Be Prepared Before Your Borrower Files a Farm Bankruptcy
By John D. Leary
December 15, 2016
How prepared are you for a workout or Chapter 12 farm bankruptcy filed by your Borrower? Make it your New Year’s Resolution to know the answer to these questions about your Borrower.
Do you conduct regular file reviews? Regular loan file reviews can be used as tools to increase certainty as to collateral priority and collateral value. Increased certainty in your collateral position can reduce transaction costs and mitigate exposure in workouts or in the event your Borrower files bankruptcy. Often, lenders are surprised in a Chapter 12 that their lien priority and collateral values are not what they expected. Regular file reviews can help eliminate that surprise.
Who owns your collateral? There is no title for most farm equipment. So, who owns it? A LLC? An individual? If you have parents and children operating the farm, which individual owns the equipment? In the agricultural setting, there are often multiple individuals and entities involved and Lenders run into collateralization issues such as when the Borrower or one of its owners creates a new entity; changes the name of a current entity; creates a new entity; or when an in-law, sibling, or child now claims to be the owner of collateral pledged to Lender by the Borrower.
Do you obtain updated and signed equipment lists? An equipment list updated annually and signed by the properly authorized individual or representative of Borrower can mitigate exposure by preserving collateral and deterring erosion or conversion. The equipment list should include: (a) all major pieces of equipment, (b) any purchase money interest (c) valuation, balances due and payments (d), attached insurance policy schedule listing the owner and when appropriate, updated appraisal, and (e) contain a statement that Borrower understands Lender is relying on the accuracy of the equipment list and an inaccurate or incomplete equipment list will cause Lender harm.
Who signed your security agreement? The best practice requires that security agreements be signed by all entities and individuals in the farming operation, so that you eliminate the surprise that arises when ownership is claimed by an individual (or an entity) that has not signed your security agreement. We’ve seen Borrowers claim in financial statements that their LLC owns the equipment, but when the individuals file for bankruptcy, the Borrowers change their stance and assert that the individual owns the equipment.
Do you have copies of farm land leases? Many Borrowers in the Ag sector are either Lessors or Lessees of farm land which are often entered after the loan to Borrower has been made. The leases can be oral or written, can be for cash or crop share, some hybrid of the two, or include barter provisions for labor or equipment. Even written leases often leave out basic provisions such as the land description (tillable acres only?), term, default/remedy, liability insurance, and more specific provisions such as crop prohibitions, tillage restrictions, fall tillage requirements, or fertility levels. Requiring regular or on demand copies of the leases in the Credit Agreement or as a condition of renewal can help Lender better evaluate loan exposure and determine actual cash flow.
Are the heifers being raised offsite by third parties? Heifer raising contracts where calves are shipped offsite are now commonplace, and can raise lien priority issues and decrease the value of Lender’s collateral. Other issues such as breeder’s liens, pasture liens, and mechanics liens on equipment, can all affect Lender’s collateral priority and value.
Have you obtained an assignment of important contracts? Easements and contracts for access and hunting/recreation uses remain common, but there are increasing issues related to easements and contracts related to minerals/sand, manure, water/irrigation and tiling. All can affect the priority of your lien and the valuation of your collateral.
Good and current information can strengthen Lender’s position, deter off book transactions, and help provide clarity and certainty as to Lender’s collateral priority and valuation. Clarity and certainty reduce transaction costs in workouts and bankruptcies for the Lender. Also, verifying lien priority and valuation before a workout or Chapter 12 can reduce Lender’s exposure and help to increase recovery of the loan.
In the current farm economy climate, it pays to be prepared for a workout or farm bankruptcy by your Borrower.
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