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A debtor borrowed money from a lender and pledged dairy cattle as collateral. The lender secured an interest in the cattle. The debtor later borrowed additional money from the lender, pledging crops, farm products and livestock as collateral with lender's security interest containing a dragnet clause. The lender secured its interest. The debtor later entered into a "Dairy Cow Lease" with a third party to allow for expansion of the herd. The third party lessor perfected its interest in the leased cattle. The debtor filed Chapter 12 bankruptcy and the bankruptcy court determined that the lease arrangement actually created a security interest rather than being a true lease. The court noted that the "lease" was not terminable by the debtor and the lease term was for longer than the economic life of the dairy cows. The third party lessor also never provided any credible evidence of ownership of the cows, and the parties did not strictly adhere to the "lease" terms. The court noted that the lender filed first and had priority as to the proceeds from dairy cows. In addition, the bankruptcy court held that the lender's prior perfected security interest attached to all of the cows on the debtor's farm and to all milk produced post-petition and milk proceeds under 11 U.S.C. Sec. 552(b). In a later action in the district court, a different creditor failed to comply with court’s order requiring posting of bond as a condition to stay the effect of the court’s prior ruling. As a result, there was no stay in effect during pendency of the appeal and the lender was entitled to have the proceeds turned over to it. A feed supplier creditor did not have standing to seek surcharge of the bank’s collateral under 11 U.S.C. Sec. 506(c). The bankruptcy trustee did not file a motion for surcharge and court could not order the amount that the supplier paid for feed deliveries to be retained from funds turned over to the lender. The lender's motion for abandonment and turnover of proceeds was granted. On further review of the bankruptcy court's decision concerning the dairy cow lease, the appellate court reversed. The appellate court determined that under applicable law (AZ) as set forth in the "lease" agreement, a fact-based analysis governed the determination of the nature of the agreement. However, if the lease term is for longer than the economic life of the goods involved, the "lease" is a per se security agreement. The bankruptcy court focused on the debtor's testimony that he culled about 30 percent of the cattle annually which would cause the entire herd to turnover in 40 months. That turnover time of 40 months was less than the 50-month lease term. Thus, according to the bankruptcy court, the lease was a security agreement. The appellate court disagreed with this analysis, holding that the agreement required the focus to be on the life of the herd rather than individual cows in the herd because the debtor had a duty to return the same number of cattle originally leased rather than the same cattle. Thus, the agreement was not a per se security agreement. On the economics of the transaction, the appellate court held that the lender failed to carry its burden of establishing that the actual economics of the transaction indicated the lease was a disguised security agreement. There was no option for the debtor to buy the cows at any price, and there was no option at all. The court remanded the case to the bankruptcy court. The cattle owned outright by the debtor were sold at auction by the bankruptcy trustee subject to the security interest of the bank. The debtor had purchased the cattle with commingled funds from the bank's account which was sufficient for the bank's lien to attach and the court, on remand, determined that it was immaterial that the funds were later reimbursed by a third party under the lease. Thus, the proceeds of the auction were subject to the bank's security interest and were the bank's property. The leasing party's brand on the cows was not sufficient under state (KY) law to establish ownership of the cows because it was unregistered. After-acquired livestock were also subject to the bank's lien, as being proceeds of the pre-petitioner lien. In re Purdy, No. 12-11592(1)(12), 2015 Bankr. LEXIS 2938 (W.D. Ky. Sept. 2, 2015), on remand from, Sunshine Heifers, LLC v. Citizens First Bank (In re Purdy), No. 13-6412, 2014 U.S. App. LEXIS 15586 (6th Cir. Aug. 14, 2014), rev'g., 2013 Bankr. LEXIS 3813 (Bankr. W.D. Ky. Sept. 12, 2013).
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