For many farmers and ranchers, it is often necessary to borrow large amounts of capital and incur considerable debts in order to produce an agricultural commodity. Ordinarily, the lender will require the agricultural producer to provide a security interest in crops, livestock, or equipment. 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 produces a security interest for a creditor. Creditors hold a security interest in debtors’ personal property, known as collateral, to ensure that the debtor repays the debt.
However, Article 9 requires that a creditor 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 crucial because, once the interest attaches, the creditor has the right to enforce the security interest in the collateral against the debtor. However, attachment does not allow creditors to enforce security interests against third parties that also have claims to the collateral. To do that, the creditor must complete the next step by perfectingtheir security interest.
The third article of this series explained that perfection is necessary to put other persons on notice of a creditor’s security interest, and it also helps determine priority among creditors who claim a similar interest. Article 9 offers creditors many mechanisms to perfect, such as perfecting by possession or control, automatically, or by filing a financing statement. However, the majority of security interests in agriculture are perfected by filing a financing statement. Therefore, agricultural lenders must be aware of the filing rules Article 9 places on creditors to perfect their security interest in farm products.
Financing Statement Overview
Agricultural lenders typically choose to perfect by filing because the financing statement can perfect most kinds of farm collateral, including crops, livestock, farm equipment, and inventory. However, lenders must satisfy the requirements provided under Article 9 for a financing statement to be effective. Section 9-502(a) and (b) of the UCC explains the information that must be included in a financing statement. To be effective, it must include the name and address of the debtor, whether the debtor is an individual or an organization, the name and address of the secured creditor, and an indication of the collateral covered by the financing statement. Unlike a security agreement, a financing statement does not require the debtor’s signature.
Debtor’s Name
A creditor must include the debtor’s correct name in the financing statement. Article 9 permits minor errors or omissions in a financing statement, but seriously misleading errors or omissions will make a creditor’s financing statement ineffective. Thus, filing a financing statement with an error in the debtor’s name can easily make the financing statement seriously misleading. If a creditor does not provide the full legal name of the individual or the organizational name of the debtor, the creditor may lose priority in the collateral.
Description of Collateral
To perfect by filing, a financing statement must include an adequate description of the collateral subject to a creditor’s security interest. Under Article 9, the description must reasonably identify what property is being used as collateral. In other words, if a third person would understand what collateral is being covered by the financing statement, the description is probably sufficient. If a creditor incorrectly labels collateralized property in the financing statement, the creditor’s interest will likely not be perfected and they risk losing priority in the collateral.
Agricultural lenders must pay special attention to collateral descriptions in the financing statement because farm property can be classified in several different ways. In general, agricultural collateral can be classified as equipment, farm products, inventory or documents of title.
Each type of collateral is defined under Article 9:
- Equipment is machinery used on the farm, such as tractors, plows or seeders.
- Inventory refers to items that are held for sale or lease, raw materials, or goods used or consumed in a farming operation.
- Farm products are typically crops, livestock, or products produced and in possession of a farming operation.
- Documents of title are warehouse receipts, usually a scale or weight ticket from a grain elevator.
Including the correct classification to describe the collateral in a financing statement is crucial because a single item of agricultural property can take on different classifications. Thus, a creditor must include an accurate description of the collateral in the financing statement because an erroneous description can mislead the reader of the financing statement. If a court determines that the collateral should have been classified differently in the creditor’s financing statement, the creditor may lose priority in the collateral because their security interest is not perfected.
The classification of the collateral depends on the type of property and the actual use of the property. Several cases have demonstrated that there is a fine-line between a “farm product” and “inventory.” This is because collateral can be classified as farm products only if they remain in their unmanufactured state. The UCC does not define “unmanufactured state,” so this determination has been left to the courts.
Crops are one type of agricultural collateral that can easily be classified as farm products or inventory. This is because crops can change classification once harvested. Some courts have determined that harvested crops that are stored off the farm, but still owned by the farmer, were still considered “farm products.” However, if the farmer stored their crops with a grain broker to hold for sale, the crops would be considered “inventory” because the crops are no longer being sold by a person engaged in farming. Overall, it is important for a creditor to properly classify the collateral serving as a security interest, and specify the collateral to reduce the risk of losing priority to other creditors.
Where to File
A creditor’s security interest is not perfected unless its financing statement is filed in the proper location. Determining which filing office is correct for a creditor’s financing statement depends on what type of collateral is serving as a security interest. Thus, depending on the type of collateral, a creditor will either have to file in a central location, or a local location.
In most situations, the financing statement must be filed in a central location as designated by each state. § 9-501(a)(2). The majority of states have selected its Secretary of State’s office to serve as the central location for filing financing statements. Article 9 requires most types of collateral be filed at this central office. Accordingly, if the collateral held by an agricultural lender is classified as equipment, inventory, or farm products, the lender will need to file a financing statement at the state’s central filing office to perfect its security interest.
The state a creditor must file the financing statement is the state where the debtor resides. If the debtor is a business organization, the creditor must file the financing statement in the state where the business was formed or incorporated.
Agricultural lenders will typically file in a central location, but there are certain types of collateral that require a lender to file a financing statement in a local office. This type of filing is called local filing. Local filing is required for collateral that is connected to real estate—such as timber or fixtures—and the financing statement must be filed in the recording office or county court in the county where the real estate is located. In other words, a security interest in personal property or timber that is physically attached to the property must be filed locally. Article 9 requires local filing for this type of collateral because this is the location where third persons are most likely to search for such an interest on the property.
