Court Says Farm Products Rule Requires Strict Compliance

May 6, 2013 | Erika Eckley

The 1985 Farm Bill created a set of rules that federalized the farm products rules that had been adopted in different forms in many different states. Under the federal rule, 7 U.S.C. § 1631(e) of Food Security Act (FSA) (a.k.a. “Farm Products Rule”), states could either adopt a centralized filing system for security interests in farm products or an actual knowledge system.  The rule allows a buyer in the ordinary course to purchase a farm product free and clear unless the buyer has received notice of a security interest in the farm product within one year before purchasing the farm product, the buyer does not pay for the product, or the buyer has received a notice of an effectively filed financing statement from the Secretary of State’s office and has not obtained a release.

The direct notice system requires a secured creditor had to send the purchaser of farm products a written notice that lists the following:

  • The secured creditor’s name and address
  • The debtor’s name and address
  • The debtor’s social security number or taxpayer identification number
  • A description of the farm products covered by the security interest and a description of the property, and
  • Any payment obligations conditioning the release of the security interest.

The description of the farm products must include the amount of the farm products subject to the security interest, the crop year, and the county or counties in which the farm products are located or produced. The centralized system requires secured parties to file a financing statement with the Secretary of State’s office with the same information.

In a recent Illinois case, a farmer obtained a loan from the plaintiff, a bank, and used his crops as collateral. To secure its interest in the growing crops, the bank gave notice of its security interest in the crops to the defendant as required by the Farm Products Rule. The defendant purchased crops from the farmer, but failed to include the bank on the check one year and allowed a check to be negotiated without the bank’s endorsement the following year. The bank sued the defendant for failing to protect the bank’s interest.

The defendant claimed that the bank’s notice did not strictly comply with the Farm Products Rule.  In particular, the notice left blank the designated space for a description of the property or county where the farm products that were claimed as collateral may be located.

Both parties filed motions for summary judgment.  The bank claimed it substantially complied with the notice requirements of the Farm Products Rule.  The defendant argued that by failing to identify the location of the crops, the notice was invalid. The defendant argued that the Farm Products Rule required strict compliance for direct notice of a security interest.

The defendant relied on an Eighth Circuit case, Farm Credit Midsouth, PCA v. Farm Fresh Catfish Co., 371 F3d 450 (8th Cir. 2004), which held that the FSA requires strict compliance. The bank pointed out  that the case was not binding on the court, and that a substantial compliance standard should apply as established in the Illinois case First National Bank v. Effingham-Clay Service Co., 633 N.E.2d 67 (Ill. Ct. App. 1994).  In that case, the Illinois court interpreted a UCC provision involving notice of a secured claim and held that substantial compliance was sufficient to give notice. The trial court agreed, finding the defendant had actual and sufficient notice of the claim. The defendant appealed.

The appellate court reversed.  The court determined that the First National Bank case was not binding because it never cited the FSA. Instead, the court found “highly persuasive” the Eighth Circuit’s Farm Credit Midsouth opinion.  The court found that in addition to the Eighth Circuit,  the United States Court of Appeals for the Fifth Circuit had also ruled in Peoples Bank v. Bryan Brothers Cattle Co., 504 F.3d 549 (5th Cir. 2007) that providing the debtor’s trade name rather than the debtor’s name did not comply with notice required under the FSA. Based on these cases, the court held that the federal courts had uniformly decided that direct notice under the FSA requires strict compliance because Congress included language under the requirements for a centralized system that did not appear under the direct notice. Because of this, the court agreed with the Eighth Circuit’s holding that the plain language of the FSA allowed for minor errors in a central filing state, but not when direct notice applied. The court also agreed that these distinctions were “intentional and logical.”  Thus, as applied to the present case, the court found that the failure to provide the name of the county and location of the crops was fatal to the bank’s notice because strict compliance was required. Therefore, the defendant did not receive valid notice and was entitled to purchase the farm products free and clear of the bank’s interest.

A dissent was filed in this case. The dissent cited several other court decisions that allowed for substantial compliance with the FSA when the creditor provided imperfect notice, but which reasonably placed the purchaser on notice of the claim. Because of these other cases, the dissent disagreed with the majority’s reliance on the Eighth Circuit’s Farm Credit Midsouth decision.  The dissent also pointed out that the majority’s opinion requiring strict compliance for direct notice of a security interest under the FSA was “absurd and illogically flawed.” The court’s decision, according to the dissent, allowed for two completely different results under the FSA. The dissent stated it was not aware of any “rule of statutory construction which requires a reviewing court to conclude that the legislature must have intended an illogical result.” The dissent pointed out that under the majority’s interpretation of the Farm Products Rule a party can make an error in identifying the secured party in a centralized filing state, but all parties will be deemed to have constructive notice of the claim, while a creditor can be unsecure where direct notice is given but the notice contains any minor error even if the party has enough sufficient knowledge of the claim.

In reality, this case should never have occurred.  The bank was sloppy in the manner in which it completed a form to give notice of a secured interest. While the result of the opinion may seem harsh and even illogical, the bank has no one to blame but itself. State Bank of Cherry v. CGB Enterprises, Inc., No. 3-10-0495, 2012 WL 34098 (Ill. Ct. App. Jan. 4, 2012).

Update:  The Illinois Supreme Court agreed federal jurisprudence applied in addressing the issue of whether strict compliance was required to provide direct notice of a security interest in crops under the Food Security Act of 1985. The Court agreed with the appellate court that Farm Credit Midsouth, PCA v. Farm Fresh Catfish Co., 371 F.3d 450 (8th Cir. 2004) was directly on-point with the issue presented and aligned with the Court’s analysis of the statute. Because of this, the Court affirmed the appellate court’s opinion following the Farm Credit Midsouth opinion holding a secured party must strictly comply with the notice requirements of section 1631(e) in order to provide sufficient written notice. State Bank of Cherry v. CGB Enterprises, Inc., No. 113836, 984 N.E.2d 449 (Ill. Sup. Ct. 2013).