Many agricultural producers borrow money to successfully run their operations. Typically, the lender requires the borrower to give a security interest in land, equipment or commodities before supplying the funds. This type of transaction is considered a secured transaction, as explained in the first article of this series, which is primarily governed by Article 9 of the Uniform Commercial Code (“UCC”). In general, a secured transaction is one that creates a security interest for the creditor. The creditor holds a security interest in debtors’ personal property, known as collateral, to ensure that the debtor repays the debt.

However, Article 9 requires the creditor to take several steps to make that security interest enforceable. As recently discussed in the second article of this series, the first of those steps is attachment. This step is important because, once the interest attaches, the creditor has the right to enforce the security interest in the collateral against the debtor.

After attachment, the next step for the creditor is perfecting their security interest. The third article of this series explained that the creditor must perfect in order to enforce its security interest against third parties that also have claims to the same collateral. Article 9 offers creditors many mechanisms to perfect, but as explained in the fourth article of this series, the majority of security interests in agriculture are perfected by filing a financing statement.

The creditor who completes each of these steps will hold a strong security interest, but when multiple creditors have an interest in the same collateral, the order of priority must be determined. As discussed in the fifth article of this series, priority is the order in which creditors receive money to satisfy a debtor’s loan debt. In other words, when multiple creditors have a security interest in the same property, the creditor with higher priority will receive payment before a creditor with lower priority.

Article 9 contains rules that determine which creditor has priority over others. In a priority dispute between unperfected creditors, the first creditor to attach their interest will receive priority over all other unperfected creditors. Under Article 9, when two or more creditors hold security interests that are perfected by filing a financing statement, priority is determined by the time of filing. This is known as the “first-to-file” rule.

However, Article 9 also contains exceptions to the general priority rules, and if these exceptions are satisfied, priority rests with a third party who comes along after a secured creditor. In agricultural lending, purchase-money security interests and agricultural liens are the two most important and common priority exceptions.

Purchase-Money Security Interest

Priority rules such as the “first-to-file” are general rules when dealing with secured transactions; however, exceptions do exist. There are certain secured transactions that provide creditors with a special interest in the collateral. Under Article 9, a transaction creating a purchase-money security interest (“PMSI”) in collateral gives creditors special advantages for holding such interests. Primarily, a PMSI provides the creditor “super-priority” over other parties claiming an interest in the same collateral covered by the PMSI. Super-priority means the creditor with a PMSI will have first priority over third parties, even when these third parties perfected their interests before the creditor gained the PMSI.

A transaction which creates a PMSI occurs when a creditor loans money to a debtor so that they can purchase an item. In return, the debtor gives the creditor a security interest in that property. In terms of agriculture, a PMSI exists when a lender loans money so that a farmer can purchase either equipment or livestock, and the farmer gives the lender a security interest in the equipment or livestock purchased.

Even when the lender obtains a PMSI in farm collateral, they do not automatically have priority over third-party claims. The lender must take certain steps to gain super-priority in the collateral. However, depending on the type of farm collateral involved, Article 9 requires the creditor to accomplish different steps in order to perfect their interest.

In agricultural financing, PMSI’s are not the only type of security interest that enjoy super-priority. Another common form of interest that creates super-priority for the lienholder is an agricultural lien, which will be discussed in the next article of this series.

PMSI in Equipment

An agricultural lender who holds a PMSI in farm equipment can have priority over a conflicting interest in the same equipment if they perfect the PMSI. Under Article 9, the lender will have priority if their PMSI is perfected at the time the farmer takes possession of the equipment, or within twenty days after receiving possession. Although “possession” is not defined by the UCC, courts have determined that “possession” occurs when the farmer physically receives the equipment. Therefore, the lender must perfect their PMSI before, or within twenty days, of possession to have priority.

For example, consider the following situation:

• On March 1, Peyton went to Hometown Bank and received a loan to operate his farming operation. The parties sign a security agreement which states, “Peyton gives Hometown Bank a security interest in all of the farm equipment he currently owns and acquires in the future.” That same day, the bank perfected its interest by filing a financing statement.
• Later, Peyton decides he needs a new tractor. On June 4, he goes to Mr. Blue’s tractor dealership and picks out a tractor, but he does not have the money to cover the entire cost of the tractor. The parties entered into an agreement where Mr. Blue sells the tractor to Peyton on credit, and Peyton provides Mr. Blue a security interest in the tractor. Peyton takes possession of the tractor that same day.
• On June 15, Mr. Blue files a financing statement.
• On September 10, Peyton defaults on both loans, and the bank claims it has priority over Mr. Blue in the tractor.

