Summary of a Recent
Judicial Development in
Bankruptcy

Pre-Revised Article 9 Security
Agreement Not Effective

Brandy L. Brown
National AgLaw Center Graduate Assistant

In an action brought by two Chapter 12 debtors to determine the status of a creditor's security interest in the debtors' growing crops, the United States Bankruptcy Court for the District of Kansas has ruled that the creditor's interest did not attach to the growing crops because the security agreement did not contain a description of the land on which the crops were growing as required by former Article 9. In re Stout, 284 B.R. 511, 515 (Bankr.D.Kan. 2002). Thus, the court ruled that the debtors' estate was entitled to the proceeds of the growing crops that were planted prepetition, free of any of the creditor's claims. See id.

Sam and Debra Stout, debtors, filed a Chapter 12 bankruptcy petition on June 4, 2002. See id. at 512. The debtors obtained loans from the First National Bank of Sterling, Kansas ("Bank"). See id. At the time of the bankruptcy filing, the debtors owed the Bank "not less than $891,161.39." Id. This debt was secured by several mortgages and security agreements. See id. at 511.

Two of these security agreements applied to the Bank's interest in the debtors' growing crops. See id. The agreements were executed on February 26, 1993, and May 2, 2000. See id. at 512. Each of the security agreements were "executed and delivered to the Bank prior to July 1, 2001, the effective date of the revised Article 9 of the Kansas Uniform Commercial Code." Id. at 511. Neither of these agreements complied with the attachment requirements contained in former Kan. Stat. Ann. § 84-9-203 (1996) because they failed to describe the land on which the crops were growing. See id. at 512.

Former Article 9 provided that "'a security interest is not enforceable against the debtor or third parties with respect to the collateral and does not attach unless'" the debtor signed the agreement which adequately described the collateral, value was given for the collateral, and the debtor had rights in the collateral. Id. (quoting § 84-9-203(1) (1996)) (emphasis supplied). Former Article 9 also required a security agreement that covered "crops growing or to be grown" to include "a description of the land on which they are grown." Id. (citing § 84-9-203(1)(a) (1996)).

Under revised Article 9, a legal description of the land is no longer required for a security interest that covers "crops growing or to be grown." See id. Revised Article 9 also states that a "'security interest attaches to collateral when it becomes enforceable against the debtor with respect to collateral, unless an agreement expressly postpones the time of attachment.'" Id. (quoting Kan. Stat. Ann. § 84-9-203(a) (Supp. 2001)).

If the Bank had executed its security agreements covering the debtors' growing crops after July 1, 2001, the agreements would be sufficient to attach to the debtors' crops and, absent some other defect in the agreements, the debtors' bankruptcy filing would not affect the validity or perfection of the liens created by the agreements. See id. However, because the Bank executed its agreements prior to July 1, 2002, and because the Bank failed to comply with the requirements of former Article 9, the parties stipulated that the Bank's security interest did not attach the debtors' growing crops. See id. The parties also agreed that without the enactment of Revised Article 9, the Bank's security interest would be unenforceable against the debtors. See id.

The central issue before the bankruptcy court, therefore, was "whether a security interest which did not attach prior to the enactment of revised Article 9 can be 'saved' by that enactment." Id. The Bank contended that its defective security agreement could be saved by the enactment of revised Article 9. See id. The Bank argued that revised Article 9 cured any defects in its security agreements and allowed their security interests to attach upon its enactment. See id. The Bank asserted that had their security agreements been filed after July 1, 2001, those agreements would have attached and would have been perfected. See id. Therefore, the Bank reasoned that since the security agreements now met the requirements of revised Article 9, they should be saved, and their security interests should have priority over the debtors as lien creditors. See id.

The court stated that having found "virtually no scholarship or case law on this point (and being cited none), the Court is left to a careful study of the statutory language, and, in particular, the transitional rules found in Part 7 of Article 9, [Kan. Stat. Ann] § 84-9-701 (Supp. 2001), et seq." Id. at 512-13. First, the bankruptcy court explained that the debtors became lien creditors with respect to their bankruptcy estate on June 4, 2002. See id. at 513. The court reasoned that the debtors became debtors in possession of the assets of the estate when they filed their bankruptcy petition. See id. "As such, the debtors [stood] in the position of a chapter 11 trustee and, as debtors in possession, they [were] lien creditors under the Kansas Uniform Commercial Code." Id.

