“Lender Beware” No More:

States Relying on a Direct Notice System

For Buyers of Farm Products Should Adopt

a Central Filing System

 

Daniel D. Covington

 

Daniel D. Covington, wrote this article as a third-year student at the University of Kansas School of Law in Lawrence, Kansas.  He is currently an attorney with Anderson, Byrd, Richeson, Flaherty & Henrichs, LLP in Ottawa, Kansas.

I.  BUYING WHEAT: THE VULNERABLE LIEN

A.   Introduction

This paper begins by explaining the current law with respect to buyers of farm products and when they take subject to a security interest.  Then, because contrasting the two notification systems would make little sense otherwise, many of the intricacies and uncertainties of the law are analyzed.  Finally, direct notice and the central filing system are contrasted.  The paper ends by suggesting that states, which have not yet done so, should adopt a central filing system.

 

B.  UCC 9-307(1) and the Food Security Act of 1985

The Uniform Commercial Code provides that “[a] buyer in ordinary course of business other than a person buying farm products from a person engaged in farming operations takes free of a security interest created by his seller. . . .”[1]  This provision is expressly preempted by 7 U.S.C. § 1631 (1994) of the Food Security Act of 1985.  It provides that a buyer who buys farm products in the ordinary course of business from a seller engaged in farming operations shall take free of a perfected security interest created by the seller, even if the buyer knows of the existence of such interest, unless the buyer has actual notice or is deemed to have notice.[2]

Lenders can still protect their security interest, however.  Section 1631 provides two options.  The lender can either directly notify potential buyers of its security interest, or the lender can rely on a state central filing system to notify buyers.[3]  Under a direct notification system, the lender requires the borrower to provide a list of the borrower’s potential buyers.[4]  The lender must then give written notice of the security interest to each potential buyer.  This notice must be renewed annually, and the lender has a duty to supplement with notice of significant changes in the collateral within three months of such change.

A central filing system provides an alternative means to the same result.[5]  The secured lender reports its borrower to the Secretary of State by filing an effective financing statement (“E.F.S.”), the requirements of which will be discussed infra.  The Secretary then compiles a master list of liens and borrowers.  Buyers of farm products may subscribe to regularly receive updated versions of the list or they may inquire on a case-by-case basis, and receive an oral response followed by written confirmation from the Secretary’s office.

In theory, both notification systems work perfectly.  All involved parties are forthright and true, and even the need for notification is obviated by the buyer’s willingness to investigate the existence of liens.  In reality, however, the cashier at the local grain elevator, knowing nothing of a lien, buys a farmer’s wheat, issues a check to the farmer as the sole payee, and obliterates the lender’s lien.  That is to say, as the human element is introduced to the notification options provided by the Food Security Act, the best laid liens often run awry.

 

C.  Section 1631

The official rationale for Section 1631 is iterated in the congressional findings of 1631(a).          

Congress finds that:

 

(1) certain State laws permit a secured lender to enforce liens against a purchaser of farm products even if the purchaser does not know that the sale of the products violates the lender’s security interest in the products, lacks any practical method for discovering the existence of the security interest, and has no reasonable means to ensure that the seller uses the sales proceeds to repay the lender;

(2) these laws subject the purchaser of farm products to double payment for the products, once at the time of purchase, and again when the seller fails to repay the lender;

(3) the exposure of purchasers of farm products to double payment inhibits free competition in the market for farm products; and

(4) this exposure constitutes a burden on and an obstruction to interstate commerce in farm products.[6]

 

If there is a question of which camp, as between buyers and lenders, brought about Section 1631, Professors White and Summers clear up the confusion by stating, “[t]he law was passed under the noses of the bankers and other farm lenders who apparently did not know of the law’s existence until the skids were already greased for its passage.”[7]

 


D.  Reaction to Section 1631

Section 1324 and the United States Department of Agriculture (“U.S.D.A.”) have upset the U.C.C. by redefining crucial U.C.C. terms, thus altering some fundamental U.C.C. requirements, and failing to meaningfully define vital terms in the Food Security Act.[8]  Importantly, the term “buyer in the ordinary course of business” is redefined as “a person who, in the ordinary course of business, buys farm products from a person engaged in farming operations who is in the business of selling farm products.”[9]  This is a marked change from the U.C.C. treatment which further requires one to act “in good faith and without knowledge that the sale to him is in violation of the ownership rights or security interest of a third party in the goods” before being accorded with buyer in the ordinary course status.[10]  This single change enables an enormous expansion of the ability of buyers to take free of a lien.  Unlike defendant-buyers of the past, buyers no longer have the burden to prove that they acted in good faith or without knowledge of violation of a lien.[11]  Their chance to take free and clear is abundantly improved under the Food Security Act.  Clearly, and to the same extent, lenders have a diminished chance to maintain liens when the crops are sold.[12]

