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Ag Lending: Could Selling Crops Be a Crime?
In an agriculture heavy state such as Indiana, lenders necessarily will have a certain portion of its lending dedicated to agricultural and farming operations. There are certain protections for lenders under both Indiana law and federal law, which, while easy to follow, may not often be employed by lenders.
The Uniform Commercial Code (“UCC”) was written to provide guidance concerning commercial transactions, and has been adopted in some fashion throughout the United States, including Indiana. States are free, however, to adopt certain other provisions or deviations from the UCC. As a general rule under the UCC, someone who buys a product in the “ordinary course” of the seller’s business buys that product free from any security interest or lien that a lender may have attached to that product. This is true even if the lien is perfected and the buyer knows about the lien.
Historically, there was an exception to this rule for “farm products”, which includes crops. Therefore, under the UCC, a wholesale buyer of a farmer’s crops bought those crops subject to any lender’s lien.
Congress, however, passed a federal law in 1985 to override this UCC exception, and stated that a buyer who in the ordinary course of business buys a farm product from a seller engaged in farming operations buys that farm product free of any lender’s lien.
As with every rule, there are exceptions, and this one is no different. This same federal law provides that the buyer of farm products will take the farm products subject to the lender’s lien if the buyer has been provided specific written notice of that lien within one year before the sale.
So what happens in the situation where a farmer has borrowed money, pledged a security interest (granted a lien) in his crops, has provided a list of the people to whom he intends to sell those crops, but then, not wanting to repay the lender, sells those crops to a buyer not shown on the list? Under the federal law, that farmer would be fined the greater of $5,000 or 15% of what the farmer received for those farm products.
In 2001, Indiana took this “written notice” concept from the federal law and incorporated a version of it into the Indiana UCC. Under the Indiana law, a buyer in the ordinary course of business takes free of a lien granted by the seller, even if the lien is perfected and the buyer knows of its existence. This applies to farm products as well unless the lender has followed the same notice provisions as are identified in the federal law. If the lender does provide that notice, Indiana says that a farmer who then sells his crops to someone not on the list of buyers or fails to pay the proceeds of that sale to the lender within fifteen days of the sale, has actually committed a crime (Class C misdemeanor). In addition, any purchaser who has received notice from the lender of the lender’s lien and fails to issue a jointly payable check (to include the lender) takes those farm products subject to the lien.
So what does this all mean for lenders making agricultural loans? First, the security agreement should include language that requires the farmer/borrower to provide a list of all of the buyers to whom the farmer intends to sell in the next year. The lender needs to update this list each year. After receiving that list of potential buyers, the lender should notify those potential buyers of the lender’s security interest in any farm products delivered by the particular borrower. By taking these two relatively simple steps, the lender can better protect its security interest, and also create additional remedies to be repaid its loan.
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Priority of Purchase-Money Mortgage
Under Indiana law, a “purchase-money mortgage” is given as security for a loan used by the mortgagor (buyer) to acquire legal title to a property. Indiana Code § 32-29-1-4 provides that “[a] mortgage granted by a purchaser to secure purchase-money has priority over a prior judgment against the purchaser.” Therefore, if a mortgage is considered a purchase-money mortgage, it has priority over a previously recorded judgment lien. This issue was recently addressed by the Indiana Court of Appeals.
In Amici Resources, LLC; et al. v. The Alan D. Nelson Living Trust; et al. (http://www.in.gov/judiciary/opinions/pdf/01191602cjb.pdf), Sabine Matthies (“Matthies”) obtained a judgment against Solid Foundation Investment Properties, Inc. (“SFIP”) in December 2012. In April 2013, SFIP purchased real estate in Indianapolis. SFIP financed the purchase of the property through a loan from The Alan D. Nelson Living Trust (the “Trust”), and SFIP executed a promissory note and mortgage in favor of the Trust to evidence and secure repayment of that loan. At the time of the closing, SFIP also entered into an agreement with Amici Resources, LLC (“Amici”) whereby Amici agreed to finance renovations and improvements to the property with a loan to be secured by a second mortgage against the property.
Matthies brought an action to enforce her judgment lien, and argued that her judgment lien should be deemed “senior”, or “first”, among all of the liens.
