In agricultural finance, it is common for creditors to obtain an interest in a farmer’s crop insurance payments to secure a loan. This article discusses the availability of federal crop insurance proceeds to creditors and the laws that govern interests in these proceeds. Basically, there are two separate sets of laws that apply to creditor’s interests in crop insurance proceeds: Article 9 of the UCC, and the Federal Crop Insurance Act.
Many agricultural producers borrow money to successfully run their operations. Typically, the lender requires the borrower to give a security interest in personal property such as livestock, crops, or equipment before supplying the funds. A security interest is an interest held by a lender in property, referred to as collateral, that has been pledged by a debtor. This interest allows the lender to take possession or sell the collateralized property if the debt is not paid. In these situations, the producer-debtor and lender-creditor have entered into a secured transaction, which is primarily governed by Article 9 of the Uniform Commercial Code (“UCC”).
The UCC is a collection of rules affecting commercial transactions, and every state has chosen to enact some version of the rules within it, including Article 9. Specifically, Article 9 contains rules and requirements that creditors must satisfy to obtain an enforceable security interest in certain collateral. In general, Article 9 requires that the creditor satisfy two steps to obtain an enforceable interest. The first of those steps is attachment of the security interest, which is typically accomplished by executing a security agreement. The second step is perfection, which is typically satisfied by filing a UCC-1 financing statement. Once a creditor satisfies these two steps, they hold an enforceable security interest in the collateral. Thus, a secured creditor can enforce its interest to gain possession of the collateralized property, sell the property and use the funds to satisfy the debtor’s loan debt.
Creditors who satisfy these steps usually hold an Article 9 security interest in collateral, but there are some instances where Article 9 rules do not entirely govern a creditor’s interest. Sometimes state Article 9 laws are replaced by federal laws depending on the property serving as collateral for a creditor’s security interest. In agricultural secured transactions, this occurs when federal crop insurance proceeds are serving as collateral to secure a loan. Specifically, the Federal Crop Insurance Act (“FCIA”) replaces some Article 9 rules when a creditor seeks to enforce their interest in a producer’s insurance proceeds.
Although creditors can gain an Article 9 security interest in federal crop insurance proceeds, these interests are not always enforceable because the FCIA governs interests in these proceeds. The FCIA is a federal law, passed by Congress, and it applies to the entire United States and preempts or supersedes laws such as certain UCC provisions passed by state legislatures. The FCIA contains a statutory provision that directly preempts Article 9 security interest in insurance proceeds. Specifically, this provision explains the extent of the FCIA’s preemptive effect of Article 9 rules.
Under Section 1509 of the FCIA, “claims for indemnities…shall not be liable to attachment, levy garnishment, or any other legal process before payment to the insured….” Congress enacted this statutory provision with the intent of limiting a creditor’s ability to enforce an Article 9 security interest against federal crop insurance proceeds. The statute expressly prohibits creditors from enforcing an Article 9 security interest against a producer’s insurance proceeds. However, Congress did not intend the FCIA to completely preempt Article 9 security interests.
In general, the FCIA prohibits creditors from enforcing an Article 9 security interest in insurance proceeds, but only “before payment to the insured….” Under §1509, Congress clearly mandates that a producer’s insurance proceeds are not subject to a creditor’s security interest when proceeds have not yet been issued by a producer’s insurance provider. In other words, a creditor holding an Article 9 security interest can enforce that interest once insurance proceeds are issued to a producer-debtor. Thus, both the FCIA and Article 9 rules govern interests in crop insurance proceeds, but at separate periods of time.
Overall, whether the FCIA preempts an Article 9 security interest in crop insurance proceeds depends primarily upon timing. If the producer-debtor has yet to receive an insurance payment from the insurance provider, §1509 of the FCIA governs. Thus, the creditor’s security interest in the insurance proceeds is not recognized and cannot be enforced. However, if the producer receives an insurance payment, state law applies and the creditor can enforce their Article 9 security interest against the producer to recover the insurance proceeds. Accordingly, whether the producer-debtor receives insurance proceeds controls whether the FCIA or Article 9 governs the creditor’s interest in proceeds.