The “farm product” definition in Section 1631 differs only slightly from the U.C.C. definition.[13]  Key portions of the definition, however, are not clarified.  For goods to be considered farm products, they must be in the “possession of a person engaged in farming operations.”[14]  Neither of these terms is defined by the Act or its correlative federal regulations.  The Act does not address when something ceases to be a “farm product” and becomes inventory.  Though of absolutely fundamental import, this appears to remain an open question.[15]

Section 1324, no doubt, deserves a much more thorough measure of criticism.  Notwithstanding that contention, consider whether a state without a U.S.D.A.–approved central filing system should adopt such a system.

 

II.  LEARNING FROM HISTORY; THE POST-FOOD SECURITY ACT ERA

A.  Central Filing Systems

As of this writing, twenty states have adopted central filing systems.[16]  Perhaps the fact that so many states did so in only a few years speaks highly of central filing.  Case law scrutinizing central filing is sparse.  Such a lack of litigation may alone weigh heavily in favor of its adoption.

Occasionally, a borrower will, in contravention of the security agreement, make a seemingly unauthorized disposition of secured collateral.  The buyer will then argue that such a sale was authorized by a prior course of dealing or usage of trade, or that the lender’s course of performance or acquiescence waived its security interest.  Although courts have split on whether such apparent prior authorization trumps the terms of the security agreement, most have agreed that the noted post-disposition behavior can establish waiver. 


It seems the farm products exception preemption would change the decisions regarding the  unauthorized sale of farm products subject to a perfected security interest.[17]  Courts in jurisdictions which have adopted the central filing system generally look to the effective financing statement to discern whether the sale was authorized as a condition of releasing the security interest.[18]  Whereas the Act, in rather strict language, provides that the buyer takes subject to a security interest if he receives written notice of the security interest and fails to  “secure a waiver or release of the security interest specified in such effective financing statement” from the secured party.[19]  Instead of unpredictable decisions on usage, practice, or course of dealing authorization, interested parties presumably could rely on this more clear test for authorization determining whether the buyer secured a waiver or release.[20]

The central filing system fairly allocates risks between the secured lender and the buyer, by requiring that both parties act to be protected.  The secured party must file an effective financing statement–a task fraught with potential for error.[21]

 

1.  The Effective Financing Statement: Requirements

First, the effective financing statement to be filed by the secured party should not be confused with the UCC-1 financing statement used to perfect a security interest.  These are distinct writings, and though they each serve a notice function, neither obviates the need for the other.  The effective financing statement can be an original or copy thereof.[22]  The statement must be signed by both the debtor and secured party, and must be filed with the Secretary of State by the secured party.[23]  The statement must contain: the names and addresses of the secured party and the person indebted to the secured party, the social security or taxpayer identification number of the debtor, a description of the farm products subject to the security interest created by the debtor (including the amount of such products where applicable), and a reasonable description of the property (including the county or parish in which the property is located).[24]  The statement must be amended in writing, within three months, similarly signed and filed, to reflect any “material changes.”[25]  However, it is unclear precisely when the three-month period begins to run.

The statement “remains effective for 5 years from the date of filing, subject to extensions for additional periods of 5 years each by refiling or filing a continuation statement within 6 months before the expiration of the initial 5-year period.”[26]  Finally, the statement must be accompanied by the requisite filing fee and it must substantially comply with the above requirements “even though it contains minor errors that are not seriously misleading.”[27]  As one might guess, this standard also is not defined by the statute, so the prudent lender will exercise great care in preparing the effective financing statement.

 

2.  Buyer’s Action


While the secured party must file an effective financing statement, the buyer must also act to be protected in the central filing system.  A buyer, commission merchant, or selling agent must subscribe to the Secretary of State’s list or inquire on a purchase-by-purchase basis to protect itself under the Food Security Act.  Registration (subscription) is accomplished by submitting a form indicating: the name and address of each buyer, commission merchant and selling agent; the interest of each such party in receiving the lists; and the farm products in which each such party has an interest.[28]  Upon receiving the submission, the Secretary of State distributes “regularly as prescribed by the State” to each buyer, commission merchant, and selling agent so submitting a copy of the master list of effective financing statements that cover the farm products in which such parties have registered an interest.[29]

Those who do not register for regular distribution of the master list may request case-by-case information from their Secretary of State.  The Secretary’s office will furnish to them, within 24 hours of a request, oral confirmation of “any effective financing statement followed by written confirmation to any buyer of farm products buying from a debtor, or commission merchant or selling agent selling for a seller covered by such statement.”[30]

In theory, at least, the buyer’s duty in protecting himself is one of inquiry.  As long as he has registered and checks his list or inquires of the Secretary’s office as to a particular debtor/property, the buyer presumably may rely on information so supplied and confidently issue a check to the appropriate payee(s).  However, even though the secured party has filed an effective financing statement, problems can arise if a buyer for some reason does not learn of the security interest.