Matthies argued that the Trust’s mortgage was not a purchase-money mortgage because it was signed the day before SFIP closed on the purchase of the real estate. If the Court had agreed with Mattheis, her lien would have been first in line. However, the Court did not agree. While the Court noted that there is case law that indicates that the mortgage must be executed “simultaneously” with the deed in order to be considered a purchase money mortgage, literally requiring simultaneous execution can be impractical and the more important question is whether the deed and real estate acquisition are part of the same transaction. Here, the Trust wired money for the acquisition of the real estate to SFIP and the mortgage was executed on April 29, while the note and deed were executed and loan proceeds delivered to the seller on April 30. Therefore, the court determined that the lending of the money and the execution of the mortgage were all part of the same transaction, and the Trust’s mortgage constituted a purchase-money mortgage that had lien priority over Matthies’ prior recorded judgment lien.
Amici’s second priority mortgage secured future advances for the improvement of the real estate after its acquisition, rather than the acquisition itself. Accordingly, the second mortgage was not a purchase-money mortgage, which meant that it was subject to the general rule that interests in real estate take priority based on the order in which they are recorded. The judgment lien in favor of Matthies and against SFIP instantly attached to the property upon SFIP recording the deed to the property and therefore had priority over any subsequently recorded mortgage (other than a purchase-money mortgage). Therefore, the Court determined that the Trust’s mortgage was first; Matthies’ judgment lien was second; and Amici’s was third.
There are a couple of takeaways from this case. First and most obviously, a lender financing improvements to a property rather than the acquisition of the property must complete a judgment lien search pre-closing because that lender does not enjoy any type of super-priority over prior judgment liens in the same way that a purchase-money mortgage lender would.
With that being said, even if a lender has a purchase-money mortgage, that lender should still determine whether there are any judgment liens outstanding against the borrower. Even though the purchase-money mortgage enjoys priority over the prior recorded judgment lien, the judgment lien is still a lien that must be released in order to complete the sale of the property. Therefore, the judgment lien holder has leverage to require a payment before releasing the judgment lien even if the judgment lien does not attach to any equity in the property given the superior mortgage. Although that does not appear to have been an issue in this case due to an agreement of the parties that facilitated a sale of the property, it would be in the borrower’s and lender’s best interest if the borrower could sell the property without litigation and/or making any payments on the judgment lien.
As an aside, although it is not covered in the appellate decision, it would be interesting to know why SFIP closed on the real estate acquisition with the judgment lien outstanding rather than forming a new limited liability company for the sole purpose of owning this one property. Had it created a separate limited liability company, it would have avoided the judgment lien attaching to the real estate and left the Amici mortgage in second position.
Let me know what you think about this recent Indiana Court of Appeals decision below:
Mediation? Arbitration? Same Thing, Right?
There is often some confusion on the part of business clients concerning the differences between mediation and arbitration. Some people tend to use the terms interchangeably, but in actuality mediation and arbitration are quite different.
In a mediation, typically the parties hire a third party “neutral” person who, while she may be a lawyer, does not need to be in order to help facilitate settlement discussions. Sometimes the attorneys involved will suggest a mediation as a way to have their clients listen to a neutral third party describe the strengths of the opponent’s case and the weaknesses of their own client’s case so that the parties can try to reach a resolution before incurring significant costs. As previously noted in this blog, you are not sacrificing anything legally by engaging in mediation or other forms of settlement negotiations. That is because if the case does not settle at mediation, any judge or jury who ultimately tries the case in court will never hear what offers of compromise may have been made by the parties.
It is important to remember that in a mediation, the mediator makes no decisions. Rather, all of the ultimate decisions about whether to settle, and for how much, are left to the parties. The mediator cannot force a settlement on anyone. The mediator can make suggestions, and the parties can agree on different ways to mediate. However, ultimately it is up to the parties to decide if the case will settle or not. This is one of the big advantages of mediation, because the parties control their own destinies. After a case goes to court, there are simply no guarantees about what may happen.
In an arbitration, the parties hire a third party to hear the testimony, examine evidence, and then decide the result of the case, similar to what a judge or jury might do. In some situations the parties may hire a panel of three arbitrators. What would typically happen is each side selects an arbitrator, and then those two arbitrators select a third. A major difference with arbitration (versus a mediation) is that you actually present the full case to the arbitration panel, and the arbitrator(s) decide who wins and loses. The parties share in the expense of paying the arbitrators.
