Successfully Resolving Distressed Agricultural Loans in Kansas
| Citation | Vol. 90 No. 3 Pg. 30 |
| Pages | 30 |
| Publication year | 2021 |
By Michael D. Fielding [1]
I. Introduction
Agriculture is a major part of the Kansas economy. According to the Kansas Department of Agriculture, in 2017, there were more than 58,000 farms that generated over $18.7 billion in agricultural output.[2] The vast majority of the farms (84.6%) were family owned, while 6.2% were in partnerships, 5.3% were held by corporations and the remainder was owned by cooperatives, estates/trust, etc.[3] In 2017, the average age of a Kansas farmer was 58.1 years and the average farm acreage was 781.[4] A whopping 87.5% of all Kansas land (over 45 million acres) is farmland of which more than 21 million is used for row crop operations and another 14 million for pasture.[5] Overall, the agricultural section is the biggest economic driver in the state employing almost 13% of the Kansas workforce.[6]
Farming is also extremely difficult. The weather is always unpredictable, market prices are impacted by global events and operating margins are very thin. Furthermore, international trade disputes, COVID-19 and government payments to assist producers put farmers on an emotional roller coaster given that their financial condition is highly impacted by so many events which are out of their control. To put it mildly, farming in today's economy is not for the faint of heart.
The sad reality is that many farmers are struggling today. Because the vast majority of farmers use debt to finance their operations, lenders are also constantly struggling with how best to resolve the situation which minimizes losses. Unfortunately, the answers are frequently difficult to find.
The aim of this article is to provide a high-level overview of key issues that arise in the context of distressed agricultural loans in Kansas so as to provide a means for more effectively and efficiently resolving distressed agricultural loans. In a perfect world there would be a book written on distressed agricultural loans in Kansas with a highly detailed chapter covering each topic. Unfortunately, time and space constraints prohibit such an exhaustive discussion. However, this article addresses from a high level each of these competing issues and provides a springboard from which a practitioner may take a deeper dive into the particular issues impacting his or her clients.
II. Pre-Loan Enforcement Considerations for Distressed Agricultural Loans
When signs of a distressed loan appear, it is critical that the lender develop a strategy for successfully resolving the troubled credit. Loan workouts can be golden opportunities to fix past mistakes and structure the deal to enhance the likelihood of full loan performance. The first step that should be taken is a deep assessment of where things stand. This begins with a review of the loan file. The lender should verify that key loan documents have been properly signed and documented. It should also determine whether the applicable promissory notes properly refer to the mortgages or security agreements that secure them. The lender should determine whether the applicable security documents adequately reference the collateral. Future advance clauses (also known as dragnet clauses) should be carefully considered. Do subsequent promissory notes appropriately reference the prior security agreement or mortgage - i.e., something more than just a date? If a new security agreement or mortgage was issued to secure a previously executed note, does the new security instrument properly describe that earlier note? If the lender spots any issues with the loan documents then its loan resolution strategy should have a high priority of "fixing" or correcting the errors.
Once the loan documents have been reviewed lenders should then determine whether liens have been property recorded such that the lender is perfected. In this regard lenders need to determine whether UCC financing statements were properly filed and whether mortgages were properly recorded. Again, if recording errors have occurred a top priority for the lender will be to rectify these mistakes. In doing these lien searches lenders need to also determine their status vis-a-vis other secured creditors. These searches should not just be limited to obtaining UCC searches and title reports on real estate but should also be broad enough to include any possible state or federal judgment liens and any state or federal tax liens. Lenders should also analyze any preexisting intercreditor agreements with other secured lenders to determine their respective rights and remedies as they prepare for possible legal action to enforce their loan documents.
In addition to normal collateral perfection issues, lenders also need to verify that they have been designated as the assigned party for the payment of any possible federal government payments and that they are noted as the loss payee on crop insurance proceeds. These notations are critical. If the borrower has not assigned federal government payments to the lender or if the borrower has not noted that the lender is the loss payee on crop insurance then the particular government agency or crop insurer will simply send the funds directly to the borrower even if the lender has a properly perfected security interest in general intangibles.[7] In a similar fashion, lenders need to insure that they have properly issued Notices of Security Interest under the Food Security Act each year to all possible grain elevators, sale barns or other possible places where crops or livestock may be sold.[8]
Agricultural collateral can be broadly divided into a few discrete classes: real estate; equipment (including non-titled farm equipment such as tractors); titled vehicles and trailers; general intangibles (such as government payments, crop insurance, other contracts rights, etc.); and agricultural products (e.g., livestock and crops). Agricultural collateral is unique in that the livestock and crops are both fungible and easily moved. A closely related problem in distressed agricultural loans is poor documentation of the borrower. This problem is particularly acute in situations where family members have on-going farming operations where the lines are blurred as to who owns particular items of collateral. For example, a lender may do an on-site visit and see a piece of equipment that the borrower regularly uses in their farming operations. Lenders sometimes assume or believe that the borrower owns the equipment. But in reality, it may be a close family member – someone who is not obligated on any of the lender's loan documents – who actually owns the equipment. Or it could be that the equipment was purchased in the name of one person but paid for from the sale of crop or livestock proceeds from another family member. Wise lenders will recognize these issues and should – at the outset of the loan – obtain signed statements from both borrowers and family members as to who owns or does not own non-titled assets.
A major issue with agricultural loans is the status of the collateral. If the collateral is livestock an immediate issue is whether the animals are tagged or microchipped so that it is easily discernible who owns what. Another key issue is whether the livestock are properly registered. Herd health is another critical concern. Is the borrower sufficiently caring for the animals or are shortcuts being taken (such as skipping vaccines) that could pose a threat of major loss for the lender? The type and nature of the collateral as well as prevailing market conditions will greatly impact the course that the lender takes to preserve and maximize value. For example, if the collateral is growing (such as newborn livestock or newly planted crops) the lender has a major incentive that the collateral properly matures so as to maximize value. But in that regard the lender will want to make sure that the borrower has sufficient resources to bring that collateral to full maturity. If the borrower does not have those resources or if there is a major risk the borrower will abscond with the collateral, then the lender may seek the appointment of a receiver to take control of and manage the collateral.
In some instances, borrowers will operate a concentrated animal feeding operation ("CAFO") where a large number of livestock are kept and cared for in a relatively small amount of space. CAFO operations create unique issues for the lender because of the possible environmental and third-party liabilities that exist. For example, it is critical for the lender to verify that the borrower is complying with all applicable state and federal regulations applicable to the facility and that animal waste is being legally and properly disposed. Furthermore, there is a risk to the borrower that it may become subject to nuisance lawsuits brought by nearby landowners. Lawsuits such as these can have a major adverse impact on producers given the razor thin margins in agriculture.
Aside from the nuts and bolts of legal perfection, lenders dealing with distressed agricultural loans need to take a global look at the borrower's operation and determine how their loans fit into and impact the big picture. This begins by considering the farming operation itself - i.e., is it a sole proprietor, general partnership, limited-liability company, S corporation or something else. Furthermore, the lender needs to consider the different types of loans it has compared to that of other lenders - i.e., loans secured by real estate, operating loans, purchase-money security interest loans, or loans for side-businesses (such as trucking or other custom work).
Personal guaranties should also be reviewed. Typically, these are granted by any owners of legal entities that borrowed funds from the bank. The vast majority of lenders that loan to small farming operations will use form...
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