Agricultural producers typically utilize financing from lenders to fund their farming operation. Ordinarily, the lender loaning money will require the farmer to provide a security interest in crops, livestock, or equipment. As recently discussed in the first article of this series, this type of transaction is considered a secured transaction, which is primarily governed by Article 9 of the Uniform Commercial Code (“UCC”). In general, a secured transaction is one that produces a security interest for a creditor. Creditors hold a security interest in debtors’ personal property to ensure that the debtor repays the debt. However, an enforceable security interest is not automatically created when money is loaned and collateral is pledged. Article 9 requires that a creditor take several steps to obtain an enforceable interest. The first of those steps is attachment of the security interest. This step is likely the most important to a secured transaction because it involves the execution of a security agreement. Also, this step offers a creditor only opportunity to fully protect their security interest against the debtor, which is usually done by including an after-acquired property clause or a future advances clause within the agreement.
A creditor must attach its security interest to the collateral to have an enforceable security interest. Without attachment, there is no security interest. Once attachment occurs, the creditor has the right to enforce the security interest against the debtor. Section 9-230(b) of the UCC provides three requirements that must be satisfied for attachment of a security interest to occur. The first requirement is that the creditor must give value to the debtor. In agricultural financing, the ordinary scenario of “giving value” would include the act of the lender loaning money to the farmer.
Second, the debtor must have rights in the collateral or the power to transfer rights in the collateral. The term “rights” is not defined by the UCC, and situations arise where it is unclear whether the debtor actually has rights to the collateral. If the debtor owns the collateral, they are generally considered to have rights in it. Some courts have determined that a debtor has rights to collateral that is delivered or possessed by the debtor, even if the debtor lacks title or ownership of the property. A debtor with contractual rights to the collateral has also been sufficient for a security interest to attach. Additionally, some state legislatures have passed laws that establish the point at which a debtor has rights to collateral. Overall, when the question of whether a debtor had rights or power to transfer rights, the decision is found in a state statute or left up to a court’s discretion.
The third requirement is that there must be an agreement to create a security interest. This requirement is satisfied in two ways, and once it is met the security interest is considered attached. The first way the creditor’s security interest can attach is when the creditor takes possession or control of the collateral. Taking “possession” means the creditor has physical custody of the collateralized property. Having “control” of collateral means that the creditor has some right to collect from or manage the collateral. Attachment by possession is used for tangible collateral, such as equipment. Creditors use attachment by control for intangible collateral, such as deposit accounts. However, this method of attachment is used infrequently and only for certain transactions. The second, and most common, method to satisfy the third requirement is through the use of a loan agreement, generally referred to as a security agreement under Article 9.
A security agreement is essentially a contract which states that the debtor is voluntarily providing the creditor with a security interest in the collateral. This agreement governs the creditor-debtor relationship, provides the rights of each party, and specifies the remedies for the creditor in the event the debtor defaults on the loan. Creditors tend to provide a security agreement they drafted. These tend to be complex and detailed documents. However, a lengthy agreement is not necessary to create an enforceable security interest in collateral. For example, a valid agreement can simply state: “I, Farmer McFadden, provide Farm Credit Bank a security interest in all my presently owned cattle located in Feed Yard #1.” Language that extends a security interest to the creditor is crucial.
Under Article 9, there are two requirements that must be satisfied for the security agreement to be valid.
First, the security agreement must include a description of the collateral subject to the security interest. The description of the collateral is sufficient if it “reasonably identifies what is described.” U.C.C. § 9-108(a). In other words, the description will likely hold up if the agreement identifies the collateral in a way that third parties can determine what collateral is claimed by the creditor’s security interest. Article 9 provides that a description is sufficient if it reasonably identifies the collateral by specific listing, quantity, type of collateral defined by the UCC, category, computational or allocational formula or procedure, or any other method so long as the identity of the collateral is objectively determinable. U.C.C. § 9-108(b). An acceptable description does not have to be specific or detailed, but overly broad descriptions such as “all the debtor’s personal property” or “all assets” are inadequate collateral descriptions for a security agreement. U.C.C. § 9-108(c).
Second, the security agreement must be authenticated by the debtor. A security interest will not attach if the debtor has not signed the agreement. Requiring the debtor to sign the agreement is primarily for evidentiary purposes. Because a security agreement is a contract, the parties must voluntarily enter into the agreement. Therefore, when the debtor provides their signature on the written security agreement, it indicates that the debtor had the present intention to authenticate the agreement and voluntarily provide the creditor a security interest in the collateral.
To put the process of attachment into perspective, suppose Garner Grower is in the market to buy a new combine for his farming operation. Garner goes to Cobi’s Combine Dealership and finds the combine he had been searching for on the dealer’s lot, the Combine RX7000. Because the combine is $400,000, Garner cannot provide the funds for the entire purchase price of the combine. However, Cobi’s dealership provides financing. After Garner puts $50,000 towards the purchase price as a down payment, Cobi loans Garner the remaining $350,000 owed for the combine. The two parties executed a security agreement, which includes the amount of financing, interest rate, rights and remedies of the parties, and contains the sentence: “I, Garner Grower, grant a security interest in my Combine RX7000 to Cobi’s Combine Dealership.” Garner signed the agreement and Cobi gave him the keys to the combine.
