Revised Article 9 and Government Entitlement Program Payments A Suggested Solution to Classification Confusion
Receivables Under Government Entitlement Programs. This article does not contain a defined term that encompasses specifically rights to payment or performance under the many and varied government entitlement programs. Depending on the nature of a right under a program, it could be an account, a payment intangible, a general intangible other than a payment intangible, or another type of collateral. The right also might be proceeds of collateral (e.g., crops) (emphasis added).
As a result, Revised Article 9 gives no help to the lender attempting to create a security interest in a borrower's government entitlement payments or arguing that existing documentation covers entitlement payments due the debtor—from whatever program source. However, the comment offers a potential judicial solution: Implicit in Official Comment 5(i) is the recognition that the wide variety of government payments to farm debtors potentially fall into a de facto category of personal property termed "government entitlement programs."3 While the authors of Revised Article 9 might simply have defined a new category or classification of "government entitlement programs" or expressly stated that government entitlement payments fit into an existing category (such as "account"4), they did not do so. The authors suggest that the simple solution is for the courts to remedy that omission by expressly recognizing the existence of "government entitlement payments" as a valid classification of personal property under Article 9.5
In the absence of a specific classification for government entitlement payments, counsel for debtors and lenders are still faced with untangling the conflicting pre-revision case law on the issue and attempting to sort out how the Revised Article 9 and the current federal farm legislation fit into that historical framework. If past is indeed prologue, the task will not be easy.
The Tangled Case Law
The depressed farm economy coupled with the periodic resuscitation of chapter 12 (which, like the family farmer, seems to be perennially endangered or expiring) ensure that security-interest perfection issues in government entitlement payments will remain an important source of debt repayment for embattled farmers and their creditors. The quandary for farm lenders in Article 9 has long been recognized.6 Creditors in numerous reported cases under old Article 9 found themselves divested of an apparently perfected security interest in a farm debtor's entitlement payments—whether cash or in-kind distributions—because the court found that the payments were not properly described in the documents or that the entitlement payment did not fit into the collateral description included in the documentation.7 The creditor's problem under old Article 9 cases was almost always one of classification: The creditor had described with words one kind of collateral in its security instrument and financing statement, and when a dispute arose, the court analyzed the government program under which the entitlement payment was generated, and held that the payment that the lender desired to attach didn't fit the wording classification used in the lender's filing.
Unfortunately, the courts often declined to identify the correct classification for the entitlement payments and resorted to a description of what it was not. The decisions in the pre-revision cases often turn on an analysis of the timing of the grant of the security agreement, vis-à-vis the debtor's participation in the government program (especially when a bankruptcy ensues). At least one court correctly concluded that, as a matter of bankruptcy law, a pre-petition dragnet clause did not attach to an entitlement payment owed the debtor under a program that did not exist at the time the debtor filed for bankruptcy relief. (See In re Stallings, 290 BR 777 (Bankr. D. Idaho 2003).8
A summary of the old Article 9 cases are arranged by type of government program in the Appendix (see p. 56); the remaining discussion relates to the pre-revision case law and the few cases reported since the revision became effective.9 (The Appendix is a compilation, by state, of the pre-revision cases.)
Farm borrowers may also be potential recipients of government entitlement payments for less-traditional, non-crop farming and livestock activities. The plethora of existing government programs makes the accurate identification of the various government entitlement payments in loan documents challenging, to say the least, and lends support to the argument that the courts should simply recognize that entitlement payments constitute a distinct classification of personal property under the UCC.10 Lenders have two separate challenges in drafting the documents that deal with government entitlement program collateral: They must both "reasonably identify" the collateral in the underlying security agreement without using a supergeneric description,11 and they must sufficiently identify the collateral on the financing statement.12 The latter is greatly facilitated by Revised Article 9's authorization of "supergeneric" collateral descriptions such as "all assets" in the financing statements.13 Further, lenders are potentially faced with at least three different scenarios in creating a valid security interest in entitlement payments: (1) entitlement payments that are in existence at the time of the loan transaction but have not been paid for some reason, (2) entitlement payments payable from a known program in which the debtor is already enrolled or plans to enroll for a current or future year(s) but that are not yet due, and (3) entitlement payments payable from future programs that haven't yet been legislated but to which the debtor may become entitled. For example, at the time the Farm Security and Rural Investment Act of 2002 (2002 farm bill) was enacted in May 2002, the Agricultural Assistance Act of 2003 ("2003 disaster assistance act") had not yet been proposed. A lender who properly documented a security interest in August 2002 in benefits to be paid the debtor under the 2002 farm bill in crop year 2002 might be surprised to learn that the 2003 disaster assistance act payments, first announced by the government in September 2002, although potentially related to that same 2002 crop, are a separate entitlement from those described in the earlier signed loan documentation because of a change in the program entitlement. To further complicate matters, the various government programs have differing requirements for payment eligibility. Some require enrollment through an application made during a designated time period, others required signed, long-term contracts, and still others permit after-the-fact enrollment for a prior crop year upon payment of specific fees. Adding another layer of complexity is the fact that payments derived from a single entitlement program may be funded in multiple tranches payable over a period of years. The complexity of the analysis appears overwhelming and is a clear argument for recognition of "government entitlement payments" as a distinct type of collateral. If the lender describes the collateral as "government entitlement payments" and then specifically adds details relating to a specific program in the security agreement, the lender may logically claim a perfected security interest in any payment under any applicable program, pursuant to Revised Article 9, as against any other creditors and the trustee in bankruptcy. The argument, of course, is founded on the assumption that the entitlement payments are akin to accounts, general intangibles or similar categories of collateral in which perfection is achieved by filing. However, if there is any doubt as to either the nature of, or the conditions imposed for, eligibility on the farm debtor's receipt of the government subsidy, then the UCC-1 financing statement filed by the lender should describe all forms of collateral, including proceeds of crops, general intangibles, contract rights and accounts.
