Agricultural operations are capital intensive, often requiring producers to take out loans to fund operating costs. Producers may receive loans from the Farm Credit System (“FCS”), commercial banks, processors, input suppliers, equipment dealers, or the Farm Service Agency (“FSA”). Due to the cyclical nature of agriculture, producers are “price-takers” and susceptible to market fluctuations, increased input costs, unpredictable weather conditions, deadly disease outbreaks, and trade disruptions. If a farmer is unable to generate enough revenue from their operation, they may struggle to repay their loan obligations.
When a borrower fails to repay their loan or violates their loan agreement, this is known as defaulting. At that point, the lender may require immediate payment of the entire outstanding loan, and if the borrower cannot pay the entire balance, the lender may foreclosure or liquidate the collateral pledged to secure the loan. As discussed in the first article of this series, the roadmap to foreclosure of a farmer’s debt depends on the type of loan, collateral, loan agreement, and lender.
This article examines the initial loan status determinations that must be made for an FSA borrower to be eligible for loan servicing options or for the lender to start foreclosure proceedings. Producers may experience financial difficulties from time to time that could result in missed loan payments. Therefore, it is important for producers to be aware of the warning signs so they can work with their lender to repay their loan and prevent foreclosure.
Lending Basics
When a lender issues a loan to a borrower, the goal is to assist the borrower by providing financing while at the same time, recouping that money plus interest through scheduled loan payments. Generally, the borrower must pledge collateral as security for the loan, meaning that if the borrower fails to pay off the loan, the lender can sell the collateral to cover the debt.
Collateral types can include real property, tangible personal property, and intangible personal property. Real property includes real estate or land. Tangible personal property includes farm products, crops, farm equipment, or livestock. Intangible personal property includes items like accounts receivable, crop insurance payments, federal farm program payments, or grower contract proceeds.
A loan is considered “secure” when the borrower pledges collateral in exchange for the loan funds- in other words, when the lender has a security interest or a lien in the collateral. This security interest gives the lender the right to take possession of the collateral and foreclose or sell the collateral to pay the debt. A lien is a “legally enforceable claim” on real or personal property that is used to secure repayment of a debt, or it can be “an encumbrance on property to enforce payment of an obligation.” 7 C.F.R. § 761.2.
To formalize the lending agreement, the parties must enter into certain legally binding documents that provide for the repayment terms, remedies for default, and terms and conditions of the loan. First, the parties will sign a promissory note, which records the borrowers’ promise to repay the certain loan amount by a specific date.
Promissory notes include information such as the principal loan amount, interest rate, schedule of loan payments, and duration of the loan. In other words, a borrower agrees to repay the principal loan amount plus interest to the lender on a pre-determined schedule for the duration or term of the loan.
FSA interest rates for direct loans are set in accordance with the Consolidated Farm and Rural Development Act. 7 C.F.R. § 761.9. FSA sets interest rates for direct loans and institutes maximum interest rates for guaranteed loans. FSA is barred by statute from setting interest rates that exceed the “current average market yield on outstanding marketable obligations of the United States with remaining periods to maturity comparable to the average maturities of such loans.” 7 U.S.C. § 1927.
The promissory note may also include terms like late payment penalties, a default clause, an acceleration clause, an after-acquired clause, cost of collection, an assignment, and a due on sale clause. However, some lenders may utilize a separate legal agreement called a loan agreement, in addition to the promissory note, that includes customized terms, conditions, and covenants.
Conditions are events that must occur prior to the loan being funded by the lender. A common condition is that the borrower must meet certain financial metrics prior to the distribution of funds. A covenant states requirements that must occur after the loan is funded by the lender. This may include affirmative covenants, which state “the borrower shall,” or negative covenants which state “the borrower shall not.”
A default clause may list certain parameters or events that trigger a default determination. The Federal Reserve Bank of Kansas City defines a loan default as “failure to repay a loan.” However, a lender may also issue a default declaration if the borrower breaches a covenant in the loan agreement, even if they have kept up with their payments. For example, if the buyer sells the listed collateral without the lender’s approval, that may be grounds for a default determination. An acceleration clause permits the lender to require the borrower to pay the entire balance of the loan if the loan is in default. An after-acquired clause gives the lender a security interest in any property the borrower acquired after the signing of the loan documents, even if the lender did not provide the financing. Loan agreements may be customized by the lender to fit the needs and financial circumstances of the borrower.
Next, depending on the type of collateral and type of loan the borrower needs, an additional legal document may be needed to establish a security interest. These documents may include a mortgage, security agreement, installment contract, personal guarantee, or operating loan agreement. The promissory note and any additional legal documents make up the borrower’s loan file. To learn more about the specific loan documents, click here to read “Financing the Farm: A Law Bulleting Series on Legal Arrangements for Farm Financing.”
A mortgage is commonly used to secure an interest in real property and is used in conjunction to the promissory note. In other words, if the borrower breaks their promise in the promissory note, then the mortgage enables the lender to go after the collateral listed in the mortgage to pay the debt. Therefore, it is important to understand the rights and responsibilities created in each loan document.
A security agreement is a loan document used in a secured transaction which occurs when one party provides credit to another in exchange for a security interest in property or the performance of and agreed upon action by the borrower.
Article 9 of the Uniform Commercial Code (“UCC”), as adopted in each state, is a set of model laws that cover aspects of commercial transactions in the U.S. It applies to secured transactions concerning tangible or intangible personal property and fixtures. Under Article 9, tangible personal property includes farm products, equipment, inventory, consumer goods, and fixtures, while intangible personal property includes items like deposit accounts or accounts receivable. To learn more about secured transactions in agricultural lending, click here to check out NALC’s series, “Lending for Livestock, Credit for Crops: The Basics of Secured Transactions in Agriculture.”