The court stated that "[i]f the Bank's security agreements were valid and enforceable as of the effective date of revised § 84-9-203, the Bank's interests would take priority over those of a lien creditor." Id. Under Kan. St. Ann. § 84-9-317(a)(2), "[a] lien creditor that acquires its interest in the collateral before a security interest becomes perfected takes priority over the secured party." Id. The court explained that "[a] lien creditor that acquires its interest in the collateral before a security interest becomes perfected takes priority over the secured party." Id. (citing § 84-9-317(a)(2)). Noting that the debtors did not acquire their status as a lien creditor until June 4, 2002, "well after the effective date of the Article 9 revision . . . which is arguably the earliest that the Bank's liens could have attached to the crops," the court explained that the only remaining question was whether the Bank's liens were "'saved' [by one of the transitional rules] and attached upon the enactment of revised § 84-9-203." Id.

The first transitional rule that the court examined was § 84-9-702(a). See id. Section 84-9-702 provides that "'this act applies to a transaction or lien within in its scope, even if the transaction or lien was entered into or created before this act takes effect.'" Id. (quoting § 84-9-702(a) (Supp. 2001)). Section 84-9-702 also provides that a valid transaction that was not governed by former Article 9 remain valid under revised Article 9. See id. (citing § 84-9-702(b)). The court stated that this provision was "telling . . . in that it amply provides for the numerous classes of transactions which were formerly beyond the scope of Article 9, but makes no provision whatever for the curing of faulty pre-enactment Article 9 transactions." Id. The court determined that while § 84-9-702 could arguably render the Bank's security agreements enforceable and valid, "the other transition rules suggest that, while faulty pre-enactment perfection is remediable, failed pre-enactment attachment is not."

The next transitional rule that the court examined was § 84-9-703 (Supp. 2001). See id. at 514. Section 84-9-703 provides that

[a] security interest that is enforceable immediately before this act takes effect and would have priority over the rights of a person that becomes a lien creditor at that time is a perfected security interest under this act if, when this act takes effect, the applicable requirements for enforceability and perfection under this act are satisfied without further action.

Id. (quoting § 84-9-703(a)) (emphasis supplied).

The court also examined the transitional rule provided in § 84-9-703(b). That rule applies to a security interest that is enforceable under former Article 9, but not enforceable under revised Article 9. See id. Under § 84-9-703(b) the holder of a security interest has a grace period of one year in which the holder "must meet the applicable enforceability and perfection requirements in order to preserve the security interest's priority over a lien creditor." Id. (citing § 84-9-703(b)).

Finally, the court examined § 84-9-704. See id. Section 84-9-704 provides that

A security interest that is enforceable immediately before this act takes effect but which would be subordinate to the rights of a person that becomes a lien creditor at that time:

(1) Remains an enforceable security interest for one year after this act takes effect;

(2) remains enforceable thereafter if the security interest becomes enforceable . . . when this act takes effect or within one year thereafter; and

(3) becomes perfected:

        (A) Without further action, when this act takes effect if the applicable requirements for perfection under this act are satisfied before or at that time; or

        (B) when the applicable requirements for perfection are satisfied if the requirements are satisfied after that time.

Id. (quoting § 84-9-704) (Supp. 2001) (emphasis supplied).

The court determined that none of these transition rules "saved" the Bank's security interests in the debtors' growing crops. See id. The court concluded that the Bank's security interest in the Debtors' growing crops did not attach and was not enforceable because the agreements did not describe the lands upon which the debtors' crops were growing. See id. The court concluded that "[b]ecause it was unenforceable before the enactment of revised Article in Kansas, it is unenforceable now. None of the transition rules addresses or cures the pre-enactment failure to attach." Id. The court granted the debtors' motion stating that "the estate's interest in the proceeds of the crops planted prepetition is therefore free and clear of any lien or claim of the First National Bank of Sterling, Kansas." Id.

The case was decided on Oct. 22, 2002; this summary was posted in February 2003