & (4) applied to the present case. Section 41-09-33[(2)] states that:

a perfected security interest in crops for new value given to enable the debtor to produce the crops during the production season and given not more than three months before the crops become growing crops by planting or otherwise takes priority over an earlier perfected security interest to the extent that such earlier interest secures obligations due more than six months before the crops become growing by planting or otherwise.

Id. at 626.

The district court ruled that § 41-09-33(2) was inapplicable because Ag Acceptance's promissory note became due on January 15, 2000, which was less than six months before the debtors 2000 crops were planted. Id. The court also ruled, without discussion, that the exception found in § 41-09-33(4), "which provides a security interest to purchase money security interests (PMSI), does not apply to the facts here." Id. The court added that "FarmPro's security agreement did not create a PMSI in the crop disaster payments; it created a PMSI, if [at] all, only in the 2000 crops." Id.

The case was decided on April 22, 2002; this summary was posted January, 2003