As has been previously noted, the foregoing is subject to the crucial caveat that government entitlement program legislation and related regulations have in the past frequently contained restrictions on the farm debtor's ability to grant a security interest in the entitlement payment to secure existing indebtedness.14 Thus, the lender frequently will not be able to assert a security interest in after-acquired entitlements—not because of any problem under the UCC, but because the entitlement payment was subject to conditions that would defeat any existing security interest. Thus, the lender must check the applicable regulations and determine whether a security interest in the entitlement payment is even permitted.15 Moreover, some of the older programs required that the lender register a formal assignment of that payment with a government agency, such as the Farm Service Agency, in order to receive the payment at the appropriate time. (It is not clear whether the older programs requiring the filing of an assignment with an agency were designed to defeat a UCC security interest or simply protect the government from double liability if it made the payment directly to the farmer. See, e.g, In re Harvie, 84 B.R. 197, 6 UCC Rep. Serv. 2d 841 (Bankr. D. Colo. 1988).)
Government Programs Since 2002
The 2002 farm bill, enacted May 13, 2002, and the 2003 disaster assistance act, signed Feb. 20, 2003, are only the latest in federal legislation that extends and substantially increases federal government assistance to farmers. Farm politics virtually guarantee that there will be additional programs in the future. The 2002 farm bill provides the structural framework for price supports for six years, through fiscal year 2007. The 2003 disaster assistance act provides substantial subsidies to farmers for qualifying losses to both livestock herds and to 2001 and 2002 crops (for commodities other than sugar and tobacco) caused by weather and related conditions. Both statutes provide for substantial cash payments and other benefits to farmers under a myriad of circumstances, continuing long-standing federal government policy of extensive price supports and direct payments in order to bolster farm income, control production, and promote conservation and other institutional policies.16 Although the amount and type of support varies by commodity, farm and locality, the size and scope of the programs is enormous and of substantial importance to both farmers and lenders. The 2003 disaster assistance act alone provides payments of up to $80,000 per producer, with a limitation on payments where the combined total of disaster assistance act payments, crop insurance recoveries and noninsured crop disaster assistance program (NAP) payments exceed 95 percent of the farmer's income had a successful crop been harvested.17 The 2002 farm bill provides non-recourse marketing assistance, direct payments and counter-cyclical payments that kick in when the effective price for a crop is less than the government's targeted price.18 Direct payments are capped at $40,000 per person, counter-cyclical payments at $65,000 per person and marketing loan and loan deficiency payments at $75,000.19 However, a married couple may be entitled to receive the individual capped limits for each spouse, meaning that the couple can potentially receive up to $360,000 in a single crop year from the 2002 farm bill support programs.20
In addition to the 2002 entitlements, the 2003 legislation provides for special disaster payments and other crop insurance payments for which many farm debtors become eligible. Between the two programs, the government may be the most substantial source of a farmer's income and thus the most important source of debt repayment. Since the payments are often tied to crop failure, they become vital to debt repayment to a lender that previously relied on the crops for repayment—again a cogent argument in favor of recognition of a "government entitlement payments" classification.
Because Revised Article 9 fails to provide a catch-all classification category in which to corral farm entitlement payments, confusion will continue to reign in the farm-lending arena unless the courts take it upon themselves to recognize "government entitlement payments" as a valid collateral classification and enforce descriptions using similar language. Unfortunately, even this "solution" is imperfect, since Congress frequently undertakes to restrict the types of debt for which an entitlement may be pledged as security.
The following summary lists historical cases by state jurisdiction and provides a summary analysis of each listed case. Cases are listed in ascending chronological order within the jurisdiction.
AR: Bank of North Arkansas v. Owens, 884 F. 2d 330 (8th Cir. 1989): Contract rights: Dairy termination program payments, which compensated farmer for leaving the dairy business, were contract rights and not proceeds of collateral; although the cattle that were the secured party's collateral were sold, the payments were for the abandonment of the milk business and for taking facilities out of production, and had nothing to do with the cattle that were the secured party's collateral. A competing secured creditor with perfected security interest in contract rights and general intangibles was permitted to obtain proceeds. (See, also, prior decision at Bank of North Arkansas v. Owens, 76 BR 672, 4 UCC Rep Serv. 2d 1065, (Bankr. E.D. Ark. 1987)).
CA: In re Munger, 495 F 2d 511 (C.A. Cal. 1974), 14 UCC Rep. Serv. 790: Proceeds of crops: An interested third party could be expected to know that the crops described were sugar beets, and that the farmer was entitled to conditional subsidy payments from the Department of Agriculture under the Sugar Act of 1948 based on the amount of sugar in the beets. Likewise, abandonment payments based on acreage abandoned due to disease, although in the nature of insurance, are integral part of sugar-beet farming; both are within a broad reading of "proceeds," and to find otherwise would be contrary to UCC's intent. In Re Dettman, 84 BR 662 (9th Cir. B.A.P. (Cal.) 1988), Bankr. L. Rep. P 72,267: General intangibles and proceeds: Payments received from the Raisin Industry Diversion Program for diverting previously planted grape vineyards to non-production, where payment is based on quantity of raisins diverted, prior crop's yield, and rate established at present crop year end, constituted either general intangibles or proceeds, both of which were described by secured creditor's security agreement.
