Summary of a Recent
Judicial Development in
Bankruptcy

Lender's Interest in Proceeds
Superior to Landowner's

Brandy L. Brown
National AgLaw Center Graduate Fellow

In an action involving competing security interests between an agricultural lender and a landowner over certain proceeds of an insolvent farmer's crop, the Arkansas Court of Appeals has affirmed a trial court's decision that the lender's security interest was superior to the landowner's interest. Nef v. Ag Services of America, Inc., No. CA 02-32, 2002 WL 31019323 (Ark. Ct. App. Sept.11, 2002). The appeals court ruled that the amount of attorneys' fees awarded to the lender should be reduced and that the farmer's bankruptcy filing did not toll the statute of limitations period on the landowner's action to enforce its crop lien. See id. The court also ruled that Article 9 of the Uniform Commercial Code was not preempted by the federal laws pertaining to production flexibility contract payments. See id.

For several years, including 1998, Lynn Kinder d/b/a Kinder Farm Partnership ("Kinder") rented farmland from Hans Nef. See id. at *1. The lease agreement for 1998 required Kinder to make two payments of $15,335.00, one on February 1, 1998, and the other on October 1, 1998. See id. The agreement required a third rent payment of $15,330.00 on December 31, 1998. See id. Kinder gave Nef a security interest his federal agricultural program payments as collateral. See id.

Nef filed a financing statement for Kinder's 1998 crop on January 14, 1998, that covered:

All crops of rice, wheat, soybeans & milo grown on Secured Party's lands in Drew County, AR, . . . during the 1998 crop year, together with all products & proceeds thereof; accounts, general intangibles arising from or relating to the sale of farm products, farm products thereof; all crop insurance thereon and proceeds thereof; all Federal Agricultural Program payments ther[e]fore, in cash or in kind.

Id. Kinder executed a CCC-36 assignment of payment form in favor of Nef on March 6, 1998. See id. This form was properly filed on March 17, 1998. See id.

Kinder obtained crop input financing from Ag Services of America, Inc. ("Ag Services") for several years prior to and including 1998. See id. at *1. Kinder gave Ag Services a promissory note and an agricultural security agreement on November 5, 1997. See id. The security agreement gave Ag Services a security interest in "'all of Debtor's farm products, accounts, goods, inventory, chattel paper, general intangibles, documents and instruments, including, but not limited to: all annual and perennial crops of whatever kind, whether heretofore grown, now growing or hereafter grown . . . and all entitlements and payments . . . arising under governmental agricultural subsidy [payments] . . . .'" Id.

Ag Services filed several financing statements, "the most recent of which was filed on November 24, 1997," as required by the Arkansas Uniform Commercial Code. Id. Kinder "executed a U.S.D.A. CCC-36 assignment of payment form in favor of AgServices on November 13, 1997." Id. Ag Services properly filed the CCC-36 form on June 1, 1998. See id.

In August 1998, Kinder received a production flexibility contract ("PFC") payment for $32,830.00. See id. Kinder assigned this payment to Nef and Nef applied the amount "to Kinder's 1997 rent and to an earlier debt of Kinder." Id. Kinder failed to pay Nef rent for October and December 1998. See id.

In January 1999, Riceland Foods gave Kinder a check for $26,401.00 "dated December 29, 1998, for the purchase of certain products of the 1998 crop." Id. at *2. This check was payable to Kinder, Nef, and Ag Services. See id. Kinder immediately endorsed this check and delivered it to Ag Services. See id. Nef refused to endorse the check and on February 23, 1999, he brought an action against Kinder and Ag Services seeking a determination of the priority of his security interest in the Riceland check. See id. Nef failed, however, to complete service of process on the defendants within the requisite time period. See id. Kinder subsequently filed for bankruptcy on March 17, 1999. See id.

On June 28, 1999, Nef brought another action against Kinder and Ag Services "asserting a paramount interest in the proceeds of the Riceland Foods check by virtue of his statutory landlord's lien and promissory note." Id. Ag Services argued that the applicable statute of limitations barred Nef from collecting the proceeds "and filed a counterclaim, contending that it had a prior security interest in the proceeds of Kinder's 1998 crop and that Nef had wrongfully received the August 1998 PFC payment of $32,830." Id.

The bankruptcy court granted relief from the bankruptcy stay with respect to the funds in dispute in this action on July 13, 1999. See id. Ag Services filed a motion for summary judgment soon thereafter, arguing that Nef had converted the $32,830.00 PFC payment when he received the check and applied it to Kinder's 1997 rent. Id. This motion was denied. See id. The case was then transferred to the Pulaski County Chancery Court. See id.