Although it may make sense that crops could be classified as “fixtures” because crops are affixed to the real estate when plated, Article 9 rules assert that crops are not fixtures for purposes of secured transactions.
Time of Filing
Article 9 has no provision requiring creditors to file a financing statement within a specified time period. However, a creditor will not want to delay filing because they risk having priority over other creditors.
For example, on July 1, First Bank executed a security agreement with a Felicia Farmer which provided First Bank with a security interest in her livestock. First Bank did not file a financing statement afterwards. On July 20, Felicia Farmer borrowed money from Second Bank, and entered into a security agreement which stated “Felicia gives Second Bank a security interest in all of her livestock.” On July 25, Second Bank files a financing statement, perfecting its security interest. On July 30, First Bank files a financing statement, which perfects its interest in the same livestock.
In this example, Second Bank has priority in Felicia’s livestock. This means if Felicia defaults on her loans, Second Bank will get paid first for its unpaid debt. Although First Bank was the first to take a security interest in Felicia’s livestock, it was not the first creditor to perfect its security interest. Consequently, this delay in filing its financing statement cost First Bank priority.
Importantly, Article 9 does not require a creditor to delay filing until a security agreement is made or until a security interest attaches. § 9-502(d). A creditor can go ahead and file its financing statement before the creditor and debtor execute a security agreement. However, if the creditor does file prematurely, its interest will not perfect until a security agreement has been executed or the interest attaches.
From the example above, suppose First Bank filed a financing statement describing Felicia’s livestock as collateral on June 30. When the two parties entered into the security agreement on July 1, First Bank’s security interest attached to Felicia’s livestock, meaning First Bank had a perfected interest. Thus, First Bank would have priority over Second Bank. Accordingly, First Bank would receive payment for its unpaid debt before Second Bank does.
Financing Statement Duration
Creditors who perfect their interest by filing are in a good position to enforce their interest against third parties who claim a similar interest. However, a single financing statement does not survive forever. Section 9-515(a) clearly states that financing statements are only effective for a five-year period. This five-year period begins from the date of filing the financing statement. If the creditor does not file a continuation statement before the five-year period ends, the creditor’s interest lapses.
When the creditor’s security interest lapses, its interest becomes unperfected. In other words, the creditor loses priority in the collateral. If there are other creditors with perfected security interests in the same collateral, those creditors would then take priority over the creditor who allowed their interest to lapse. Therefore, creditors must ensure they don’t allow their interests to lapse to keep priority over third parties.
Continuation Statement
When the five-year perfection period is about to expire, a creditor may extend the time of perfection by filing a continuation statement. A continuation statement is a form, such as this UCC example, which extends the perfection of a security interest an additional five years. This additional five-year period is measured from the filing date of the original financing statement. For a continuation statement to be effective, creditors must identify the original financing statement, indicate that the document is a continuation statement for the initial financing statement, and include all the information contained in the original financing statement.
Unlike a financing statement, Article 9 does require a creditor to file a continuation statement within a specific time period. Creditors must file a continuation statement six months before the end of the five-year period of the original financing statement. § 9-515(d). For example, suppose a creditor filed a financing statement on December 1, 2020. To preserve a perfected security interest, the creditor must file a continuation statement between June 1, 2025 to November 30, 2025.
If a creditor files more than six months before the end of the five-year period, the continuation statement is ineffective. If a creditor files a continuation statement after the five-year period ends, that continuation statement will not be effective. The creditor’s original financing statement will lapse and the creditor will lose its perfected security interest. In this situation, the creditor would have to file a new financing statement to revive perfection.
When the property serving as collateral is a fixture, and the creditor filed a financing statement in the correct local office, no continuation statement is required.
Amendment to Financing Statement
In some situations, a creditor may need to amend a financing statement. Usually, a creditor may file an amendment when adding collateral or a new debtor which are not covered in the original financing statement. When adding collateral or a debtor, the debtor must sign the amendment for it to be effective. A creditor must identify the financing statement the amendment is augmenting. Additionally, the creditor must indicate that the form they are filing is an amendment.
Sometimes, an amendment is not necessary. If the creditor’s original financing statement described the new collateral, then no amendment is needed. Usually, creditors will include an after-acquired property clause in their security agreement with the debtor. This clause allows the creditor’s security interest to cover property the debtor obtains in the future. Thus, if the creditor files a financing statement which describes the after-acquired collateral, then the creditor’s interest automatically perfects when the debtor obtains that collateral.
Termination Statement
Once a loan is completely paid off, the debtor may request that the creditor terminate the financing statement. To obtain a termination statement, the debtor must send the creditor a signed demand. When the creditor receives this demand, they have two options. The creditor may either send a termination statement directly to the debtor, or the creditor may file the termination statement with the correct filing office. § 9-513(c). The creditor must send or file the termination statement within twenty days of receiving the debtor’s demand.
Conclusion
Perfection is a crucial step for creditors. Without perfecting a security interest, the creditor will not be able to assert a superior claim to the collateral if other perfected creditors have a conflicting interest in the same collateral. Most agricultural collateral is perfected by filing a financing statement, but lenders must pay special attention to the rules laid out in Article 9 to ensure they are filing a proper financing statement. Overall, financing statements must contain correct information, which are filed in the proper location and timely filed for a creditor to obtain a perfected security interest in the collateral.
Upcoming
This article is the fourth 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 priorities among security interests.
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.
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.