CO: In re Preisser, 33 BR 65, 10 Bankr. Ct. Dec. 1306, 36 UCC Rep. Serv. 1768 (Bankr. D. Colo. 1983): Rents or profits: Court held that the benefits the debtor received from the government for non-production of grain is rents or profits of the land and belonged to the secured creditor (United States) with a deed of trust covering rents, issues, profits, revenues and income. The case concerned the question of whether the debtor could assign his rights in PIK program to attorney for payment of attorneys' fees in bankruptcy; court did not address the classification of the PIK program rights under the UCC. In re Mahleres, 53 BR 86, 41 UCC Rep. Serv. 1473 (Bankr. D. Colo. 1985): Proceeds of collateral: Wool incentive payments received by the debtor under the National Wool Act of 1954, whereby sheep farmers are incentivized to cultivate sheep and sell wool at the best possible price, and receive government subsidies based on the price actually received for wool sold, were "proceeds" of wool, which was a "product" of sheep, not general intangibles. Since the secured party's security agreement did not cover products from sheep, the secured party could not reach the incentive payments. In re Patsantaras Land and Livestock Co., 60 BR 24, 42 UCC Rep. Serv. 1805 (Bankr. D. Colo. 1986): Proceeds: Government-paid wool incentive payments were proceeds from products of sheep, and were covered by the secured party's security interest, which described products of sheep. In re Ratliff, 79 BR 930, 5 UCC Rep. Serv. 2d 788 (D. Colo. 1987): Rents, not proceeds of crops: The government paid the debtor rent on land and part of the cost to plant grass cover-crop per a contract under which the debtor was barred from using land for grazing or crop harvesting, the government payments are not like PIK payments made for specific crops on specific acreage for specific production, but are in the nature of rent. In re Clark, 82 B.R. 131, 5 UCC Rep. Serv. 2d 1187 (Bankr. D. Colo. 1987): CRP contract rents, which the court says are akin to PIK payments and were paid to debtors who diverted acreage to conservation purposes, are rents, not proceeds, under §9-306. In re Harvie, 84 B.R. 197, 6 UCC Rep. Serv. 2d 841 (Bankr. D. Colo. 1988): Rents: CRP contract payment made in form of in-kind commodity certificate is rent; again, court did not address classification issues under Article 9.
FL: Matter of Azalea Farms Inc., 68 B.R. 32, 3 UCC Rep. Serv. 2d 325 (Bankr. M.D. Fla. 1986): Not proceeds: Milk Diversion Program payments are not proceeds or substitute for collateral within the meaning of UCC, and are not assignable as matter of law.
GA: Matter of Hollie, 42 BR 111, 38 UCC Rep. Serv. 1772 (Bankr. M.D. Ga. 1984): Cash collateral: Milk diversion program payments, which are government subsidies to the debtor for reduction in his production and that do not require a reduction in size of dairy herd for eligibility, are cash equivalents similar to actual milk proceeds; they are substitutes for post-petition milk and proceeds, and the secured creditor is entitled to its lien. In re Ring, 169 BR 73 (Bankr. M.D. Ga. 1993), aff'g. 160 BR 692 (Bankr. M.D. Ga. 1993): Proceeds: Government disaster relief payments for weather-destroyed crops are the substitute for proceeds of the crop and are analogous to insurance payments for crop loss or damage.
IL: J. Catton Farms Inc. v. First Nat. Bank of Chicago, 779 F 2d 1242, 54 USLW 2391, Bankr. L. Rep. P 70,882, 42 UCC Rep. Serv. 1049 (7th Cir. 1985): Account or proceeds of contract right: The debtor's grant of security interest to the secured creditor in receivables, accounts, inventory, equipment, fixtures and proceeds and products thereof, in exchange for substantial multi-million dollar new loan, was sufficient to reach payment-in-kind of corn that the debtor received for planting cover crop to prevent erosion, in lieu of corn. Corn PIK was an executory contract right, and falls within the definition of " account" under §9-106. Following the bankruptcy filing, the debtor sold his contract right for the future receipt of the PIK corn bushels to a competing creditor for a cash payment substantially discounted over the value of the future corn. The court held that the first lender was the secured creditor entitled to the crop-in-kind payment, and that the debtor's failure to follow the government's regulatory requirement that assignment be recorded did not affect the secured creditor's right to obtain the PIK proceeds. In re Schmaling, 783 F 2d 680, 54 USLW 2433, 42 UCC Rep. Serv. 1074 (7th Cir. 1986): General intangible or contract right: A PIK payment of bushels of corn is not proceeds of a crop, but rather an account payment derived from an executory contract right because the payment was not received for the sale, exchange, collection or other disposition of the crops, and no crop was ever planted. Here, the bank could have acquired an interest in the PIK payment by directly referring to the government entitlement program, or by listing general intangibles or contract rights. In re George, 62 BR 671 (Bankr. C.D. Ill. 1986): Proceeds of crop: The "sealing profit" created where the debtor places an existing crop in a government program under which the government loans the debtor funds at a predetermined price per bushel by non-recourse loan, and the debtor sells his crop through the government at a subsidized rate if the market price drops below the loan rate, thus "sealing" his profit at the higher rate, constitutes proceeds of crop. In re Kruger, 78 BR 538, 4 UCC Rep Serv. 2d 1190 (Bankr. C.D. Ill. 1987): General intangible: Deficiency payment received on a corn crop, where calculated based on the number of acres planted (not harvested), multiplied by historical yield (not actual yield), multiplied by the difference between national average