Summary of a Recent
Judicial Development in
Secured Transactions

Eighth Circuit Requires Strict Compliance
With "Direct Notice" Exception

Gaby R. Jabbour
National AgLaw Center Research Assistant

Summary of Decision

In Farm Credit Midsouth, PCA v. Farm Fresh Catfish Co., 371 F.3d 450 (8th Cir. 2004), the United States Court of Appeals for the Eighth Circuit held that a secured creditor was required to strictly comply with the direct notice requirement set forth in § 1631(e)(1) of the Food Security Act (FSA or Act) in order for a buyer in the ordinary course of business to take farm products subject to the secured creditor's security interest.

Background

Farm Credit Midsouth, PCA (Farm Credit) loaned funds to Reece Contracting, Inc. (Reece) so that Reece could purchase and operate a catfish farm. See id. at 450. As collateral for the loan, Reece granted Farm Credit a first priority security interest in its catfish and catfish fingerlings. See id. Farm Credit filed a financing statement with the Arkansas Secretary of State and those counties in which Reece operated. See id. It also sent two letters to Farm Fresh Catfish Company (Farm Fresh), a company that purchased catfish from Reece, to inform Farm Fresh that Farm Credit provided financing to Reece and that it held a first priority lien in all of Reece's catfish. See id. Farm Fresh typically made its checks for catfish purchases payable to Farm Credit and Reece. See id. After Reece defaulted on its payment obligations, however, Farm Credit discovered that Farm Fresh only listed Reece as payee for the last forty-four payments it made prior to default, totaling approximately $700,000.00. See id. As a result, Farm Credit brought an action against Farm Fresh alleging that Farm Fresh converted Farm Credit's security interest. See id.

Section 1631(d) of the FSA provides that, except as provided in § 1631(e), "a buyer who in the ordinary course of business buys a farm product from a seller engaged in farming operations shall take free of a security interest created by the seller, even though the security interest is perfected; and the buyer knows of the existence of such interest." Id. Section § 1631(e) provides that

a farm products purchaser "takes subject to a security interest created by the seller if" (1) the secured creditor provided, within a year before the sale, the farm products purchaser with direct written notice of the secured creditor's interest (direct notice exception) . . . or (2) the secured creditor filed an effective financing statement covering the farm products if the state has established a central filing system that complies with the Act (central filing exception) . . . .

Id. (citations omitted).

The district court found in favor of Farm Fresh and concluded that the letters sent by Farm Credit did not strictly comply with the direct notice exception set forth in § 1631(e). See id. Farm Credit appealed the district court's judgment to the Eighth Circuit. See id.

Arguments

Farm Credit argued that "it need only [to] substantially comply with the Act's direct notice exception, and [that] its letters to Farm Fresh substantially complied with the direct notice exception." Id. Thus, Farm Fresh purchased the catfish from Reece subject to Farm Credit's security interest and its failure to make payment to both Farm Credit and Reece constituted a conversion of Farm Credit's security interest. See id.

Analysis and Holding

The court explained that Congress's use of the term "if" in § 1631(e) emphasizes that "the farm products purchaser takes the farm goods subject to the security interest only when the secured creditor complies with the direct notice exception or the central filing exception." Id. See also id. (noting that Arkansas did not have a central filing system and as a result the direct notice exception was applicable). The court explained that to comply with the direct notice exception

a secured creditor must send the farm products purchaser a written notice listing (1) the secured creditor's name and address, (2) the debtor's name and address, (3) the debtor's social security number or taxpayer identification number, (4) a description of the farm products covered by the security interest and a description of the property, and (5) any payment obligations conditioning the release of the security interest.

Id. (citations omitted).

The court stated that "[u]nlike the Act's definition of an effective financing statement in a central filing state, the Act's direct notice exception does not contain language indicating the required contents of the written notice are merely permissive or can be satisfied through substantial compliance." Id. It added that "[b]y including substantial compliance language in defining an effective financing statement for the central filing exception and excluding such language from the direct notice exception, Congress presumptively and logically intended that a secured creditor must strictly comply with the direct notice exception." Id. (citation and quotation omitted). The court recognized that "[f]orcing secured creditors to comply strictly with the direct notice exception does not run afoul of the Act's purpose" since "Congress adopted the Act to protect farm products purchasers from double payment[,]" and requiring the secured creditor to comply strictly with this exception "removes ambiguity regarding compliance, and protects farm products purchasers from double payment." Id. at 454. It added that "[e]xtending substantial compliance to the direct notice exception would have the opposite effect, requiring a farm products purchaser to guess whether the written notice substantially complied with the Act's direct notice exception." Id.

The court concluded that

Farm Credit's . . . letters do not strictly comply with the Act's direct notice exception. Neither letter contains Reece's taxpayer identification number, Reece's address, or the counties in which the catfish subject to Farm Credit's security interest are produced or located. Because the . . . letters fail to comply with the Act's direct notice exception, Farm Fresh purchased the catfish free of Farm Credit's security interest, even though Farm Fresh knew of the existence of such interest.

Id. (citation omitted).

The case was decided on April 16, 2004; this summary was posted Aug. 3, 2004.