 

3.  The Gap Between Filing the E.F.S. and Appearing on a Distributed       List

A few hypothetical situations may be useful at this juncture.  For the basic fact pattern, suppose Lender has filed a sufficient E.F.S., Borrower decides to sell his wheat, and Buyer inquires about liens on Borrower’s wheat.  Subsequently, one of a pair of troubling situations might develop:

(1) Buyer is a subscriber to the master list.  Buyer checks the list, and finding nothing, pays Borrower as sole payee.  A few days later Elevator receives its new monthly master list, and discovers Lender filed an effective financing statement one week ago.

(2) Same facts as (1), except the lien never appears on the master list.  Lender, finding out Borrower sold his wheat, calls Buyer to find out why Buyer paid Borrower as sole payee when Lender filed his effective financing statement six months prior.  Buyer and Lender simultaneously realize the Secretary’s office has failed.

In both circumstances, Buyer takes free and clear of the security interest because it subscribed to receive the regular list and the list it received never gave it notice of Lender’s security interest.[31]


The foregoing are “gap” problems caused by the time it takes the Secretary to input statements and by the infrequency of master list distribution.  Gaps inhere in the system, and the obvious solution is to minimize them.  The frequency of such distribution is up to the discretion of each state adopting a central filing system.[32]  Where increased cost is not a minor factor, states surely wrestle with this decision.  Such costs should be absorbed, however, at least to some extent by the fees required of lenders and buyers in filing, registering, and inquiring.

 

4.  Central Filing Works: Erickson’s Survey Results

To get a feel for how truly interested parties have responded to central filing systems, the results of a somewhat informal survey are examined.[33]  Thirty-four responses from farm product buyers and twenty-five responses from agricultural lenders, all coming from nine states, comprise the results.  Phillip Erickson admits that he originated the survey not to generate a statistical analysis, but with the intent of making broad generalizations.[34]

 

a.  Results from Buyers of Farm Products

In states with a computerized central filing system, fifteen buyers use the system and nine do not.[35]  Only seventy-five percent of responding buyers consult the list each time a seller delivers a product for sale.[36]  Consider why all buyers are not consulting their lists.  A number of factors must coalesce before there is a problem such that a lender actually sues and prevails against a buyer: lender has a perfected security interest in the products, buyer issues a sole payee check, producer fails to pay lender (this subsumes that lender’s threat to withhold future credit falls on deaf ears), the amount in dispute is worthy of suit, no other human factors discourage lender from bringing action against lender, and lender can establish buyer’s actual receipt of the requisite notice of security interest.  Taken as a whole, one can imagine how a buyer may play this sort of roulette for a long time before he learns the brutal economic lesson of the costs of litigation.

After finding a lien on the product, twenty-two farm product buyers made a joint-payee check and zero did not.[37]  The obvious risk of not making a joint-payee check in that circumstance speaks for itself.  Buyers fear conversion actions from lienholders.  Fourteen buyers said the distributed list was current, while five disagreed.[38]  A common complaint among the five buyers who believe the list was not current, was the problem in taking liens off the master list once the lien is released.  While this may cause uncomfortable situations, it is not a fatal criticism in that the effect does not subject anyone to the risk of double liability.


Nineteen buyers said that even though their state has a computerized central filing system, they still receive direct mail notices, while eight do not.[39]  This is difficult to explain.  Also, eighteen buyers said they comply with direct mail notices, and three said they do not.[40]  If these buyers are not subscribers to the Secretary’s list, they should re-think their positions in that they are, regardless actual notice, deemed to have received notice of the security interest.[41]

 

b.  Results from Lenders

In central filing states, nine responding lenders said they use the central system, while one does not, but only one lender uses it for every producer of farm products.[42]  Most said they use it for fifteen percent or less of their borrowers.[43]  This percentage may be properly attributed to the lenders’ perceptions of an increased likelihood of one or more of the negative factors coalescing for particular borrowers. 