price for the crop and the target price for the crop, is not proceeds of a crop. To constitute proceeds, a crop must be planted and disposed of, and the entitlement claimed by the secured creditor must have been received in connection with the disposition. (The court applies In re Schmaling, which by implication means that the court finds the crop payment to be a general intangible.) In re Settles, 69 BR 634, 3 UCC Rep Serv. 2d 345 (Bankr. C.D. Ill. 1987): Not proceeds: "Sealing profits" derived under a government deficiency program from a substituted crop planted with money borrowed from Commodity Credit Corp. do not constitute proceeds of crop in which the Farmers Home Administration (FHA) has a security interest because the FHA-liened crop would have already been sold and the proceeds therefrom previously paid to FHA, so FHA security interest would have disappeared. This unusual case is based on unique and hypothetical facts, where the debtor sought advance permission from the bankruptcy court to deliver a crop to the FHA and then borrow funds from CCC to participate in a deficiency payment program with a substitute crop, and thereby obtain the "sealing profits" free and clear of the FHA lien.) Fayette County Farms v. Vandalia Farms, 118 Ill. Dec. 232, 167 Ill. App. 3d 471, 521 NE 2d 300 (Ill. App. 5 Dist. 1988): General intangible: PIK commodity payment received in exchange for diverting producing acreage to non-production is not analogous to crops grown and harvested, and thus is a general intangible. In re Blackert, 95 BR 972 (Bankr. C.D. Ill. 1989), 9 UCC Rep Serv. 2d 1342; (rev'd. on other grounds, 109 BR 857 (U.S.D.C., C.D. Ill. 1990)): Not proceeds or contract rights: Deficiency payments under the Agricultural Conservation Program are not "growing crops" or "stored grain" as defined in security instrument, and are not contract rights, accounts receivable or proceeds within the meaning of §9-306. In re Ladd, 106 BR 174, 10 UCC Rep. Serv. 2d 1414 (Bankr. C.D. Ill. 1989): General intangible: Disaster Assistance Act payments, which compensate a farmer for deficiency created by drought, hail, excessive moisture or related conditions, are based on historical yields and not actual yields, and are paid without a requirement that the crop be disposed of, do not constitute proceeds of a crop. For the secured party's lien to attach, the financing statements must describe the government disaster payments specifically, or must cover general intangibles.
IN: Scudder v. Farmers Production Credit Ass'n. of Scottsburg, 521 N.E. 2d 354 (Ind. 1988): Not proceeds or contract rights: The court overturned a lower-court ruling that the government milk diversion program payment was a contract right and account receivable derived from a security interest in all dairy cattle, offspring, additions and replacements of livestock, and products of livestock, but the court declined to categorize the collateral under the UCC, finding instead that the debtor's property was not acquired before the commencement of his bankruptcy case and was therefore not subject to a pre-petition lien.
IA: Matter of Sunberg, 35 B.R. 777 (Bankr. S.D. Iowa 1983) aff'd., 729 F 2d 561 (8th Cir. 1984), 37 UCC Rep. Serv. 1700): (1) General intangible: The contractual right to payment in kind constituted a general intangible in which the creditor had a perfected security interest; (2) Non-cash proceeds of contract right: The property received bushels of grain, which was non-cash proceeds of the contract right (general intangible) to receive the PIK payment; and (3) After-acquired property: Future entitlements to payment for bushels of corn obtained for agreement made pre-bankruptcy filing to divert acreage from planting constitute after-acquired property that was covered by the secured party's perfected security interest, which described crops, growing crops, farm products, contract rights, accounts and general intangibles "existing or hereafter acquired." In re Fowler, 41 BR 962 (Bankr. N.D. Iowa 1984): General intangible: PIK payments made if debtors agreed not to create collateral are not proceeds of anything, but rather are a general intangible. In re Liebe, 41 BR 965, 39 UCC Rep. Serv. 1025 (Bankr. D. Iowa 1984): General intangible: The PIK entitlement program creates a contract right properly classified as a general intangible; a security agreement that asserted interest in a specific intangible, the contract right of the debtors, would create a security interest in the PIK program right if all other requirements are satisfied. Here, security interest does not attach, as the secured creditor's "now owned or hereinafter acquired" language modified only specifically described personalty and did not extend to the PIK contract rights acquired post-petition. Matter of Heims, 65 B R 112, 2 UCC Rep. Serv. 2d 275 (Bankr. N.D. Iowa, 1986): Accounts: PIK cash payment made to the debtor for limiting the number of acres of corn grown, and devoting percentage of land to conservation uses, is covered by a properly perfected security interest in accounts (following Matter of Sunberg). In re Sabelka, 57 BR 972, 42 UCC Rep. Serv. 1775 (Bankr. N.D. Iowa 1986): General intangibles: A secured party's financing statement describing corn growing or to be grown, and describing real estate involved in the crop, did not reach PIK commodity payments, which were in the nature of general intangibles. Lisbon Bank and Trust Co. v. Commodity Credit Corp., 679 F Supp. 903, 6 UCC Rep. Serv. 2d 266 (N.D. Iowa, 1987): Contract rights: Dairy Termination Program (DTP) payments paid to dairy farmer in exchange for his promise to get out of the milk production business for five years, calculated based on the quantity of milk the farmer's operation had produced and not based on the cows slaughtered or exported as part of the