In this example, Hometown Bank and Mr. Blue each have security interests in the tractor. However, Mr. Blue enables Peyton to purchase the tractor, which creates a PMSI. Also, Mr. Blue perfects his PMIS because he files a financing statement within twenty days of Peyton taking possession of the tractor. Even though the bank perfects first, Mr. Blue has priority in the tractor because he holds a perfected PMSI in the equipment.

PMSI in Livestock

Many agricultural lenders loan money to farmers for the purchase of livestock. When this occurs, the lender can gain a PMSI in the livestock and enjoy priority if they perfect this interest. However, unlike equipment, Article 9 requires the lender to meet certain criteria to perfect a PMSI in livestock.

Under UCC §9-324(d), a creditor will have priority over an earlier-filed security interest in the same livestock if: (1) the creditor perfects their interest by filing a financing statement before the debtor receives possession of the livestock; (2) the purchase-money creditor provides a signed notice to the holder of the conflicting security interest; (3) the holder of the conflicting security interest receives the notice within six months before the debtor receives possession of the livestock, and (4) the notice specifies that the purchase-money creditor has or expects to acquire a PMSI in the debtor’s livestock and describes the livestock.

Different from a PMSI in equipment, Article 9 places strict requirements on a creditor to obtain a PMSI in livestock. Specifically, for the creditor to gain a PMSI in livestock, they must file a financing statement before the debtor takes the livestock. Also, the PMSI creditor must send actual notice to other secured creditors before the debtor takes possession of the livestock. Consequently, when the creditor fails to meet these requirements, they do not hold super-priority status in the livestock over other creditors’ security interests in the same livestock.

For example, consider the following situation:

• Agri Bank extends an operating loan to Kate. The parties execute a security agreement which provides the bank a security interest in all of Kate’s cattle she presently owns, and any cattle Kate purchases in the future. The bank perfects this interest by properly filing a financing statement.
• Kate wants to purchase 20 calves from Steven, but does not have the cash to do so. Steven sells her the calves on credit, and the two enter into a security agreement that provides Steven a security interest in the cattle. Steven properly files a financing statement reflecting this interest.
• Steven sends a letter to Agri Bank stating that he provided Kate money to purchase the 20 calves.
• One day after the bank received Steven’s letter, he delivered the 20 calves to Kate.

In this situation, Steven has priority over Agri Bank even though the bank perfects its interest before Steven. Here, Steven obtains a PMSI in livestock because he sold cattle to Kate on credit. He also properly files a financing statement, sent the bank with notice that he was taking an interest in the 20 head of cattle, and the bank receives this notice. Importantly, Kate did not take possession of the cattle until all of these steps were complete. Thus, Steven perfects his security interest and obtains priority over the bank in the 20 head of cattle.

However, Steven’s super-priority security interest is not absolute. In most cases, if Kate decides to sell the 20 head of cattle, and Steven does not provide notice of his interest to the buyer, he may lose his security interest in the cattle.

Conclusion

Priority order is important for creditors. The creditor with first priority will have their loan debt repaid before any other creditor, which is important because lower priority creditors may go unpaid. Most often, the creditor who perfects their security interest in a timely manner gains protection against other parties who claim an interest in the same collateral. However, the creditor may not be protected against claims of third-parties who hold a PMSI in the same collateral. This is because a creditor holding a PMSI will gain priority as long as they properly satisfy the Article 9 requirements to perfect the PMSI. Thus, there is not much a creditor can do to gain first priority in collateral that is secured by a perfected PMSI.

Upcoming

This article is the sixth in a series that the National Agricultural Law Center will publish over the next several weeks discussing the law surrounding secured transactions. The next article will discuss agricultural liens. Specifically, the next article will explain the difference between security interests and agricultural liens, and how these liens interact under Article 9 of the UCC.

To read the first article in this series, click here.

To read the second article in this series, click here.

To read the third article in this series, click here.

To read the fourth article in this series, click here.

To read the fifth article in this series, click here.

For a general overview of agricultural lending, click here.

For U.C.C. Forms and Filing Information, click here.

For more National Agricultural Law Center resources on finance and credit, click here.

For more National Agricultural Law Center resources on secured transactions, click here.