Details Matter When it Comes to Security Interest Priority

November 23, 2018
Kristine A. Tidgren

A recent case from the Iowa Court of Appeals assesses the impact of a below-market-value purchase on the priority of related security interests in farm equipment. It’s a timely review during this current farm downturn.

Background

A private lender made loans to a farmer and his business entities for the purpose of financing his farming operation. The parties executed security agreements for the transactions to secure all present and future debts owed to the lender. The lender had a blanket security interest in all farm-related property, perfected by the filing of financing statements with the Iowa Secretary of State’s office.

Lower Court Action

After the lender’s death, the personal representative of his estate filed a petition for replevin against the farmer, his son, and his farming entity seeking possession of all secured property. The district court issued the writ of replevin for some property, but did not grant the writ with respect to two tractors that the farmer had sold to his son. The district court ruled that the son acquired the tractors free of the lender’s security interest because of an “implied course of dealing” between the farmer and the lender that allowed the farmer to sell collateral in which the lender had a security interest without seeking his permission. The district court also found that the bank which had loaned the son money to purchase the tractors had a purchase money security interest (PMSI) in the tractors that was superior to any interest held by the lender. The estate appealed, arguing that the son had purchased the tractors at a price well below fair market value and was thus the recipient of a gift from the father. Such transactions, the estate argued were not part of any “implied prior course of dealing.”

Applicable Law

Iowa Code § 554.9315(1)(a) states that “a security interest . . . continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest.” The Iowa Supreme Court has held such authorization may be “implied from a prior course of dealing between the secured party and the debtor.” C & H Farm Serv. Co. of Iowa v. Farmers Sav. Bank, 449 N.W.2d 866, 871 (Iowa 1989). Iowa Code § 554.1303(2) defines “course of dealing” as “a sequence of conduct concerning previous transactions between the parties to a particular transaction that is fairly to be regarded as establishing a common basis of understanding from interpreting their expressions and other conduct.” This definition is girded by the rule that “in order for a buyer to take collateral free of a properly perfected security interest under the ‘course of dealing’ doctrine . . . , that buyer must present proof of a course of dealing and show that the purchase involved was within that course of dealing.” Larsen v. Warrington, 348 N.W.2d 637, 641 (Iowa Ct. App. 1984). In analyzing whether a disposition of collateral is within the course of dealing, courts focus on whether the sale of the collateral was authorized, not on the desired disposition of the proceeds.

Appellate Court Analysis

The written security agreements between the farmer and the lender restricted the farmer from consuming, assigning or transferring any collateral without prior written consent from the lender. The farmer, however, testified that he regularly bought and sold machinery without seeking the lender’s permission. He also testified that any agreements with the lender were verbal, not written. In fact, the farmer explained that he had sold or traded many items on the list of equipment for which the estate believed the lender had a security interest.

In reversing the district court holding, the Iowa Court of Appeals ruled that even assuming there was a course of dealing distinct from the written agreements between the parties, the son had not established that his below-market-value purchase of the tractors fell within that “course of dealing.” The only consideration the son provided to the farmer when he purchased the tractors was an agreement to satisfy two outstanding loans on the tractors. He ultimately paid around $27,000 for a John Deere 8430 (which was worth around $116,500) and around $28,000 for a Case IH MX 335 (which was worth around $129,000). These payments were made to the bank. Based upon these facts, the court held that a benevolent sale of tractors from father to son for less than a quarter of their value would not fall within the scope of any prior “course of dealing,” even if one did exist. The court thus ruled that the district court erred in finding that the lender did not have a perfected security interest in the two tractors.

The court then turned to the question of whether the bank had a priority perfected PMSI in the tractors because the son had obtained a loan from the bank to “purchase” the tractors from his father and listed the tractors as collateral for his loan. In analyzing this question, the court turned to an example from U.C.C. § 9-325 cmt. 3. This example provides that a perfected security interest in equipment retains its priority if the owner sells the equipment “not in the ordinary course of business.” This is true even if the buyer’s lender files first and even if the buyer’s lender takes a purchase money security interest. The court thus found that because the farmer’s sale of the tractors to his son was not within any “implied course of dealing,” the lender retained priority over the bank’s perfected security interest in the tractors. The bank, the court noted, had the opportunity to discover the farmer’s ownership of and the lender’s perfected security interest in the tractors by conducting a UCC-1 search with the Secretary of State’s office prior to making the loan to the son.

Thoughts

As financial distress continues throughout the farming sector, lenders must be very cautious to protect their interests in collateral. Here, the bank may have thought that because it was securing a purchase in the tractors, it had a perfected PMSI, which usually has priority over a conflicting security interests in the same equipment. Details are important, however, and here the fact that the son was purchasing the tractors from his father at a below-market-value price should have been a red flag causing the bank to further investigate the status of the collateral.  

The case is Security National Bank of Sioux City v. Welte, No. 17-0907 (Iowa Ct. App. Nov. 21, 2018).

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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