contract, are covered by a security interest in "contract rights." DTP payments are not proceeds because they are not based on the disposition of secured property. Matter of Hunerdosse, 85 BR 999 (Bankr. S.D. Iowa 1988): General intangibles: Deficiency and diversion payments that the debtor received from the government under the Feed Grain Program are not "proceeds of crop" (following In re Kruger), but are a general intangible (following Matter of Sunberg) because the deficiency payments are not dependent on a sale, exchange or other disposition of a crop, and the diversion payments are paid for not growing a crop and are not based on a disposition of a crop. The contractual right to future deficiency and diversion payments are general intangibles, but such was not sufficiently described by a grant of a security interest in "all general intangibles as follows," where no description followed that listing. (Interestingly, in this case, a later security agreement was prepared that followed the generic listing of "general intangibles, as follows" with "all government payments," but the debtors never signed that security agreement.) Matter of Butz, 86 BR 595 (Bankr. S.D. Iowa 1988): Not rents or profits: The debtors received cash and payment-in-kind payments from pre-filing participation in the government Feed Grain Program, and diversion payments (following In re Liebe, 41 BR 965, (Bankr. D. Iowa 1984)). In re Waters, 90 B.R. 946, 8 UCC Rep. Serv. 2d 298 (Bankr. N.D. Iowa 1988): Rents: Annual CRP contract payments under long-term lease-like arrangement are rents, and therefore a grant of security interest is not governed by UCC. In re White, 1989 WL 146417, 71 AFTR2d 93-3019, 89-2 USTC P 9622 (Bankr. N.D. Iowa 1989): Proceeds: The debtor's entitlements to government Disaster Credits and Emergency Feed under the 1988 Emergency Crop Loss Assistance and Emergency Feed federal subsidy programs qualify as crop proceeds under UCC §9-306 because a crop was required to be planted, a disposition of the crop occurred, and the federal entitlements were received in connection with that disposition. FDIC v. Hartwig, 463 N.W. 2d 2 (Iowa 1990): Rents: CRP program payments made for specific soil conservation practices over the long term are rents; the court does not analyze the payments under the UCC.
KS: In re Kruse, 35 B.R. 958, 37 UCC Rep Serv. 1303 (Bankr. D. Kan. 1983): (1) Proceeds of planted crops: PIK payment as to planted crops at time of bankruptcy filings is proceeds of crops and subject to the creditor's security interest; (2) General intangibles or contract rights: Where the creditor did not have a security interest in intangibles or contract rights, the creditor was not entitled to PIK payments on unplanted land where debtor had not entered the PIK program on the unplanted land at time of filing; even had the creditor had security interest in general intangibles, here the general intangible was not created until after the bankruptcy filing, and so both the general intangible and proceeds thereof are free of the security interest. In re Lions Farms Inc., 54 BR 241, 42 UCC Rep. Serv. 302 (Bankr. D. Kan. 1985) (clarifying prior In re Kruse decision): Accounts: PIK entitlements diversion payments, where the farmer is paid by the government for leaving diverted acres unplanted, using conservation techniques and planting a ground cover where prudent, are in the nature of rights under an executory contract and therefore fall within the UCC definition of "account" under §9-106, and do not constitute general intangibles. First National Bank v. Milford, 239 Kan. 151, 718 P 2d 1291, 3 UCC Rep. Serv. 2d 793 (1986): Proceeds of planted crop: Agricultural entitlement payments to the debtor constitute proceeds of planted crop and are subject to the creditor's security interest in the crops from which the payments arise. Rural Gas v. North Cent. Kansas Production Credit Corp., 243 Kan. 109, 755 P. 2d 529, 6 UCC Rep. Serv. 2d 827 (Kan. 1988): A security interest granted in "contract rights and receivables in all government farm program payments," which was intended to reach wheat and grain deficiency payments, is expressly excluded under Article 9-104 from the scope of UCC Article 9 because of the federal statutory prohibition on assignment of payments. In re Schneider, 864 F 2d 683 (10th Cir. 1988), 18 Bankr. Ct. Dec. 1481, Bankr. L. Rep. P 72,561, 7 UCC Rep. Serv. 2d 1681: (1) Proceeds of crops: Agricultural entitlement payments resulting from disposition of a planted crop are proceeds of that crop; (2) Accounts: Unpaid PIK diversion payments are rights under an executory contract, and are to be classified as accounts. In re George, 119 BR 800, 13 UCC Rep. Serv. 2d 570 (D. Kan 1990): (1) Proceeds of growing crops: PIK certificates already issued or that are to be issued as crop subsidy payments are proceeds of crops where the debtors were enrolled in a deficiency program pre-petition and had substantially completed the performance necessary to earn the PIK payments, such payments are part of the bankruptcy estate and secured creditor with security interest in crop proceeds is entitled to such proceeds; (2) General intangibles/contract rights: PIK certificates issued for participation in acreage reduction programs are general intangibles. (See, also, prior decision at In re George, 85 BR 133, 5 UCC Rep. Serv. 2d 1117 (Bankr. D. Kan. 1988)). In re Zweygardt, 149 B.R. 673, 20 UCC Rep. Serv. 2d 271 (D. Kan. 1992): Rents: CRP contract payments that require diversion of property to another use are "rents" in the nature of lease payments, and are therefore not subject to Kansas UCC Article 9. In re Isenbart, 255 B.R. 62, 36 Bankr. Ct. Dec. 278 (Bankr. D. Kan. 2000): Not rents: CRP payments are not rents, but are instead contract rights, general intangibles or accounts.