The parties did not dispute the relevant facts, and the trial court "awarded Nef $15,335 for the rent due on December 31, 1998." The trial court ruled that Ag Services "was entitled to the proceeds of the Riceland Foods check and to the August 1998 PFC payment 'because both of those items would have been available to apply to Ag Service's debt ($30,801.94 as of June 19, 2001) and a reasonable attorney's fee ($13,100) incurred in collecting the debt." Id. The trial court also ruled that "Nef had no interest in the Riceland Foods check and awarded Ag Services judgment for $32,830 'because Hans Nef converted that Government Payment, as to which Ag Services had a prior security interest.'" Id. The court offset the $15,335.00 that Nef was awarded against the $32,830.00 awarded to Ag Services, resulting in a judgment award of $17,495.00 to Ag Services. See id. Nef appealed the trial court's decision to the Arkansas Court of Appeals. See id.

The appeals court first examined Nef's argument that the circuit court erred when it awarded attorney's fees to Ag Services. See id. The court explained that "[t]he general rule in Arkansas is that attorney's fees are not awarded unless expressly provided for by statute or rule." Id. (citing Security Pac. Housing Servs., Inc. v. Friddle, 866 S.W.2d 375 (Ark. 1993)). The court also explained that Arkansas law "provides for a reasonable attorney's fee in certain civil actions, including actions to recover on promissory notes and for breach of contract." Id. (citing Ark. Code Ann. § 16-22-308). The court stated that § 16-22-308 "does not, however, provide for the recovery of attorney's fees in tort actions." Id. (citing Reed v. Smith Steel, Inc., 78 S.W.3d 118 (Ark. Ct. App. 2002)). The court added that a "prevailing party in a conversion action is not entitled to an award of attorney's fees." Id. (citing Mercedes-Benz Credit Corp. v. Morgan, 850 S.W.2d 297 (Ark. 1993)). Finally, the court stated that the Arkansas Supreme Court in McQuillan v. Mercedes-Benz Credit Corp., 961 S.W.2d 729 (Ark. 1998), "drew a distinction between legal fees incurred in attempting to recover collateral and those incurred in litigating a conversion claim." Id. In McQuillan the court held that "the secured party was not entitled to an award of attorney's fees for its expenses incurred in litigating conversion and replevin claims, as opposed to the costs incurred in the recovery of the collateral itself." Id. at *3.

The appeals court ruled that it was permissible under § 16-22-308 for the trial court to award attorney's fees to Ag Services with respect to the Riceland Foods check. See id. The court stated that the award was permissible, in part, because the trial court ruled that Ag Service's security interest in the Riceland Foods check was superior to Nef's security interest. See id. The appeals court also reasoned that Kinder's November 5, 1997, promissory note to Ag Services "gave Ag Services the right to collect a reasonable attorney's fee in connection with the enforcement of the note." Id. The court stated that "[t]his agreement was enforceable according to its terms and was independent of [§] 16-22-308." Id. (citing , 40 S.W.3d 230 (Ark. 2001) and Griffin v. First Nat'l Bank, 888 S.W.2d 306 (Ark. 1994)).

However, with respect to Ag Service's claim that Nef converted the PFC payment, the appeals court ruled that the trial court erred when it awarded $32,840.00 in attorney's fees to Ag Services. See id. The court stated that "[b]ased on the supreme court's decision in McQuillan, the trial judge erred in awarding attorney's fees in regard to the conversion claim." Id. Therefore, the court reduced the amount of attorney's fees awarded to Ag Services from $13,100.00 to $8,000.00. See id. at *3.

Next, the court examined Nef's argument that the trial court erred when it ruled that he was barred by the applicable statute of limitations from recovering the October 1, 1998, rent payment that Kinder failed to pay. See id. at *2. Nef asserted that he had "120 days within which to complete service of the February 1999 summons and complaint" but that the 120 day limitations period was tolled when Kinder filed his bankruptcy petition. Id. at *4 (citing Ark. R. Civ. P. 4(i) and Bakker v. Ralston, 932 S.W.2d 325 (Ark. 1996)). Nef also asserted that his claim for the rent due on October 1, 1998, was viable when he brought his February 1999 action, and that "he did not have to serve the summons and complaint until thirty days after the stay was lifted." Id. Nef reasoned that under Bankruptcy Code § 362(a)(4), Kinder's bankruptcy filing operated as a stay that prevented him from obtaining possession of, or enforcing his lien against the October 1998 rent. See id. Nef also reasoned that although he was stayed from "commencing or continuing" an action against Kinder, Bankruptcy Code § 108(c) provided him "an additional thirty days to enforce [his] claim once [he] received notice of the termination of the stay." Id. Therefore, Nef argued that the statute of limitations had not run on his claim against Kinder for the October 1998 rent payment. See id.

The appeals court noted that when the trial court awarded Nef $15,335.00 "for the December 31, 1998, rent, . . . [it] apparently applied the six-month limitations imposed on a landlord's agricultural lien set forth in Ark. Code Ann. § 18-41-101 (1987))." Id. at *3. The court stated that Nef's argument "is premised upon the assumption that the Riceland Foods check, upon which he sought to impose his landlord's lien, was a part of the bankruptcy estate. However, he has cited no legal authority to support his claim that it was part of the bankruptcy estate." Id. (citing 11 U.S.C. § 541).