Because the FCIA preempts Article 9 security interests before insurance proceeds paid to a producer, a creditor cannot enforce their interest against undistributed insurance funds. However, the FCIA offers creditors the ability to gain an interest in a producer’s insurance proceeds before an insurance payment is issued to a producer. Unlike creditors holding only a security interest, creditors may seek to gain an interest under the FCIA because it provides them the ability to receive insurance proceeds directly from an insurance provider. For creditors to obtain an interest in undistributed crop insurance proceeds, they must obtain an assignment of a producer’s insurance payment rights.
Assignment of Indemnity
The FCIA not only established the federal crop insurance program, but it also created the Federal Crop Insurance Corporation (“FCIC”). The FCIC manages the federal crop insurance program and implements regulations to carry out the purpose of the FCIA. A regulation implemented by the FCIC, entitled “Assignment of Indemnity”, provides creditors the ability to obtain an interest in a producer’s insurance proceeds. This regulatory provision permits a producer to transfer their insurance policy rights to a creditor. A creditor who obtains an assignment has an interest in insurance proceeds that have not yet been issued. When an insurance payment is warranted, the creditor-assignee has the right to collect insurance proceeds directly from the insurance provider issuing the payment.
For a creditor to receive an assignment, a producer must properly execute an “Assignment of Indemnity” form. This from is provided by the producer’s crop insurance provider, and once the producer completes the form, they must submit it to their insurance provider for approval. If the insurance provider approves the assignment, the creditor is named as an assignee under the producer’s insurance policy and holds an interest in insurance proceeds that may be issued by the insurance provider. In situations when a claim on the insurance is approved, the insurance provider will send the insurance payment directly to the creditor-assignee on the policy.
Assignments vs. Security Interests
Both the FCIA regulations and Article 9 rules provide a method for creditors to obtain an interest in a producer’s crop insurance proceeds; however, these interests operate differently. For instance, assignments and security interests provide creditors separate methods of collecting insurance proceeds. Additionally, creditors who obtain an assignment become eligible to submit a claim under the insurance policy, but creditors holding only a security interest do not have that privilege. Creditor-assignees probably avoid more financial risk then creditors holding only a security interest because assignments provide creditors a greater opportunity to receive insurance proceeds, which increases the likelihood of being repaid the money loaned to a producer. Therefore, many creditors may seek to obtain an assignment because assignments likely provide creditors a superior interest in a producer’s crop insurance proceeds over Article 9 security interests.
Claims on Insurance Policy
Assignments most likely provide creditors a superior interest in proceeds for three reasons. First, the FCIA provides creditor-assignees the ability to submit an insurance claim under the policy directly to an insurance provider. Creditor-assignees can make a claim on an insurance policy when their producer-debtor fails to do so. This provides creditor-assignees extra protection because they do not have to rely on a producer to make an insurance claim to receive an insurance payment. For example, if a producer fails to make a claim, and their creditor-assignee submits a claim that is then approved, the creditor is now able to collect insurance funds that would not have otherwise been paid had they not submitted the claim.
In situations where a producer does not make a claim for insurance proceeds—even if the reason for crop-loss is covered under the insurance policy—creditors holding only a security interest cannot make an insurance claim on behalf of the producer. Although a creditor has a security interest in proceeds, they are not entitled to any benefit under the insurance policy. Making a claim to receive insurance proceeds is a benefit under the policy, so security interest creditors may not make a policy claim. This means security interest creditors cannot collect insurance proceeds when their producer-debtor does not make a claim on their insurance policy. Therefore, assignments provide creditors a greater opportunity to collect insurance proceeds because they do not have to rely on a producer to make a claim on the policy.
Collecting Insurance Proceeds
The second advantage assignments offer creditors is the ability to collect insurance proceeds directly. Typically, a producer may never receive insurance proceeds when they have assigned their indemnity rights to a creditor because a creditor-assignee collects an insurance payment. For example, when a producer (or a creditor-assignee) makes an insurance claim that is later approved by an insurance provider, the insurance provider sends the insurance payment check directly to the creditor-assignee. Once the creditor-assignee receives this payment, they can apply the funds to satisfy the producer’s loan debt.