In this example, Cobi’s now has an enforceable security interest in the Combine RX7000 against Garner. Cobi provided value, the $350,000, and Garner had rights in the collateral since he was purchasing that specific combine. The transaction was reduced to a written security agreement that contained a description that reasonably identified the collateral, and Garner authenticated the agreement by providing his signature. Because the security interest is enforceable, Cobi is now a secured creditor, and Article 9 provides secured creditors special remedies to ensure they are repaid the debt owed. Suppose Garner defaults on his loan and Cobi goes unpaid. Article 9 permits Cobi to take possession of the combine, sell it in accordance with the Article’s provisions, and then apply the proceeds to the unpaid debt.
Once the security interest attaches, the secured creditor obtains certain rights in the collateral, but sometimes the debtor may decide to dispose of the collateral subject to the creditor’s security interest before the loan is entirely paid off. From the example above, assume Garner sells the Combine RX7000 for $300,000 to a buyer four years after purchasing it, and the buyer wrote him a check for the entire amount. At the time of the sale, Garner still owed Cobi $250,000 on the loan. Under Article 9, the $300,000 Garner received from the sale is called proceeds.
Even though the collateral was sold, Cobi’s security interest was not extinguished. Because Garner still owed money on the loan when the combine was sold, Cobi’s security interest attached to “any identifiable proceeds of collateral.” U.C.C. § 9-315(a)(2). Here, Cobi now has a security interest in the money Garner received from the sale of the combine because the proceeds can be traced to the check issued to Garner for the sale of the combine. This would stay true even if the Garner-Cobi security agreement did not mention a security interest in proceeds because Article 9 assumes the parties to the transaction intend to cover the proceeds. Thus, the creditor is not required to reference proceeds within the security agreement to obtain a security interest in the proceeds.
Many security agreements, especially in agricultural financing transactions, often include two important provisions that farmers and lenders must pay special attention to. An after-acquired property clause is commonly used because it allows the security interest to cover property the debtor acquires after the security agreement is executed. Creditors add this type of clause in the agreement because without it, their security interest extends only to collateral the debtor owns at the time of attachment.
For example, an agricultural lender loans money to a cattle farmer. The security agreement provides the lender with a security interest in “all of the farmer’s beef cattle currently owned, all presently conceived but unborn cattle, and all increase of farmer’s cattle, whether purchased or not yet conceived, hereafter acquired.” This after-acquired clause would be sufficient in the majority of courts, and allow the lender’s security interest to encompass the farmer’s cattle he receives after signing the agreement.
However, the lender’s security interest would not attach to the after-acquired cattle until the farmer had rights in the cattle. Consequently, the lender does not have a security interest in the “increased” cattle until the farmer purchases the cattle, or until new calves are conceived.
The second, commonly included provision in a security agreement is a future advances clause. A future advances clause is vital for the creditor who provides several loans to the debtor. The creditor includes this type of clause to ensure that additional loans they provide the debtor are secured by the same collateral. For example, Taylor went to Agri First Bank to borrow $20,000. She gave the bank a security interest in her grain crops and signed a security agreement that included a future advances clause. This provision reserved the bank’s right to advance future funds to Taylor, and these advances will also be secured by her grain crops. One month later, Taylor receives an additional loan from Agri First Bank for $10,000. Thus, the bank now has a security interest in Taylor’s grain crop totaling $30,000. In this example, Agri First Bank is not required to execute a new security agreement with Taylor for the additional $10,000 loan. Because the security agreement between the bank and Taylor contained a future advances clause, Article 9 permits the bank’s advances to be covered under that agreement.
When a security agreement includes an after-acquired property clause and a future advances clause, it creates an ongoing financing arrangement between the creditor and debtor. If the debtor acquires new collateral covered under the security agreement, the after-acquired property clause automatically attaches the newly acquired collateral to the creditor’s security interest. When the creditor loans additional funds to the debtor, the future advances clause will take effect and the creditor will secure the new loaned amount with previously secured collateral.
The attachment step to a secured transaction may seem like a rigid process, but it is the most crucial step for creditors. Without attachment, the creditor will not have a security interest, which means they cannot use the protections or remedies provided to secured creditors under Article 9. Thus, a creditor must properly execute this step by ensuring there is value given, the debtor has rights in the collateral, and an enforceable agreement was voluntarily entered into by the debtor. Although language reserving rights to proceeds is not typically required in a security agreement, including provisions that extends the creditor’s security interest beyond the debtor’s current assets can provide the creditor extra protection to ensure they are repaid on the loan.
This article is the second 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 examine how a creditor’s security interest becomes enforceable against third parties, most notably other creditors claiming a stake to the collateral covered by the security interest.
To read the first article in this series, click here.
For a general overview of agricultural lending, 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.