The court explained that "[a]lthough the filing of a voluntary petition in bankruptcy effects an automatic stay as to the commencement or continuance of any claim against the debtor or his estate, the stay is not for the benefit of other parties." Id. (citing Aluminum Co. of Am. v. Higgins, 635 S.W.2d 290 (Ark. Ct. App. 1982) and Van Balen v. Peoples Bank & Trust Co., 626 S.W.2d 205 (Ark. App. 1981)). The court also explained that Bankruptcy Code § 541(a)(1) states that property of the bankruptcy estate "consists of all legal or equitable interests of the debtor in property at the time that the debtor initiated the bankruptcy action." Id.

Kinder filed his bankruptcy petition on March 17, 1999, and endorsed and delivered the Riceland Foods check in January 1999. See id. Thus, the court ruled that it was not apparent whether the check was a part of Kinder's bankruptcy estate. See id. The court concluded that "[a]lthough the trustee could have attempted to bring it back into the estate as a preferential transfer . . . there is nothing in the record to suggest that this was done. Therefore, [Nef] has not demonstrated that the bankruptcy stay tolled the running of the statute of limitations for the landlord's crop lien." Id.

The court also examined Nef's argument that the trial court "erred in applying the provisions of Article 9 of the UCC to the payment of $32,830 because federal law governs the assignment and taking of security interests in such payments." Id. Nef asserted that Ark. Code Ann. §§ 4-9-104 and 4-9-302(3) supported this argument. See id.

Section 4-9-104 states that "[t]his chapter does not apply: (a) [t]o a security interest subject to any statute of the United States to the extent that such statute governs the rights of parties to and third parties affected by transactions in particular types of property . . . ." Section 4-9-302(3) states that:

The filing of a financing statement otherwise required by this chapter is not necessary or effective to perfect a security interest in property subject to . . . a statute or treaty of the United States which provides for a national or international registration or a national or international certificate of title which specifies a place of filing different from that specified in this chapter for filing of the security interest . . . .

Id.

The court explained that "[s]tate laws that interfere with, or are contrary to, the laws of Congress are invalid." Id. (citing Ciba-Geigy Corp. v. Alter, 834 S.W.2d 136 (Ark. 1992)). The court also explained that Congress' intent to preempt state laws in a particular field may be express or implied. See id. The court noted that under the facts of this case, there was no issue with respect to express preemption of state law. See id. The court stated that implied preemption can exist when:

(1) the scope of federal regulation is so pervasive as to make reasonable the inference that Congress left no room for the state to act; (2) when the state and federal law actually conflict; (3) when compliance with state and federal law is physically impossible; (4) when the state law stands as an obstacle to the accomplishment of the full objectives of Congress.

Id. (quoting Ciba-Geigy, 834 S.W.2d at 136).

Nef asserted that 16 U.S.C. § 590h(g) controls the assignment of PFC payments. See id. Section 590h(g) states that:

A payment that may be made to a producer under this section may be assigned only in accordance with regulations issued by the Secretary. This subsection shall not authorize any suit against or impose any liability on the Secretary, any disbursing agent, or any agency of the United States if payment is made to the producer without regard to the existence of such assignment.

Id.

The court rejected Nef's argument, stating that the trial court's application of Arkansas's Uniform Commercial Code to the filing and perfection issues was supported by the holding in In re Endicott, 239 B.R. 529 (Bankr. E.D. Ark. 1999). See id. (citation omitted). In In re Endicott, the bankruptcy court ruled that "the federal regulation permitting a farmer to execute an assignment of his interest in the proceeds of the Department of Agriculture's Crop Loss Disaster Assistance Program, and purporting to limit the federal government's liability if such payments were improperly made, did not preempt Arkansas's version of Article 9." Id. The appeals court stated that in In re Endicott the bankruptcy court "recognized that the regulation was to protect the government from liability if such payments were made to an unauthorized person and not to create an alternate federal filing scheme for security interests in such payments." Id.

Finally, the court examined Nef's argument that the trial court "erred in giving priority to Ag Services's security interest in the PFC check because Ag Services did not act in good faith." Id. at *2. Nef argued that Ag Services acted in bad faith because they had notice of Nef's lease with Kinder, which contained a provision that Kinder would not assign or pledge his PFC payments without Nef's consent. See id. at *6. Nef also argued that Ag Services had notice of his security interest in Kinder's PFC payments. See id.

The court rejected this argument stating that "[w]ithout a doubt, Ark. Code Ann. § 4-9-312(5) is a 'pure race' statute: That is, the one who wins the 'race' to the court house to file is superior without regard to the state of his knowledge." Id. The court added that § 4-9-312(5) "nowhere requires that the victor be without knowledge of its competitor's claim." Id.

This case was decided on September 11, 2002; this summary was prepared in December, 2002.