SD Secretary of State
► Livestock Security
Interest Statements - ERNST
following article is reprinted from the June-July 2004 issue of The UCC
Filing Flash, a newsletter provided by The UCC Guide Inc. to its
subscribers. See the box at the end of the article for disclaimer and other
information. It was written by Carl R. Ernst, Publisher. Go to
www.ernst.cc for information about publications available from Ernst
Publishing Co., LLC.
In an opinion filed March 31, 2004, the Supreme Court of South Dakota rendered
an opinion (2004 SD 40) on an appeal of a Circuit Court case, American Bank &
Trust et al v. Nathan Schaull and Deborah Schaull, d/b/a/Highmore Auction Sales,
Fin-Ag, Inc, Ag Star Financial Services, PCA et al (6th Circuit, Hyde County,
#02-20, decided October 1, 2002).
The facts of the case read like a Dan Brown novel,
so we will simplify them for the purposes of illustrating a couple of points in
this article. The opinion is worth reading for those of our readers who get
secret pleasure in learning how the due diligence performed by lenders on both
sides of the litigation could be so negligent.
As a result of their negligence, both sides lost
lots of money. It looks like the more negligent side lost every cent based on
its failure to file as required under UCC law, while the not-as-negligent side
lost more in actual dollars.
It appears that all the parties to this litigation were either professional farm
lenders or professional cattle owners. Still each and every party made some
common due diligence mistakes:
1. Nathan Schaull and his companies—They owned
cattle and also brokered and cared for other’s cattle. They got into financial
trouble, and then claimed to own cattle under their control which they did not
own. Later comes the crash.
2. Fin-Ag, Inc.—This cooperative, which used
Schaull to care for its cattle and sold him cattle, did everything right until
it subordinated its security position in 2001 to American Bank. It was left with
$2,000,000 in worthless loans or missing inventory due to American Bank’s due
3. American Bank & Trust—This lender facilitated
Schaull’s cattle auction business through a $750,000 line of credit starting in
1999. In 2001 American lent Schaull another $500,000 based on doing a UCC lien
search and a cursory inventory of about 1,000 cattle that appeared to be owned
by Schaull. It filed properly on Schaull as debtor in 1999 and in 2001. Most of
the cattle were, however, not owned by Schaull.
4. Feldman, Jennings and other actual owners of
the cattle—None of the owners of the cattle at issue had filed UCC financing
statements under Schaull’s name or tagged the cattle as notice of there
ownership in herds cared for by Schaull. Unknown to American, most of the cattle
were owned by either Jennings (625 cows under a “lease-purchase option”) or by
Feldman under a “bred cow agreement.”
5. AgStar—This expert lender had financed
Feldman’s cattle purchases and was aware that he boarded them with Schaull. It
did not file UCC financing statements naming either Feldman as a debtor or
Schaull as a consignee.
If American or Fin-Ag had performed adequate due
diligence in 2001, Schaull’s house of cards would have been discovered before
the last loan had been made. Schaull and his companies finally went under in the
Spring of 2002, leaving the cattle owners and lenders to litigate over who would
take ownership of the 910 cows still around.
The Issues Decided
The trial court ruled on all issues in favor of American Bank. On appeal, the
Supreme Court of South Dakota affirmed on all three issues it considered:
1. Did American’s security interest attach to the
The court analyzed the facts according to the old
Article 9 version of Rev. UCC �9-203. The issue netted down to a question of
whether Schaull had sufficient “rights in the collateral” for American’s
interest to attach. The court agreed with the trial court that the “bred cow
agreement” between Feldman and Schaull by its terms “created a joint venture
relationship between Feldman and Schaull “sufficient for attachment of the
Basically, the court let American off the hook
even though its due diligence with respect to the ownership of the cattle was
way less than adequate; American was not even aware of the “bred cow agreement”
because it accepted Schaull’s word that he owned the cattle.
2. Was Feldman estopped from asserting a security
interest in the collateral?
In December 2001, after the 2001 American loan,
the 625 Jennings cows were bought by Schaull and immediately sold to Feldman.
Therefore, most of the remaining herd was owned by Feldman. Feldman claimed that
the transaction with Schaull established a bailment, which does not require the
filing of a financing statement, but the appeals court agreed with the trial
court that the “bred cow agreement” was a form of joint venture, and no bailment
was involved. Feldman should have filed something or tagged something.
3. Were the cattle inventory or farm products?
Section 1324 of the Food Security Act of 1985,
titled “Protection for the Purchasers of Farm Products,” established a new set
of rules for lenders to follow in order to protect their security interests in
“farm products,” a form of collateral defined in the act. Because we have done a
good deal of research over the years about the interplay of Section 1324 with
Article 9 of the UCC, we continue to be wary of the arcane nature of
farm-related lending. It is not something for the uninitiated lender to jump
Part of the complexity of this case is due to the
definition of “farm products”: Like the definition of “fixtures” familiar to
real and personal property lenders, the definition of “farm products” depends on
context rather than an objective test. As equipment is a fixture if it is
affixed to real property, inventory is a farm product if it is goods in the
possession of a person “engaged in farming operations.” (Section 1324 and Rev.
UCC �9-102(34) agree on this part of the definition.)
If the cattle had been inventory, Feldman would
have been considered a holder in due course of 625 cattle remaining in the herd.
As such, he would have owned these cattle free and clear. If the cattle had been
farm products, on the other hand, American would maintain its interest in the
cattle even after the sale. The court determined that the cattle were farm
This case illustrates that even farm-lending specialists can get just about
everything wrong in dealing with simple due diligence issues, not to mention
technical difficulties peculiar to farm operations.
We will narrow our recommendations to cattle
collateral, although we suppose it is applicable to other livestock and maybe
other kinds of farm product collateral. Here are the due diligence formulas in a
(1) you own cattle, and
(2) your cattle are
(a) being held by someone else or
(b) grazing on someone else’s property, then
(1) have a written agreement with the holder or the landlord
(a) allowing you to file a UCC financing
(b) providing the information necessary under
Section 1324 for you, depending on the state where the cattle or located, to
(i) file an effective financing statement or
(ii) provide direct notification to possible
buyers of your ownership.
(1) you lend against cattle collateral, whether or not the cattle may be
inventory or farm products, then
(a) file a UCC financing statement on the owner in
the proper filing office,
(b) file an effective financing statement or do
direct notification of potential buyers, depending on the state where the cattle
(2) the cattle may not be held by the owner, then
(a) determine where and by whom the cattle are
(b) obtain the information about all holders or
landlords where the cattle may be located,
(c) make sure that the owner/grazing agreements
also authorize you to file UCC financing statements and contain the information
required for you to perform Section 1324 procedures with respect to all holders
If you buy cattle from anyone,
(1) determine whether the seller owns the cattle, and
(2) in case the cattle may be considered farm products, check for any Food
Security Act filings under the name of the seller or owner of the cattle.
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