Lenders did not seem opinionated on whether the computerized list is current, insofar as only two said “yes”, one said “no”, and six did not comment.[44]  Only one responding lender in a central filing state had been involved in legal action concerning payment for farm products.  The action concerned a dispute over a lien granted to two lenders, all three, lender and secured parties A and B, were on the check. 

 

B.  Direct Notice

1.   Mechanics of Direct Notice

The secured lender should first require his borrower to provide a list of all potential buyers, commission merchants or selling agents, including names and addresses, to or through whom borrower’s farm products might be sold.  This requirement should be included in the security agreement.  Such action is authorized by the Act.[45]  Then, if the borrower sells to someone not on the list, he can be assessed a fine, also pursuant to the Act.[46]  Borrower will have to pay the greater of $5000, or fifteen percent of the value or benefit received for such products.  He may avoid such fine by notifying the secured party of the buyer’s identity at least seven days prior to the sale or by accounting to the secured party for the proceeds no more than ten days after such sale.[47]

Lender should then mail to all listed buyers notice of its security interests.  The notice should mirror an effective financing statement, as the Act requires the same contents.[48]  With respect to direct notice, however, the Act does not give lenders an “out” for substantial compliance “even though it contains minor errors that are not seriously misleading.”[49]  Compliance requirements have not been construed so strictly in court.[50]  Such notice protects lender’s security interest as to that buyer for only one year, at which time lender must again give notice to protect his proceeds.[51]  As in the central filing system, the notice contemplated in the direct notice system does not obviate the necessity of filing a UCC-1 financing statement to perfect a security interest.


In light of the allowance of section 1631(h)(2)(A) for producers to sell and buyers to take free and clear when producer has notified lender of a new buyer more than seven days prior to the sale, lenders will immediately mail notice, as discussed in the preceding paragraph, to newly “listed” potential buyers or risk losing their interest in the products and proceeds.  After receiving notice under the Act, a buyer need only comply with the secured lender’s payment obligations (commonly by issuing a joint-payee check) to take free and clear of a security interest.[52]

 

2.   Effectiveness of Direct Notice System

The concept of direct notice is simple, and in the “average” case direct notice should suffice.  That is to say, as long as involved parties, producers, lenders, and buyers abide by the “rules,” each is paid according to realistic expectations.  While such rules may seem clear, this system called “direct”, “creditor”, or “pre-notification” is not without its share of stumbling blocks.

 

3.   Problems with Direct Notice

As previously discussed, if a producer-lender sells to a buyer not on his list, he is subject to a substantial fine.  But the Act, while it provides an incentive for borrower honesty, does not otherwise benefit lenders.  Where the lender does not receive the fine and the buyer received no notice of the security interest, the lender has no conversion action against the buyer to make itself whole.  Perhaps the buyer will fear this fine provision or perhaps he will learn a valuable “next time” lesson.  But this time, the loss passed on to lender may be sufficient to inspire lender to hire a lobbyist.

State lines can also upset expectations.  Suppose, for example, Borrower lives in a direct notice state, only thirty miles from a central filing state.  If Borrower sells his milo to a buyer in such neighboring state, no lien appears in that state.  It may not be possible for buyer to timely inquire of Borrower’s home state.  Buyer receives no direct notice, and his subscription to his Secretary of State’s master list turns up nothing.  The Act seems to provide a result consistent with that in the above paragraph, especially in states like Iowa, where lenders are prohibited from sending notice to anyone not on the producer’s list.[53]  So, two of three parties comply with the Act, Buyer takes free and clear, and Borrower is probably fined.[54]  Another lender scans the yellow pages for “Lobbyist.”

 

4.   Uncertainties in the Direct Notice System


The Act provides a method for a secured lender to subject the buyer to payment obligations as a condition for release or waiver of the security interest.[55]  The provision is so poorly drafted, however, that it fails to clearly state whether a lender’s written notice “shall”  or “may”  contain “any payment obligations imposed on the buyer by the secured party as conditions of waiver or release of the security interest.”[56]  This presents two questions:  Has the buyer waived any payment obligations if he fails to include them in the notice?  And, is the notice insufficient for failure to include such obligations?  The better construction is that Congress intended that any payment obligations shall be included in the written notice.  This view is based on the idea that the only prior verb in the subsection to act on the direct object “any payment obligations” is “contains.”  Because “contains” clearly means that the notice “shall/will contain” the information such as name, social security number, and description of the products, and no more permissive language intercedes between “contain” and “any payment obligations. . . ,” the drafter seems to have intended that the notice shall also contain any payment obligations.