Unlike creditor-assignees, creditors holding only a security interest cannot collect insurance proceeds directly from a producer’s insurance provider because Article 9 security interests are not recognized until proceeds are issued to a producer. Once an insurance provider issues a payment to a producer, a security interest creditor must file an action in a court to enforce their interest against the insurance proceeds. Meanwhile, the producer may use the insurance funds for other expenses while the creditor is in the process of enforcing their interest to collect the proceeds. When this occurs, the security interest creditor risks never collecting the entire amount of insurance proceeds to satisfy the producer’s loan debt. Thus, creditor-assignees are in a greater position to receive repayment for a producer’s loan because creditor-assignees collect insurance payments directly from insurance providers.
Lastly, assignments provide creditors a superior interest because it likely provides priority to insurance proceeds over creditors who hold only a security interest. Priority is the order in which creditors receive money to satisfy a debtor’s loan debt. This means the creditor with higher priority will receive payment before a creditor with lower priority. When two or more creditors have an interest in the same insurance proceeds, the creditor with first priority is the first to receive the proceeds. Therefore, the first priority creditor has their loan repaid before all other creditors.
Currently, there is no court case that directly rules on the issue of priority between a creditor-assignee and a security interest creditor who held competing interests in undistributed insurance proceeds. However, if this issue were to be litigated, it is likely a court will find that a creditor-assignee has first priority over a security interest creditor. Creditor-assignees likely have priority in insurance proceeds because the FCIA may continuously preempt Article 9 when creditor-assignees and security interest creditors are in a priority dispute.
The FCIA preempts Article 9 security interests before a producer receives insurance proceeds. Importantly, a producer may never receive insurance proceeds when they assign their payment rights to a creditor because the creditor-assignee will receive an insurance payment directly from an insurance provider. When insurance proceeds are paid directly to the creditor-assignee, they use the funds to satisfy the producer’s loan debt, which means the producer will likely not receive any of the insurance funds. In this situation, there is likely no “payment to the insured,” and the FCIA continues to preempt Article 9. In other words, the security interest creditor will likely hold an unenforceable interest and is unable to recover the insurance proceeds issued to the creditor-assignee. Thus, the creditor-assignee most likely has priority to the insurance proceeds and can use the insurance funds to satisfy the producer’s loan debt.
Many creditors providing loans to agricultural producers take an interest in the producer’s federal crop insurance proceeds, which is governed by the FCIA. While Article 9 usually governs a creditor’s security interest in collateral, the FCIA preempts some Article 9 rules. However, the FCIA only preempts Article 9 to a certain extent. In general, whether the FCIA preempts an Article 9 security interest in crop insurance proceeds depends primarily upon timing. If a producer-debtor has not received an insurance payment, the FCIA governs and only assignments are enforceable. If a producer receives an insurance payment, state law applies, and the creditor can enforce their Article 9 security interest against the producer to recover the proceeds.
Although the FCIA and Article 9 provide creditors the ability to gain an interest in crop insurance proceeds, a creditor with an assignment likely holds a more stable interest over a creditor holding only a security interest. Creditor-assignees likely have superior interests for three reasons. First, the FCIA regulations permit the creditor to make a claim on an insurance policy when their producer fails to do so. Second, most creditor-assignees have direct access to insurance proceeds because insurers will send insurance payments directly to the creditor, not the producer. Last, and most important, creditor-assignees likely have priority to the insurance funds over security interest creditors because the FCIA may continue to preempt Article 9 when insurance proceeds are issued directly to creditor-assignees. Accordingly, creditors may consider obtaining an assignment in order to better protect themselves from the risk of not receiving insurance proceeds to satisfy a producer’s loan debt.
To read more articles discussing secured transactions, click here.
For more National Agricultural Law Center information on Secured Transactions, click here.