MI: FMB-First Michigan Bank v. Van Rhee, 681 F. Supp. 1264, 6 UCC Rep. Serv. 2d 271 (W.D. Mich. 1987): Contract rights, general intangibles or proceeds: Dairy Termination Program payments, where the debtor forgoes dairy production for five years in exchange for the government's payment based on a bid amount per hundred weight of milk plus the debtor's base amount of marketed milk, fall under security interest definition which listed proceeds, contract rights or general intangibles. Conagra v. Farmers State Bank, 602 N.W. 2d 390, 39 UCC Rep. Serv. 2d 552 (Mich. 1999): Proceeds: Government disaster relief payments for destroyed bean crops are proceeds within the meaning of UCC 9-306, based on a Schmaling analysis that a crop was planted, there was a disposition of the crop, and the payment was received in connection with that disposition.
MN: In re Bechtold, 54 BR 318, 4 UCC Rep. Serv. 2d 1214 (Bankr. D. Minn. 1985): Not Products or Proceeds: The debtor sold cattle for slaughter and received payments from participation in the Milk Diversion Program in exchange for an agreement not to produce milk; the diversion payments are not proceeds or products of dead cows, and are also not a substitute for milk the cows would have produced but for the program. Proceeds of the dead cows was the cash received from their sale, which the secured party received. The security agreement did not grant security interest in accounts or general intangibles. In re Mattick, 45 BR 615, 40 UCC Rep. Serv. 704 (Bankr. D. Minn. 1985): General intangible: The PIK Diversion Program grain entitlement here is a general intangible, paid in exchange for the debtor's agreement to forego planting a crop on a portion of land. The PIK payment was not a subsidy for a failed, lost or damaged crop, and was not proceeds of anything, and was not covered by a security interest in growing crops and proceeds of crops. Production Credit Ass'n. of Fairmont v. Martin County Nat. Bank of Fairmont, 384 NW 2d 529, 42 UCC Rep Serv. 1799 (Minn. App. 1986): Proceeds of crops: PIK entitlements are proceeds of crops under a broad reading of UCC 9-306, and are therefore reached by a secured creditor's security interest in all crops, the products of all such crops and all proceeds. Grunzke v. Security State Bank of Wells, 68 BR 446, (Bankr. D. Minn. 1987): Not products, or proceeds of products: Dairy Termination Program payments are not payments for either cattle or proceeds or offspring of them; the purpose of the payments is to compensate the debtor for loss of future income in exchange for agreement to leave the milk production business for five years. Payments are based on the debtor's business expertise. The court held that the bank did not have a conclusive lien against such payments, even in the face of a comprehensive security agreement that covered equipment, products, accounts, contract rights, general intangibles, all substitutes and replacements now owed or hereafter acquired because it did not have a security interest in the debtor's "farming expertise," and the bank's lien is only good to the extent that the bank can show it was prejudiced by having collected the slaughter value of the herd, as opposed to its market value as a dairy herd.
ND: In re Schmidt, 38 BR 380, 38 UCC Rep. Serv. 589 (Bankr. D. N.D. 1984): General intangible: Corn that the debtor may claim under a PIK contract in exchange for his conservation and diversion of land during the growing season is an executory contract characterized as a general intangible under UCC 9-106. Osteroos v. Norwest Bank Minot N.A., 604 F. Supp. 848, 40 UCC Rep. Serv. 1460 (D. N.D. 1984): Proceeds of crop: PIK payment of corn that was received in exchange for the debtor's agreement not to raise corn during a specific season was a substitute for corn the debtors would have otherwise grown during that same season, and thus constituted proceeds; this type of payment is analogous to a cash payment under federal deficiency and disaster programs. In re Kingsley, 865 F 2d 975 (8th Cir. 1989), 57 USLW 2437, 7 UCC Rep. Serv. 2d 1252: Not proceeds of crops: Diversion payments paid in exchange for agreement to divert land from wheat, corn and barley crops, and based on historical yield and target price for crop, were not received upon sale, exchange, collection or other disposition of crops, and are therefore not "proceeds" within meaning of UCC 9-306. Further, deficiency payments that were paid as part of a complex federal price support system that took into account a target price, the national average loan rate for the crop, national supply, crop perishability, ability to dispose of stock of crop and the need to offset temporary losses of export markets were also not crop proceeds derived from disposition of a crop, but rather contract rights (Following In re Schmaling, 783 F 2d 680 (7th Cir. 1986); reverses lower court decision that had relied on Osteroos v. Norwest Bank Minot N.A.). In re Farmpro Services Inc., 276 B.R. 620 (U.S.D.C. D. N.D. 2002), 47 UCC Rep. Serv. 2d 1142: Not proceeds of crop: Year 2000 crop disaster program payments are proceeds in the broadest sense for purposes of the Bankruptcy Code, but are not "proceeds" under the narrower Article 9 definition because the payments "were not received as a result of the sale, exchange, collection or disposition of the crops."