In light of this construction, it seems the lender is, by failing to include payment obligations as conditions in his written notice, informing the buyer that there are no such obligations.[57]  And, the buyer takes subject to the security interest only when he “has failed to perform the payment obligations.”[58]  If one prefers a contrary position, how is the buyer to know, in a system predicated upon receipt of notice, of lender’s payment obligations?  Admittedly, it seems inconsistent for lender to acquire a security interest, then fail to impose and notify of such payment obligations, but since when does logic supersede statutory authority?  Also, in the sometimes fragile relationship between producer and lender, there might exist sensitivity and perceived distrust if lender requires joint-payee checks.

The direct notice system clearly hinges on receipt of notice.  Buyer, under this system, takes clear title unless he received sufficient written notice.  Receipt is governed by the law of the State in which the buyer  resides.[59]  So, receipt could mean actual receipt of notice in one state and deposit of notice in the mail in the neighboring state, but the definition of receipt should be clear within a given state.

What is the standard for sufficiency of notice?  Unlike the central filing provisions, direct notice provides no “out” for substantial compliance notwithstanding minor errors that are not seriously misleading.[60]  The court, in Lisco State Bank v. McCombs Ranches, Inc., notwithstanding the fact that lender could establish actual oral notice to the buyer, required strict compliance with the statute, and found such notice insufficient.[61]  The FDIC, in Federal Deposit Ins. Corp. v. Bowles Livestock Comm. Co., however, had to go to court to establish that posted, rather than mailed, notice was sufficient to maintain its secured status as against the buyer.[62]

Even a perfectly sufficient written notice loses such quality when it lapses.  Section 1631(e)(1)(A)(iv) provides that notice “will lapse on . . . the expiration period of the statement.”  Hence, the notice lapses one year after receipt.[63]  As shown, with time requirements come gaps.  Suppose Producer has granted Lender a security interest in 1998 soybeans.  Lender sends Buyer notice that is fully sufficient in all respects.  Within a year of receipt, Producer harvests but retains possession of the soybeans, awaiting a better market price.  Slightly more than a year post-receipt, Producer sells to Buyer, who pays with a check payable only to Buyer.  Result:  Buyer takes free and clear, and Lender is left to pursue the proceeds.


As in central filing systems, material changes cause uncertainties.  Material changes must be reflected in amendment to the notice within three months.[64]  Suppose there is a true material change, Lender is so informed, Producer sells to Buyer before Buyer receives Lender’s amendment, and Buyer issues a single-payee check to Producer.  Here, all complied with the Act.  The court is left to grapple with deciding on whom the burden should fall.  Though the Act does not provide a clear result, the decision may turn on how much time lapsed between the material change and when Producer notified Lender and on what opportunity Lender had to notify Buyer before the sale.  Still, heaping uncertainty upon uncertainty, the character of a “material change” is not clearly known.

Direct notice places seemingly all of the burden of action and risk of loss on lenders.  While some may consider this just, consider the effects.  Lenders are, after risking or actually suffering enough loss, persuaded to turbo-charge their direct notification operations.  This enhancement may include: inserting payment conditions on all notices; sending all notices certified mail; blanket notification of all reasonably possible buyers, even those not listed by producers (where allowed) and out of state buyers; fast-tracking amendments following material changes; closely monitoring the one-year lapse of notices; and pursuing litigation more aggressively.  Each of these activities must be funded and producer-borrowers are the obvious candidates to pick up the tab.  It is virtually unimaginable that lenders will decide not to pass along their increasing costs by raising origination fees, penalties, rates and by practicing more selective lending.  In sum, buyers make out like bandits in a direct notification state.  They receive the benefits of certainty and of taking free and clear, while lenders and producers bear the cost.

 

5.   Buyers and Lenders Chime In: Erickson’s Results

Erickson’s work and assembly of responses again provide insight into evaluations of the system in direct notification states.[65]

 

a.   Buyers

When buyers of farm products were asked whether they reject notices, they answered that they reject notices that reference “all crops” or notices that have expired.[66]  Though rejection does not preclude receipt, buyers would seem safe in not bothering with such patently insufficient notices.  “All crops” has been consistently deemed an insufficient description of farm products for purposes of the Act.  Expiration is expressly contemplated by the Act, but buyers must remain ready to prove their receipt a year or more before they rejected the notice.[67]

None of the buyers, in direct notice or central filing states, had been involved in legal actions concerning payments for farm products.[68]  One-third of the buyers expressed dissatisfaction with the perception that they are being forced to act as collection agents for lenders.[69]  Almost half of the buyers acknowledged that they like the direct notification system.[70]  It seems buyers should love the direct notice system and sit content to check their files and sometimes issue a joint-payee check.  Perhaps these responding buyers have a low threshold for burdens, or maybe they believe collection agents enjoy a role without much challenge.

