The Food Security Act of 1985 (“FSA”) established a rule known as the federal farm products rule (codified as 7 U.S.C. §1631) that affects both creditors and buyers of farm products. In general, the farm products rule affects 1) buyers of farm products purchasing those products in the ordinary course of business; 2) sellers of farm products; and 3) creditors who provided financing to the sellers. The rule protects buyers, providing that the buyer will receive a purchased product without the creditor’s security interest attached, as long as certain conditions are met.
Before the enactment of the FSA, buyers of farm products often purchased farm products that were collateral for a secured creditor’s loan. Because a creditor’s interest followed the farm products, several buyers of farm products assumed the risk of paying twice for the same goods, once to the seller and once to the secured creditor! Thus, Congress enacted the federal farm products rule to protect farm product purchasers from this risk.
In general, if a buyer meets the requirements of the farm products rule, a creditor’s security interest will not follow the farm products purchased unless the creditor put the buyer “on notice” of its interest in the farm product. In other words, whether a buyer of farm products in the ordinary course of business takes the goods subject to a creditor’s security interest primarily depends on whether the creditor complied with the notice requirements under the FSA. When the federal farm products rule took effect in 1986, states were given two options: follow a direct notice system or implement a centralized filing system.
In a state that follows the direct notice system, a secured creditor must send the buyer of farm products a written notice that includes the list of specific information contained under §1631(e). If a creditor provides direct notice to a buyer up to one year before the farm products are sold, the creditor’s security interest will continue to follow the collateral. On the other hand, states operating a central filing system allow a secured creditor to file an “effective financing statement” (“EFS”) or send direct notice to a buyer, as explained under §1631(c)(4). If filing an EFS, creditors must include the same information as required for a direct notice, and it must be filed with the Secretary of State’s office to be effective. Thus, before purchasing farm products in a state that operates a central filing system, the buyer is expected to review the list to determine whether the goods are subject to a creditor’s security interest. The notice requirements are outlined in more detail as part of the first fact sheet in this series.
In §1631 cases, the primary issue parties litigate is whether the creditor provided proper notice to a buyer of farm products. If a creditor provided notice, then their security interest followed the farm products after the sale, and the creditor can collect the unpaid money from the buyer. If the creditor did not provide notice that complied with the FSA, then the creditor’s security interest did not follow the farm products after the sale, meaning the creditor cannot collect payment for the products from the buyer. As a result, it is essential to provide a detailed notice to the buyer including all items listed under §1631.
Although it is important to provide a notice that contains all the required information under the FSA, the federal statute contains other rules that also affect a creditor’s direct or central filing notice. Specifically, these rules are important because they determine whether the FSA applies to a buyer’s purchase of collateralized farm products. If a creditor overlooks these requirements, they risk losing their security interest in collateralized farm products.
To read a more in-depth discussion on how the federal farm products rule operates, the provisional rules creditors and buyers must satisfy to protect themselves financially, and the legal issues that can arise when collateralized farm products are sold, check out the National Agricultural Law Center’s “Figuring the Federal Farm Products Rule” fact sheet series here.
Because many producer’s farm products are secured as collateral for a loan, creditors and farm product purchasers must understand how the federal farm products rule operates, what requirements the rule places on each party, and how they comply with those requirements. Parties that do not consider the farm products rule and its requirements when securing or purchasing farm products may risk the ability to adequately protect themselves financially.
To read the FSA, click here.
To read 7 U.S.C. §1631, click here.
To read NALC’s “Figuring the Federal Farm Products Rule” fact sheet series, click here.