OH: In re Lee, 35 B.R. 663, 11 BCD 337 (Bankr. N.D. Ohio 1983): Proceeds of crop: The debtor's receipt of cash-advance diversion payment and subsequent PIK Diversion Program payment in corn, in exchange for an agreement not to plant corn and to instead plant an erosion-preventative crop, are substitutes for corn crop debtors would have otherwise planted, and should be treated the same as corn or proceeds of corn. Matter of Binning, 45 BR 9, 40 UCC Rep. Serv. 707 (Bankr. D. Ohio 1984): Accounts: PIK and cash diversion payments are accounts because they flowed from the debtors' performance pursuant to a contract. The payments are not substitutes for crops and they are neither proceeds nor contract rights because they were not generated from the sale, exchange, collection or other disposition of collateral. In re Cupp, 38 BR 953, 38 UCC Rep. Serv. 592 (Bankr. N.D. Ohio 1984): Proceeds: Proceeds of PIK program, designed to compensate farmers for not producing crops they otherwise would have raised, are proceeds of collateral within meaning of security agreement that covered crops and proceeds of sale. (See court's policy analysis against distinguishing between sale of crops grown, and proceeds received as though they had been grown.) Apple v. Miami Valley Prod. Cr. Assoc., 614 F Supp. 119, 41 UCC Rep. Serv. 1469 ( S.D. Ohio 1985); aff'd. on alternative grounds, 804 F.2d 917 (6th Cir. 1986): Proceeds: PIK corn entitlements received in exchange for agreement not to plant corn constituted proceeds within meaning of creditor's security agreement. Matter of Vanasdale, 71 BR 270 (Bankr. N.D. Ohio 1987): Unpaid Grain Reserve Program diversion and deficiency payments are payable to a secured creditor (note, however, that the court here does not make a specific finding as to the type of collateral such payments represent under the UCC).
OK: Farmers and Merchants Nat. Bank, Fairview v. Sooner Co-Op Inc., 1988 OK 135, 766 P 2d 325, 79 ALR 4th 891, 7 UCC Rep Serv. 2d 321 (1988): Proceeds: In a case where the debtor planted but did not harvest a crop, and then participated in PIK Diversion Program, the PIK payments were "proceeds" from the sale of debtors' crops because they are a substitute for the actual sale, and are therefore subject to the bank's security interest in growing crops and the proceeds thereof. Farmers and Merchants Nat. Bank, Fairview v. Fairview State Bank, Fairview, 1988 OK 136, 766 P 2d 330, 7 UCC Rep. Serv. 2d 329 (1988): Proceeds: PIK payments are proceeds of growing crops; it is not necessary for a financing statement to predict the form in which proceeds will appear.
OR: In re Sumner, 69 B.N.R. 758, 3 UCC Rep. Serv. 2d 282 (Bankr. D. Or. 1986): (1) Proceeds: Deficiency Program Payments are proceeds; (2) General intangibles, contract rights or accounts: Diversion Program entitlements paid for diverting acreage from wheat, even when planted in another crop such as barley, are described as general intangibles, contract rights or accounts. A secured party's security interest did not extend to crop-storage payments, Conservation Reserve program set-aside payments or ACP payments that partially compensated the debtor for costs incurred in implementing conservation practices, because the security-interest description was limited to "government set-aside programs," and the additional payments did not meet that definition.
SC: United States v. Carolina Eastern Chemical Co. Inc., 638 F Supp. 521, 2 UCC Rep. Serv. 2d 681 (D. S.C. 1986): Not proceeds: The government agency's security interest in all crops grown within seven years of its agreement with the debtor, including proceeds and products thereof, was not drafted broadly enough to reach PIK Diversion Program commodity payments that were based on a percentage of the historical crop yield and the number of acres set aside, because the debtor never planted crops to which the government's interest in crop proceeds could attach.
SD: In re Frasch, 53 BR 89, 42 UCC Rep. Serv. 309 (Bankr. D. S.D. 1985): Not proceeds: ASC milk diversion program payments are not proceeds of anything; they are derived from an agreement to produce less milk, and not a subsidy for milk produced; the secured party's words did not reasonably describe the milk diversion program payments. In re Cloverleaf Farmer's Co-Operative, 114 BR 1010, 23 Collier Bankr. Cas. 2d 1143, 12 UCC Rep. Serv. 2d 517 (Bankr. D. S.D. 1990): The SBA failed to reasonably define the CRP commodity payments given in exchange for non-crop use of land when it used the terms " rent" and "profit;" although UCC Art. 9-104 is not applicable to rent and security interests subject to a federal statute such as the CRP provisions, the SBA failed to give notice of its security interest and properly perfect a security interest in chattels with a central filing in the Office of Secretary of State.
TN: In re Judkins, 41 BR 369, Bankr. L. Rep. P 69,986, 39 UCC Rep. Serv. 1018 (Bankr. M.D. Tenn. 1984): Proceeds: PIK Program entitlements are proceeds of crop collateral under UCC 9-306, (in the form of a substitute for the crop) even if a crop is never planted, because the payments are traceable to crops that are subject to a security interest, are paid for specific crops on specific acreage and are paid for a specific product. (See court's policy argument that to permit any other finding would produce an unconscionable means for a farm debtor to dissipate collateral at the expense of his creditors).