 

 


b.  Lenders

Lenders in direct notice states were asked to whom they send notices.  Nineteen lenders said they send only for selected debtors, while only one sends notice for every debtor.[71]  Among those sending notice to selected debtors, the overwhelming single criterion prompting such selection is high risk or adverse account status.  Twelve lenders said they rely in almost all cases on the debtor in deciding to whom they send notices, seven do not so rely.[72]  Almost all of those who do not rely on the debtor for such information blanket their area to reach all reasonably possible buyers.  Returning to simple cost-benefit analysis, lenders feel confident in trusting certain producers with good reputations.  Lenders choose to concentrate their resources on their higher-risk borrowers, and many even choose to blanket the area rather than to trust the borrower for information on potential buyers.

Twenty-two lenders send notices each year, while two do not.[73]  An expired notice may as well not exist, unless the buyer will voluntarily pay jointly notwithstanding such expiration.  This is all well and good, but no attorney would likely advise his lender-client to rely on such acts of good faith.  After all, acts of good faith are not required by the Act.  The lenders are split on whether they send notices outside their state.[74]  Perhaps the negative respondents do not live near a border of their states.  If however they are near, they should understand that failure to contemplate foreign buyers could leave them without a lien or a conversion cause of action against the foreign buyer.  Again, these lenders may be thinking of all the factors that have to coalesce before circumstances depreciate to such an extent that litigation becomes necessary.

On how often they use certified mail to send direct notice, six lenders said they always do, eight seldom send certified mail, and two admitted that they never send notice by certified mail.[75]  Evidently, most of these lenders trust the buyers to either comply with the written notice or to admit in court, after failing to comply, that they in fact received notice.  Of course this hinges on the particular state definition of  “receipt,” but where receipt means actually receiving the notice, perhaps lenders should reconsider.

Fifteen lenders had not had legal action concerning their payment for farm products, while two had been involved in such action.[76]  Of these actions, one concerned an issue of priority as against a landlord’s lien, and the other lender lost their lien to a buyer by expiration of the written notice.  If all lenders, who have been involved in litigation over payment, were to be polled, their understanding of and respect for the conditions precedent to receiving the protection of the Act would likely be in marked contrast to those never drawn into court.

Seven of ten lenders in direct notice states were displeased with the direct notice system, citing that: it fails to stop fraud; the computer is better; it is very labor intensive; it is a favor to buyers which creates additional work for lenders; it needs to expand its teeth; it is redundant to the UCC on a select class of collateral and it increases cost of products and services to debtors and buyers.[77]  This laundry list speaks for itself.


III.  SUGGESTION.

The question examined gleans opinions along sharply partisan lines.  Buyers favor the direct notice system, and lenders prefer central filing.

It is, of course, no wonder buyers like direct notice.  The burden of notification falls squarely on lenders.  Buyer responsibilities are clear, predictable and unfairly limited.  Finally, mistakes in notification, even seemingly minor ones, tend to benefit buyers by allowing them to take free and clear of a security interest.  The burden is cast upon lenders.

Surely that which buyers prefer, lenders will dislike.  This is true for notification, indeed.  Lenders fancy the central filing system.  It puts them on a more equal footing with buyers.  A computerized, efficient system will allow for the greatest possibility that buyers will meet payment obligations or take subject to lender’s security interest.  Lender’s burden is, thus, minimized.  The costs of blanketing buyers with annual notice by certified mail, policing material changes, and fast-tracking amendments reflecting such changes are much greater than sending effective financing statements and registration fees to the Secretary of State.  Likewise, the buyer, in a central filing system, is confronted with at least limited investigative responsibility if he is to be rewarded, rather than all the burden falling on the lender.  Last, uncertainty is reduced for the lender who can forward effective financing statements to the Secretary and basically rest assured that his part of the bargain is fulfilled and that he has done all he can. 

Greater difficulty lies in selecting which notification system is better as a whole, rather than as to buyers or lenders only.  This must begin with examining the kind of results an ideal notification system provides.  How does one recognize an ideal system?  Lessons may be learned from jurisprudence.  Such a system is equitable, it sets forth clear burdens and rewards conscientious parties, and the results of most given factual scenarios are both predictable and consistent with the common law.  Which system comes nearer this ideal?