Delinquent, Past Due, and Default
Borrowers must make periodic payments on their loan as part of a repayment schedule created with their lender. A loan is considered delinquent when a payment is even one day late, and past due based on the loan repayment terms in the loan documents. Missing a loan payment puts the borrower in violation of the loan agreement and may lead to a default determination.
A loan is in default when the borrower has failed to repay the debt. According to the Federal Reserve Bank of Kansas City, “[t]ypically, a loan must be delinquent for 90 days or more before a lender will declare that the loan is in default.” A default determination allows the lender to call due the entire balance of the loan or take legal action to recoup the debt. A borrower that defaults on a loan agreement may be vulnerable to a foreclosure or liquidation action by their lender.
Drivers of Financial Stress
Producers are subject to changes in market prices, input costs, and weather conditions. These changes may have an adverse impact on a farmer’s financial resources and result in loan default. Additionally, crop failure, disease, trade, natural disaster, input costs, and market competition may impact a farmer’s ability to pay back their loan. However, off-farm financial stressors may also contribute to loan delinquency such as illness, death, personal debt, and lack of succession planning. Unfortunately, missed loan payments may lead to more lasting consequences depending on the lender and the terms of the loan agreement.
From Past Due to Default: Farm Service Agency
The FSA serves as the “lender of last resort” for farmers and ranchers that are unable to receive credit from other lenders. With that, though, comes a statutory mandate for FSA to establish a plan to “promote the goal of transitioning borrowers to private commercial credit and other sources of credit in the shortest period of time practicable.” 7 U.S.C. § 1993.
One type of FSA loan is the Direct Loan Program, which offers farm ownership, operating, and emergency loans. This program is funded and administered directly by FSA. However, FSA also offers farm ownership, operating, and conservation loans under the Guaranteed Loan Program. A guaranteed loan is one that is “made and serviced by a lender” that FSA has signed a Lender’s Agreement with and issued a Loan Guarantee.” 7 C.F.R. § 761.2. To read about FSA’s loan options, click here to read the previous article in the series.
Loan documents for both direct and guaranteed loans include a promissory note and may include a mortgage or a lien, depending on the collateral. Under an FSA loan, an after-acquired clause is included in the loan documents if the collateral is personal property. FSA requires borrowers under the direct or guaranteed loan programs to obtain and maintain insurance on all loan collateral. 7 C.F.R. § 764.108; 7 C.F.R. § 762.123. FSA loans can be secured by collateral such as real estate, farm products, equipment, or livestock, depending on the type of loan.
If FSA borrowers are unable to make scheduled payments on their farm loan programs debt, they become a “delinquent borrower,” and federal statutes and regulations outline the next steps. After a borrower is 90 days past due on their loan, FSA will provide notice to the borrower of “primary loan servicing programs, preservation loan service programs, debt settlement programs, and appeal procedures, including the eligibility criteria, and terms and conditions of such programs and procedures.” 7 U.S.C. § 1981d(b). The goal of these programs is to get the borrower back to making regular loan payments.
However, if a borrower realizes that they will be unable to make their scheduled loan payments but is not yet 90 days past due, they may pre-emptively request the notice, in the form of a “servicing packet.” The servicing packet provides information to the borrower on how to apply for the servicing programs, deadlines, and any applicable forms. 7 U.S.C. § 1981d(b).
A “primary loan servicing program” means any combination of loan consolidation, rescheduling, reamotization, interest rate reduction, or loan restructuring. 7 U.S.C. § 1991(b). Loan restructuring includes “deferral, set aside, or writing down of the principal or accumulated interest charges, or both, of the loan.” 7 U.S.C. § 1991(b). A borrower will be eligible for loan servicing if:
- The loan delinquency occurred because of circumstances outside of their control;
- The borrower acted in good faith regarding the loan administration;
- presents a plan demonstrating they will “meet necessary family living and farm operating expenses; and service all debts”; and
- the loan proposed for restructuring will result in a net recovery to the federal government that is more or equal to the recovery gained from “an involuntary liquidation or foreclosure on the property securing the loan.” 7 U.S.C. § 2001(b).
After receiving the notice from FSA, the borrower must respond within 60 days with a completed application to be considered for loan servicing programs. 7 U.S.C. § 1981d(e). FSA loan servicing programs aim to restructure the debt and provide the borrower with the best options for repayment. If a restructuring plan is not feasible, the loan may be in default, and the lender can move forward with additional recovery actions as designated by statute. These additional actions will be outlined in upcoming posts.
Concluding Thoughts
Agricultural producers face unique financial pressures, and periods of financial stress do not necessarily mean that foreclosure is inevitable. Understanding the terms of loan agreements, recognizing early warning signs of delinquency, and communicating with lenders can help borrowers identify options before financial difficulties worsen. For FSA borrowers, federal law provides several servicing and restructuring opportunities designed to return producers to a financially viable position when possible. However, if restructuring is not feasible, borrowers may still have options before foreclosure occurs. Because loan agreements, lender requirements, and available remedies vary, producers experiencing financial difficulties may benefit from seeking legal, financial, or tax advice early in the process to better understand their rights and obligations.
Upcoming Articles & Resources
The next article will explore a loan default under the Farm Credit System, and what constitutes a distressed borrower.
To read the first article in this series, click here.
For more National Agricultural Law Center resources on finance and credit, click here.
For more National Agricultural Law Center resources on bankruptcy, click here.
For more National Agricultural Law Center resources on secured transactions, click here.