Buying Ag Equipment and Machinery – Make Sure You Don’t Lose It To the Seller’s Creditor

April 29, 2015
Roger A. McEowen

Financial stress in agriculture creates numerous legal issues.  One of those that may not necessarily be high on the “radar screen” involves the purchasing of machinery and equipment.  Does it matter if the purchase is from a private party or an implement dealer?  It just might.  There are at least a couple of common scenarios to watch out for.

Buyer in the Ordinary Course of Business

Under the Uniform Commercial Code, a buyer in the ordinary course (BIOC) is a person who, in good faith, and without knowledge that the sale is in violation of the ownership rights or security interest of a third party in the goods, buys in the ordinary course from a person in the business of selling goods of that kind.  The significance of being a BIOC is that such person takes free of a security interest in inventory items created by that person's seller even though the security interest is perfected.  For example, assume an individual would like to buy a tractor from the local implement dealer.  The buyer wants to buy the tractor free and clear of any interest that the dealer may have given to one of its creditors in its inventory.  If the implement dealer gave a security interest to the bank in its inventory, including the tractor in question, the buyer will take free and clear of the bank's interest in the tractor if the buyer is a buyer in the ordinary course of business.

There are two requirements that must be satisfied to be a BIOC:  (1) the buyer must be a BIOC; and (2) the buyer’s seller must have created the security interest involved.  The following examples illustrate the application of the requirements.

Example:

Frank bought a combine from a local dealer and granted a credit company a security interest in the combine.  The credit company filed a proper financing statement with the Secretary of State.  Frank then sold the combine to Sally. The credit company is not informed of the sale, and Frank later defaults on his obligation to the credit company.  The credit company later learns that Sally has the combine and files a repossession action against Sally.  The credit company will get the combine because Sally is not a BIOC (she didn’t purchase the combine from someone engaged in the business of selling goods of that kind).

Example:

Assume the same facts as in the previous example except that instead of selling the combine to Sally, Frank trades the combine to another dealer and that dealer sells the combine to Sally.  Frank then defaults on his obligation to the credit company.  The credit company learns that Sally has the combine and files a repossession action against her.  The credit company will get the combine because Sally’s seller did not create the security interest involved.

The examples show that, as a buyer of equipment, you have to be careful not only when you buy from a private party, but also when you buy from a dealer.  Make sure that you ask questions about the equipment/implement before you buy it?  Consider having your legal counsel draft a purchase agreement for you that has the seller acknowledge how the property was acquired and whether there might be existing security interests in the property. 

Perfection

Another matter to watch out for involves “perfection.”  “Perfection” describes the process that a secured party must take to make a security interest effective against third parties, particularly the debtor's general creditors  or  their  representative  in  an insolvency proceeding.  Perfection of a security interest in collateral is necessary to have an interest ahead of “a person who becomes a lien creditor without knowledge of the security interest and before it is perfected.”  The secured party must perfect to prevent these people from making priority claims against the collateral.  An unperfected security interest is subject to the priorities of all perfected security interests even though the perfected party knew of the prior unperfected security interest.  For unperfected security interests, a buyer of the collateral wins if the buyer gives value and receives delivery without knowledge of another party's attempt to create a security interest in the collateral, and before such interest is perfected.  For example, consider the following:

Example:

On February 1, Farmer Jones borrowed money from Second State Bank, and pledged a tractor as collateral for the loan.  The bank and Jones executed a security agreement.  On February 2, Farmer Jones sold the tractor to Farmer Brown.  Brown paid Jones the full asking price.  On February 3, Second State Bank filed a financing statement.  On February 4, Brown took delivery of the tractor purchased from Jones.  On February 5, Jones defaulted on the loan from Second State Bank. As between Second State Bank and Farmer Brown, Second State Bank would receive the tractor because Brown did not take possession of the tractor until after the bank perfected (by filing a financing statement).  If Brown had received possession of the tractor before the bank filed, Brown could keep the tractor.

Conclusion

The law surrounding secured transactions can be tricky.  Tough financial times, however, make it critical to understand at least the basics. The examples in this article are drawn from my textbook, Principles of Agricultural Law.  There is additional detailed information in that text for those that might be interested.

CALT does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. CALT's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.

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