The central filing system provides the more clear set of expectations for availing parties.  The requirements for both written notice and effective financing statements are fundamentally clear.  Buyer’s burden is not unclear in either system, but probably the slightly more clear requirements are provided by the direct notice system.  Buyer generally takes free and clear if he has not received sufficient written notice, where in the central system, he must either register to receive the Secretary of State’s list and check the list before purchases, or he needs to inquire of the Secretary on a purchase-by-purchase basis.  Either way, it is clear a buyer will be protected if he checks the list or makes inquiry.  Under central filing, the effective financing statement lapses after five years, and under direct notice, written notice lapses one year after receipt.


The central filing system provides the more predictable result as to authorization of sale and waiver of objection.  Courts have made it clear that they will look to the effective financing statement, and if written authorization is required therein, a waiver will not be found absent such strict compliance.  On the other hand, it is unclear under the direct notice system whether a buyer can safely rely on the lack of a payment obligation in the written notice.  It is surely in lender’s best interest to include such obligations therein.  Because of an uncertain construction of the written notice requirement, however, it is not known whether lender “may” or “shall” include payment obligations as a condition in the written notice or, if he “shall,” whether the lack thereof makes the notice insufficient and/or authorizes disposition of the collateral.

The “gap” problem affects the predictability of results in both systems.  While the nuisance presents itself more frequently in the central filing system, this same system is much more able to remedy the potential for error.  Computerization can close the gaps both between lender’s submission and entry of information into the Secretary of State’s master list and between entry into the Secretary’s master list and availability to buyers.

Finally, a simple examination of the equities is in order.   One must acknowledge that all parties (buyers, lenders, and producers) reap some benefit from both notice systems.  If nothing else, they glean at least substantially equal benefits under both systems.  Difficulty comes in trying to reconcile the relationships between the burdens of buyers and lenders and their benefits under the two notice systems.  Under central filing, the burdens are allocated somewhat evenly between buyers and lenders.  The lender is taxed with filing an effective financing statement as to each borrower, while the buyer is charged with inquiring for liens before closing a farm products transaction. 

Incontrovertible inequity inheres in the direct notice system, where the burden of placing notice under not only the actual buyer’s nose, but also under all potential buyers.  Farm products buyers are unfairly favored by the direct notice system at a substantial cost to lenders.  This is the fundamental problem with a state not offering a central filing system.

States that have not already done so should adopt a central filing system.  Flexibility and more thorough coverage is encouraged by doing so.  The central filing system can continue to prove itself quite efficient, and lenders and producers can thereafter stop picking up the tab for the farm product buyer’s free lunch.

 

 

Notes

 

 


[1].       U. C. C. § 9-307(1) (1998).

[2].       See 7 U.S.C. § 1631 (1994).

[3].       The terms “buyer” and  “buyers” as used herein should be construed to include buyers, commission merchants, and selling agents, as contemplated by 7 U.S.C. § 1631 of the Food Security Act of 1985 (1994).

[4].       See 7 U.S.C. § 1631(e)(1) (1994).

[5].       See 7 U.S.C. § 1631(e)(2) (1994).

[6].       7 U.S.C. § 1631(a) (1994).

[7].       James J. White and Robert S. Summers, Uniform Commercial Code, §24-14, p. 885 (4th ed. 1995).

 

[8].       See 9 C.F.R. § 205 (1-1-98 Edition).

[9].       7 U.S.C. § 1631(c)(1) (1994).

[10].     U. C. C. § 1-201(9) (1998).

[11].     See, e.g., Ashburn Bank v. Farr, 426 S.E. 2d 63, 64 (Ga. Ct. App. 1992)(holding good faith and absence of knowledge not requirements of Food Security Act; buyer takes free of security interest despite actual knowledge).

[12].     But see U. C. C. § 9-306(2) (1998)(stating the security interest continues in identifiable proceeds).

[13].     See 7 U.S.C. § 1631(c)(5) (1994).

[14].     Id.

[15].     Compare Keith Meyer, The 9-307(1) Farm Products Puzzle: Its Parts and Its Future, 60 Notre Dame L. Rev. 401 (1984), with Douglas G. Baird & Thomas H. Jackson, Possession and Ownership: An Examination of the Scope of Article 9, 35 Stan. L. Rev. 175 (1983).