An arbitration is sometimes thought of as a “mini trial”, because an arbitration often can be completed in less time than a typical jury trial would take. However, that is not always the case, and to effectively present the case for arbitration, the parties will likely need to engage in the same amount of discovery that they would have conducted if the case was going to be tried in court.
So the big difference is that in a mediation, the parties are trying to settle the case and the parties control the ultimate outcome. In an arbitration, the parties do not control the outcome; rather, the arbitrators decide who wins and who loses. Because an arbitration is so similar to trying a case in court, it is subject to the same uncertainties of outcome as a trial, and again this is why so many cases ultimately settle before the parties allow a disinterested third party to decide their ultimate fate.
The IBJ released an article today about Indiana’s pilot program that will create 6 new courts specifically for commercial litigation. Read more here.
What do you think? Will the new courts expedite the commercial litigation process?
Understanding Bank Garnishments under Indiana Law
Once you have obtained a money judgment against a party, Indiana law provides a number of different methods for collecting that judgment. While many of these collection options involve selling garnishable real estate and/or personal property that can take time and involve expenses such as auction costs, the most efficient means of collection involves assets that are already liquid, including amounts held in checking and savings accounts at financial institutions such as banks or credit unions.
The first step for garnishing deposit accounts is determining where the debtor has (or may have) deposit accounts. Examining prior financial statements and cancelled checks from the debtor is likely to provide this information, to the extent that such documents are available. The judgment creditor can also determine the location of bank accounts by serving written discovery requests on the debtor or orally examining the debtor at a proceedings supplemental hearing. It can also be beneficial to just “go fishing” and send bank interrogatories to a number of financial institutions at which it is conceivable that the debtor maintains an account. The expense of such a fishing expedition is minimal ($5.00 per judgment debtor per financial institution) while the benefit of finding an account can be substantial. Focusing on financial institutions with locations near the judgment debtor’s residence or place of business or that otherwise have a significant presence in a particular community should provide a reasonable likelihood of success for the judgment creditor.
Once the judgment holder determines the financial institutions that may have deposit accounts for the debtor, the judgment holder must send garnishment interrogatories to such financial institutions. In order to serve garnishment interrogatories, the judgment holder must have scheduled a proceeding supplemental hearing at which the validity of any bank account garnishment can be determined. Each garnishment interrogatory will include an order from the court that requires the financial institution to respond to the interrogatory and to place a hold on any funds held in deposit accounts of the garnishee defendant. Note that federal law provides that financial institutions must determine whether any funds in an account held constitute exempt federal benefits directly deposited into the account, which would primarily include social security and veteran benefits. The financial institution is prohibited from freezing such federal benefits.
If a garnishment interrogatory is served on a financial institution and that financial institution has an account for the judgment debtor with funds other than federal benefits, the financial institution is required to place a hold on the lesser of (a) the judgment amount, or (b) the amount on deposit in the account. See Indiana Code § 28-9-4-2. The financial institution will determine the judgment amount by what is included in the interrogatory. If post-judgment interest has accrued, calculate the current judgment amount and include it in the interrogatory to avoid leaving funds in an account that could satisfy the judgment. The hold must be placed for the period of time specified in the order, provided that the order cannot require a hold for more than 90 days. The hold is maintained until the judgment creditor’s rights in the account can be determined at the proceedings supplemental hearing. The hold is a recognition of the judgment creditor’s lien against the funds on deposit at the time the interrogatory is served. If subsequent deposits are made to the account after the hold is put in place, the judgment debtor should have access to those subsequently deposited funds. If the judgment creditor believes that this is occurring, the judgment creditor can serve additional interrogatories on the financial institution in an effort to capture the additional deposited funds.
It is important to note that if a financial institution that receives a garnishment interrogatory has a loan to the judgment debtor, the financial institution has a right of setoff that is superior to the judgment creditor’s lien, and the financial institution has a right to set-off against the funds held in the deposit account rather than placing a hold on them. See, Fifth Third Bank v. People’s National Bank, 929 N.E.2d 210, 2014 (Ind. Ct. App. 2010). However, if the financial institution decides to allow the debtor to access the funds rather than setting off on the funds, the financial institution will lose its superior lien priority and it will have liability to the judgment creditor for not honoring the judgment lien. See, Gray v. National City Bank, 687 N.E.2d 356, 358 (Ind. Ct. App. 1997).