An Amarillo Court of Appeals decision in Agrifund, LLC v. First State Bank of Shallowater, addressed an interesting question of whether a lender has a purchase money security interest in a harvested crop when the funds were used to purchase seed and chemical to grow the crop.  [Read Opinion here.]

Photo by Mark Stebnicki from Pexels

Background

In 2017, the Garys borrowed money from Agrifund to finance their farming operation.  They received extensions of credit under a number of promissory notes with the final note executed in December 2017.  Payment of the final note included the unpaid balances owed under the prior notes, and was secured under a security agreement by collateral that included the Gary’s rights, title, and interest in and to their crops.  Agrifund perfected this security interest by recording a UCC-1 financing statement with the Texas Secretary of State. The Gary’s defaulted by failing to pay on the note’s maturity on March 15, 2018.

In May 2018, the Gary’s obtained financing from the First State Bank of Shallowater (“Bank”).  They used the money from the Bank to buy cotton seed and chemical for their 2018 crop.  They executed a series of promissory notes and a security agreement granting the Bank an interest in all crops grown or to be grown for the 2018 crop year.  The Bank perfected this security interest by recording a UCC-1 financing statement with the Texas Secretary of State on June 4, 2018.

Upon the sale of the 2018 cotton crop, Plains Cotton Cooperative Association issued eight checks payable to combinations of payees including the Garys, Agrifund, and the Bank.  Agrifund was a payee on all eight checks, but the Bank was a payee on only four.  The Bank notified Agrifund it believed its security interest was superior, then filed suit seeking a declaratory judgment when Agrifund did not release the funds.  Agrifund filed a counterclaim requesting injunctive relief and seeking a declaratory judgment that its security interest in the 2018 crop has priority over the Bank’s interest.

Both parties filed summary judgment motions.  The trial court held that the Bank had a superior security interest and granted its motion for summary judgment.  The trial court did not award attorney’s fees to either party.  Agrifund appealed.

Applicable Law

The long-standing general rule of priority of payment between competing security interests in the same collateral both perfected by filing is that the secured party who first properly filed a financing statement prevails.  An exception to this general rule applies if there is a purchase money security interest (“PMSI”).  A PMSI arises when a person who loans money to another to acquire property obtains a lien on the property purchased.  The definition of “goods” in Texas statute is “all things movable when a security interest attaches” and includes “crops grown, growing, or to be grown…”

Here, the parties agree it was Agrifund that first filed their financing statement.  However, if the Bank’s interest in the 2018 crop was a perfected PMSI, it would take priority over Agrifund’s security interest.

Amarillo Court of Appeals Opinion 

The Amarillo Court of Appeals reversed.  [Read Opinion here.]

The Bank’s interest is not a PMSI

The Bank argued its interest is a PMSI for two reasons: (1) the Garys pledged as security the supplies to be used in their farming operation and their crops to be grown; and (2) the Bank’s loan to the Garys enabled them to acquire the seed, which it characterizes as a ‘crop to be grown’ and chemical purchased in August 2018.  Thus, the Bank argues it had a perfected security interest in the crops to be grown, which are goods under the statutory definition.

The court agreed that the statutory definition of “goods” includes “crops to be grown,” but disagreed that this “inevitably leads to the conclusion that the bank has a PMSI in the Gary’s cotton crop.”  As the court explained, “The very term purchase money security interest denotes that the security interest must be taken in the items already purchased.  The Bank’s loan to the Gary’s did not enable them to purchase a crop; it enabled them to produce one.”  Here, the Gary’s purchased the seed and the chemical, not the crop.

Further, the court was unpersuaded by the Bank’s argument that the seed purchased was the equivalent to a “crop to be grown” which is also included in the definition of “goods.”  The court noted that seed is just one of several necessary inputs to grow a crop, others being chemical, fertilizer, water, soil, and the farmer’s labor. The cotton crop, then, is clearly distinguishable from the individual components–like seed and chemical funded by the Bank–that were combined over time to produce it.

Finally, the court noted that the crop was not the “proceeds” of the seed.  “Proceeds” are defined as “whatever is acquired upon the sale, lease, license, exchange, or other disposition of collateral.”  Here, the crop was not the result of the sale, lease, license, exchange, or other disposition of the seeds.  The seed was planted and cultivated, not transferred or disposed of, making the crop the resulting product not the proceeds.

One interesting note from the court was that when the Legislature enacted the statutory provisions of Article 9 in 1999, it eliminated section 9.312, which allowed creditors to obtain a super-priority interest in crops to be grown.

Thus, because the Bank’s security interest is not a PMSI, it is not superior to Agrifund’s interest.  Instead, it is the general rule of first to file that applies, and it is undisputed that Agrifund filed its interest first.

Attorney’s fees should be granted

Agrifund argues that it is entitled to attorney’s fees and costs under the Uniform Declaratory Judgments Act (“UDJA”).  The UDJA authorizes the court to award attorney’s fees and costs in a declaratory judgment action if the court determines the award to be equitable and just and the party presents evidence that the fees are reasonable and necessary. An attorney fee award is not required but is left with the discretion of the trial court.  Here, because Agrifund is entitled to summary judgment on its declaratory judgment claim that it has priority to the proceeds of the cotton crop, the issue of attorney’s fees is remanded to the trial court to determine whether the award is equitable and just under the UDJA.

Conclusion

The court reversed the trial court’s grant of summary judgment in favor of the Bank’s claims and reversed the denial of Agrifund’s summary judgment motion.  “We render judgment that Agrifund have and recover a declaratory judgment declaring that its perfected security interest in the Garys’ 2018 crop is superior to any claim of the Bank.”  The matter is remanded to the trial court for the sole purpose of determining whether attorney’s fees are equitable and just under the UDJA.

To date, no appeal has been filed.

Dissenting Opinion

Chief Justice Quinn issued a dissenting opinion. [Read Dissent here.]  He relies on the statutory definition of “goods” including “crops to be grown.” Here, the Garys borrowed money and the Bank obtained a right in the collateral, which was the 2018 crop.  The Garys agreed to borrow the money to grow the crop which they would own or at least have some property interest in.  So, it can be said they incurred a “purchase money obligation” in the “goods,” which was the crops the be grown.  He would have found the Bank’s interest a PMSI and superior to Agrifund’s interest.

Interestingly, he notes, “In all candor…, I also acknowledge that if higher authority were to address this issue of first impression in Texas, the majority opinion would most likely find approval.  It is supported by the work of learned writers, commentary, and authority from neighboring states.  My dilemma concerns whether to follow those writers, that commentary, and neighboring authority or apply the plain words incorporated by the Texas Legislature into the statutes at play.  Because our Supreme Court mandates I apply the statute as written, I follow the course selected at the risk of comparison to Don Quixote”