[16].     These states include Alabama, Arkansas, Colorado, Idaho, Louisiana, Maine, Minnesota, Mississippi, Montana, Nebraska, New Hampshire, New Mexico, North Dakota, Oklahoma, Oregon, South Dakota, Utah, Vermont, West Virginia, and Wyoming.  See Phillip L. Erickson, The Federal Farm Products Statute: What Do Buyers and Agricultural Lenders Think After Eight Years of Living With It, 18 Hamline L. Rev. 363, fn. 39 (1995).

[17].     See Syed A. Salat, Federal Preemption of the Farm Products Exception: Coherence or Confusion?, 15 S.U. L. Rev. 53, 67 (1988).

[18].     See 7 U.S.C. § 1631(e)(3)(B) (1994).

[19].     See 7 U.S.C. § 1631(e)(3) (1994).

[20].     But see First Bank of Okarche v. Lepak, et. al., 961 P.2d 194, 35 U.C.C. Rep. Serv.2d 1360 (1998)(holding under that state’s nonuniform version of 9-307, the consent defense to a conversion action was available, notwithstanding the strict language of § 1631 to the contrary, where the court concluded that Congress had not intended to preempt state common law).

[21].     See 7 U.S.C. § 1631(c)(4) (1994).

[22].     See 7 U.S.C. § 1631(c)(4)(A) (1994).

[23].     See 7 U.S.C. § 1631(c)(4)(B), (C) (1994).

[24].     See 7 U.S.C. § 1631(c)(4)(D) (1994).

[25].     See 7 U.S.C. § 1631(c)(4)(E) (1994)(requiring amendment); 9 C.F.R. § 205.209(a)(1-1-98 Edition)(defining “material change” as whatever change would render the master list entry no longer informative as to what is subject to the security interest in question).

[26].     7 U.S.C. § 1631(c)(4)(F) (1994).

[27].     7 U.S.C. § 1631(c)(4)(I) (1994).

[28].     See 7 U.S.C. § 1631(c)(2)(D) (1994).

[29].     7 U.S.C. § 1631(c)(2)(E) (1994).

[30].     See 7 U.S.C. § 1631(c)(2)(F) (1994).

[31].     See 9 C.F.R. § 205.208(c)(1-1-98 Edition).

[32].     9 C.F.R. § 205.1-.214(1-1-98 Edition).

[33].     See Erickson, supra note 16, at 381, app. A.

[34].     See id., at n. 118.

[35].     See id. at 381.

[36].     See id.

[37].     See id.

[38].     See id.

[39].     See Erickson, supra note 16, at 382.

[40].     See id.

 

[41].     See 9 C.F.R. § 205.208(b)(1-9-98 Edition).

[42].     See Erickson, supra note 16, at 384.

[43].     See id.

[44].     See id.

[45].     See 7 U.S.C. § 1631(h)(1) (1994).

[46].     See 7 U.S.C. § 1631(h)(3) (1994).

[47].     See 7 U.S.C. § 1631(h)(2) (1994).

[48].     See 7 U.S.C. § 1631(e)(1)(A) (1994).

[49].     7 U.S.C. § 1631(c)(4)(I) (1988).

[50].     See First Nat’l Bank and Trust v. Miami County Coop. Ass’n, 257 Kan. 989 (1995)(construing congressional intent to put buyers on notice, the court found the description of “grain and beans grown by [the borrower] in Miami County, Kansas” sufficient notwithstanding lack of specificity).

[51].     See 7 U.S.C. § 1631(e)(1)(A) (1994).

[52].     See 7 U.S.C. § 1631(e) (1994).

[53].     See White & Summers, supra note 7, at 886.

[54].     But see 9 C.F.R. 205.210(b)(1-1-98 Edition)(stating if Borrower lived in a central filing state and sold in a direct notice state, Buyer in the direct notice state would be charged with notice for his failure to subscribe to the other state’s master list.)

[55].     See 7 U.S.C. § 1631(e)(1)(A)(v) (1994).

[56].     See Charles W. Wolfe, Comment: Congress Preempts ‘Farm Products Exception’ of Section 9-307(1) of the Uniform Commercial Code, 55 U.M.K.C. L. Rev. 454, n. 106 (Spring, 1987).

[57].     See U.C.C. § 9-306(2)(whereby such failure to include payment obligations may constitute authorization by the secured party).

[58].     7 U.S.C. § 1631(e)(1)(B)(1994).

[59].     See 7 U.S.C. § 1631(f) (1994).

[60].     See First Nat’l Bank and Trust v. Miami County Coop. Ass’n, 257 Kan. 989 (1995).

[61].     See Lisco State Bank v. McCombs Ranches, Inc., 752 F.Supp. 329, 13 U.C.C. Rep. Serv.2d 927 (D.Neb. 1990)