TX: In re Nivens, 22 BR 287, 34 UCC Rep. 1711 (Bankr. N.D. Tex. 1982) Proceeds of crops: Disaster payments are a substitute for crops, or proceeds of crops; deficiency payments, based on the target price for a crop, are also a substitute for proceeds. The right to disaster and deficiency payments is not separable from growing crops. Since the secured party had a security interest in both growing crops and proceeds, and low-yield/disaster payments to cotton farmers were a substitute for proceeds of crops where the crop was already planted, the secured party had a security interest in the government payments. O'Brient v. Sweetwater Production Credit Ass'n., 764 S.W. 2d 230 (Tex. 1988), 7 UCC Rep. Serv. 2d 1247, reversing 745 SW 2d 412 (Tex. App. 1988), 5 UCC Rep. Serv. 2d 1201: Proceeds: PIK contract proceeds generated by the farmer's compliance with the government contract constitute proceeds, not a non-farm general intangible.
WA: In re Barton, 37 BR 545, 38 UCC Rep. Serv. 598 (Bankr. D. Wash. 1984): Crop substitutes: The court concludes that parties intentionally excluded crops and farm products from a security agreement, and accordingly, PIK entitlements (which are intended to compensate producers for reduced acreage) are in the nature of substitutes for crops and products, and are also not covered by that security agreement. Rainier Nat. Bank v. Bachmann, 111 Wash 2d. 298, 757 P. 2d 979, 57 USLW 2069, 6 UCC Rep. Serv. 2d 1338 (1988): Proceeds: Statutory definition of proceeds under UCC 9-306 is broad enough, under the phrase "or other disposition," to reach Dairy Termination Program payments to the debtor, by which the government paid him for disposing of his herd and leaving the dairy business. Such payments are proceeds to which the secured party's security interest in herd and its proceeds attached.
WI: In re Weyland, 63 BR 854, 15 Collier Bankr. Cas. 2d 308, Bankr. L. Rep. P 71,275, 2 UCC Rep. Serv. 2d 624 (Bankr. E.D. Wis. 1986): General intangibles: Dairy Termination Program payments, which require the dairy producer to slaughter or export his entire herd, were general intangibles; secured party's security interest, which covered the herd but excluded all accounts and contract rights and did not include general intangibles, did not describe and therefore did not reach the payments.
1 Hon. John K. Pearson is a retired U.S. Bankruptcy Judge; he is Of Counsel with Hinkle Elkouri Law Firm L.L.C., Wichita, Kan. He received his B.A. from the University of Wisconsin, Madison, in 1968; and his J.D. from the University of California, Hastings College of Law, in 1973. Sally J. Fisher received her B.A. from Kansas State University in 1974 and her J.D. from Presidents College School of Law 2002. Return to article
2 For the purposes of simplicity, the authors have lumped together all of the myriad program payments to farmers, ranchers and others in the agribusiness as "government entitlement payments" or simply "entitlement payments." As we note below, some care is essential in approaching an entitlement payments problem, as Congress has frequently placed conditions on the entitlement that complicate the creation and perfection of a security interest in the right to receive the payment. See notes 6 and 13 below, discussing how the problem of classification is complicated by Congress's efforts to place some or all of the payment beyond the reach of the typical after-acquired property or dragnet clauses in existing financing arrangements to ensure that the payment goes to continue the debtor in farming, not repay old debt. Return to article
3 Non-agricultural entitlement payments are beyond the scope of this article, although there are reported decisions on other forms of entitlements. See, e.g, Johnson v. Cottonport, 259 BR 125 (W.D. La. 2000), holding that per-capita payments paid by an Indian tribe to a tribal member constituted a general intangible in which a bank held a properly perfected security interest, because no services were performed by the debtor in exchange for the payments. Return to article
4 "Account" is defined in 9-102(a)(2) as "...a right to payment or a monetary obligation, whether or not earned by performance...." Since many of the entitlement payments require some action on the part of the farmer/producer, an argument can be made that the payments already fit into the accounts classification. Return to article
5 Recognition of the specific classification of "government entitlement payments" and the principle that they are subject to the common dragnet or after-acquired property clauses in most security agreements will not mitigate Congress's occasional attempts to place new entitlement payments beyond the reach of existing creditors. Return to article
6 See Note, "Agricultural Financing Through Production Payments: Planning for Protection of Farmer and Lender," 34 Drake L.R. 515, 535 (1984-1985), making an early argument for adoption of a specific statute within the UCC applicable to creation and perfection of a security interest in government production payments. Return to article
7 It appears from the case law that the lender is frequently in the position of arguing that the payment falls into a category listed when the security interest was created—because the farm program payment did not exist at the time the documents were created. Court recognition of a specific classification of "government entitlement payments" would eliminate some of that confusion. Return to article
8 Recent litigation in bankruptcy courts concerning whether government disaster program payments derived from programs not in existence at the time the debtor filed for bankruptcy are properly included within the bankruptcy estate portend future difficulties having Article 9 perfection implications. In re Stallings, 290 BR 777 (Bankr. D. Idaho 2003), held that payments derived from a federal disaster program were not property of the bankruptcy estate, since the federal program was created after the debtor's filing. The debtor's chapter 11 filing in April 2002 was converted to a chapter 12 filing on July 5, 2002. Although the government made appropriations for the program funds in late 2001 or early 2002, the USDA had announced the program in June 2002, and the program compensated the debtor for crop damage to a pre-petition crop caused by the government's use of herbicides on adjacent lands, the court nevertheless determined the legally significant and controlling factors were that the program enrollment period did not commence until July 15, 2002, and the Federal Register notice concerning the application process was not published until July 31, 2002. Since both those events occurred post-petition, the court excluded the program proceeds from the bankruptcy estate. The court cited with approval