Iowa Supreme Court Says Secured Lender Entitled to Recoup Storage and Drying Charges

The Iowa Supreme Court recently issued a decision in a key case involving competing claims by a secured lender and a grain elevator over the costs of storing and drying the grain. The April 17, 2020, case--MidWestOne Bank v. Heartland Co-op, No. 19-1302 (Iowa 2020)--has caused grain warehouses and lenders to take a closer look at their business practices.

Background

A married couple was engaged in the commercial production of corn and soybeans. These farmers regularly sold and delivered their grain to Heartland Cooperative, a licensed grain dealer that operates a grain warehouse and handling facility. The farmers entered into a contract with the grain warehouse for the storage, drying, and sale of their grain. From 2013 through 2016, the farmers obtained operating loans from MidWestOne, a bank in Story County. In return, the farmers granted the bank a security interest in their farm products and sale proceeds. The bank perfected its security interest by filing a UCC-1 financing statement. The security agreement signed by the farmers required them to inform the bank of the location of the collateral and prevented them from removing the collateral from its location without the bank’s consent, unless they did so in the ordinary course of their business. The security agreement prevented the farmers from allowing the collateral to be subject to any other lien, security interest, encumbrance, or charge without the prior written consent of the bank. The farmers were also required by the security agreement to ensure that the crops were properly maintained at the farmers’ expense, without allowing the attachment of liens by a grain warehouse.

The security agreement required the farmers to provide the bank with a list of grain warehouses that they might use to store or sell their grain. The farmers provided the name of the grain warehouse to the bank, and the bank sent the grain warehouse a “Notice to Buyer of Security Interest in Farm Products” on three occasions between 2014 and 2016. These notices informed the grain warehouse that the bank had a security interest in the farmers’ grain and directed them to make a joint payment to the farmers and the bank for all proceeds from the eventual sale of the grain. Between 2013 and 2017, the farmers sold grain to the grain warehouse six times. Each time, the grain warehouse deducted from the sale proceeds its costs of drying and storing the grain before sending the balance in a joint check to the farmers and the bank. In total, the grain warehouse withheld $79,895.68 from the sale proceeds for the cost of storage and drying.

Trial Court

Upon learning of these withholdings in 2017, the bank filed an action against the grain warehouse, alleging $79,895.68 in damages, plus attorney fees and court costs. The bank asserted that the grain warehouse had a junior interest in the grain to the bank’s prior perfected security interest and that the grain warehouse was not a buyer in the ordinary course. The grain warehouse filed an answer asserting several counterclaims, including unjust enrichment. The trial court ruled that the grain warehouse had only an unsecured interest in the outstanding storage and drying debt and that the bank’s prior perfected security interest in the proceeds was superior. The court then rejected the grain warehouse’s argument that it was entitled to offset the drying and storage charges because such an offset was a normal and regular practice recognized throughout the industry. Finally, the trial court found that the bank was not unjustly enriched by the value of the storage and drying charges.

Supreme Court Decision

Two-Year Statute of Limitations Applied

On appeal, the Iowa Supreme Court affirmed the major holding in the case. The Court did, however, determine that the two-year statute of limitations in Iowa Code § 614.1(10) applied to claims based upon a secured interest in farm products. The Court also ruled that the discovery rule did not apply to this statute. In reaching this conclusion, the Court noted that because the agricultural industry involves multiple producers, lenders, suppliers, and vendors, the UCC’s preference for clear rules must be honored.  Consequently, the Court limited the bank’s damages to those stemming from transactions that occurred in the two years prior to the filing of the lawsuit.

Unjust Enrichment?

The key question in the case was whether the grain warehouse was entitled to withhold the drying and storage charges from the proceeds before issuing the check to the bank and the farmers. All parties agreed that  storage and drying were necessary to preserve the grain for sale. The grain warehouse argued that storage and drying charges were routinely deducted from sale proceeds across the state and that the bank should have been aware of this common industry practice. The district court had found that the bank was not aware of these deductions and that the grain warehouse had not provided the bank with actual notice of them. The Supreme Court was left to decide whether the UCC priority system trumped the grain warehouse’s unjust enrichment claims.

The Court explained that an unjust enrichment claim “arises from the equitable principle that one shall not be permitted to unjustly enrich oneself by receiving . . . benefits without making compensation therefore.” The Court stated that it had never held that a grain elevator as an unsecured creditor could recover under a common law or equitable unjust enrichment theory against a bank with a valid perfected security interest in grain and proceeds.

The grain warehouse argued that a Colorado case was analogous to the facts at hand. Ninth District Production Credit Ass’n v. Ed Duggan, Inc., 821 P.2d 788 (Colo.  1991). In Duggan, the Colorado Supreme Court held that under limited circumstances, a creditor with a perfected security interest in collateral could be liable “to an unsecured creditor based on a theory of unjust enrichment for benefits that enhance the value of the collateral.” 

The Iowa Supreme Court distinguished the Duggan case because in that case, the lender initiated and encouraged the holder of a junior lien to expend money to protect the collateral. In this case, the Court noted that there was no evidence that the bank was aware of the storage and drying charges. Furthermore, the bank did not ask for or encourage the grain warehouse to provide those services. The farmers were contractually obliged to pay the storage and drying charges and neither the farmers nor the grain warehouse had provided the bank with documentation of those charges. Although the grain warehouse argued that the bank should have been aware of those charges because it was a common practice in the industry, the Court affirmed that there was no evidence of actual knowledge by the bank of these charges and that the bank did not discover the deductions until 2017.

In rejecting the unjust enrichment claim, the Court stated that it favors adhering to the UCC’s priority system to provide clarity, uniformity, and consistency in commercial transactions. Those objective would be undermined by allowing unjust enrichment claims against secured creditors. The Court thus affirmed the summary judgment in favor of the bank on the unjust enrichment claim, but limited the bank to recouping only two years of setoff charges.

Conclusion

In making its ruling, the Supreme Court affirmed the importance of predictability in commercial transactions. Lien statutes and priorities are strictly construed to ensure fairness and consistency. To take advantage of statutory remedies, parties must carefully follow all legal requirements.

This case has exposed an apparent disconnect between statutory law and historic practice. Although an Iowa grain warehouse can acquire a lien of warehouse for storage and drying charges under Iowa Code §554.7209, several procedures must be followed. First, the grain must be held under a signed storage agreement or a warehouse receipt. In this case, the grain warehouse issued no such receipt or agreement and did not acquire a valid warehouse lien. 

Second, even if a valid lien is present, the lien is only effective against a previously perfected security interest (like that of the bank) if the security interest holder granted the farmer actual or apparent authority to incur the drying and storage charges. In the case at hand, the lower court found that the bank did not give the farmer actual or apparent authority to store the grain because the bank’s security agreement had placed many limitations on the farmer’s ability to sell and encumber the grain.

Before pausing their session because of the COVID-19 crisis (and before this decision was issued), the Iowa Legislature was considering whether changes should be made to current warehouse lien law. In the meantime, grain warehouses should work with legal counsel to ensure that they are protecting their rights to collect storage and drying charges. Lenders should also more carefully consider these charges, particularly when working with financially distressed debtors.

We will keep you posted.