Harvest is here—the culmination of months of sweat, toil, worry, and investment. Hopefully your harvest is safe and smooth, your yields are excellent, and your marketing gets you excellent prices. If either your yields or prices are low, however, you might worry about coming up short. Nobody wants to shortchange their landlords or vendors, but you also have to pay the bank. Which creditors should you pay when funds are short—and what happens if you don’t?

Collateral is Key

When you borrow input financing you sign a security agreement with the bank. You might not remember that you signed it, or it may have been years ago, but it states that all your inputs, crops, and government program payments (and maybe other property as well) are collateral for your debts to the bank.

“Collateral” has two important practical meanings. First, if you don’t pay your debts, the bank can seize and sell the collateral to pay the debt. And even if you’re current with your debts, the bank still has an interest in that collateral, and you can’t just do what you please with it or the proceeds you might get from selling it, you’ll need to use the proceeds to pay off the lien.

When things are good and there’s enough money to go around, your bank might not worry much about this. If the bank is happy, it might not look too hard to see if you paid a landlord or a vendor with crop proceeds before paying off your input note. However, when there’s not enough money to go around, the bank might view this as taking money out of its pocket.

Landlords and certain other vendors have statutory liens on your crop. Most of the time these don’t matter because those creditors don’t properly perfect (or enforce) them, but if they do, in many instances these statutory liens can jump ahead of the bank in the payment line and legally say, “Sorry bank, but I get paid before you do.” For more information, refer to our February 2024 blog post Landlord’s Liens: Cheap, Easy, but Time-Critical Insurance.

Creditors’ Rights

A creditor who has your crop or other farm products as collateral has the right to demand a list of potential buyers and send notices to them to get their name on your checks. As with statutory liens, this right affords secured creditors extra protection but isn’t frequently used; however, just because yours is the only name on the check doesn’t mean your secured creditors lost their security when you sold the collateral. The creditors who had your crop as collateral still have a right to its proceeds—whether or not their name is on the check!

When faced with the question of who to pay first when selling your crop or other collateral, the law says the creditor with the senior lien on the collateral gets paid in full first, then down the line from there, any leftover proceeds only going to you once all the lienholders are paid in full. The law doesn’t care who you want to pay or who deserves to get paid—it is concerned only with who has a lien on the collateral and their place in line.

Better Permission Than Forgiveness

The law can put a farmer in a bind when there’s not enough money to go around. If your landlord isn’t paid, that would likely damage a longstanding relationship and they might even terminate your lease. Your vendor may also be your neighbor or relative. And you still need to put food on the table and support your family.

Sometimes borrowers choose to pay the bills they want to pay first and then hope that somehow everything will work out or the bank will ignore this transgression even though the input loan isn’t paid off. This is a dangerous path to take, since it can damage your relationship with your banker and lead to civil and even criminal liability. It’s better to clear your plans with your banker before acting on them, then consult an experienced ag attorney, such as those with Ag & Business Legal Strategies—especially if you can’t reach a deal.

Conversion

Selling collateral and using the proceeds, without authorization, for anything other than paying off lienholders in their proper order is conversion, which is the civil counterpart of theft. If a farmer wants to get a check without a secured creditor’s name on it and sells farm products to a buyer whom they haven’t disclosed to the secured creditor who requested disclosure, that’s conversion as well, and doing this makes using those proceeds for something other than paying off lienholders in their proper order even more blatantly wrong.

In some circumstances conversion might constitute theft. Conversion can also be grounds for a debt to be nondischargeable in a bankruptcy. Nondischargeability means the debt survives bankruptcy, even though bankruptcy is meant to provide a fresh start by discharging most debts.

If you choose to ask for forgiveness rather than permission in these circumstances, you need to know the stakes.

Far too often a farmer comes to us after they’ve converted collateral and failed to pay off the senior lienholders, leaving us struggling to salvage something from a bad situation. If these farmers had come to us before converting collateral, we might have been able to obtain a better outcome. When we have to try to pick up the pieces after collateral has already been converted, we often negotiate settlements with the creditor in which some or all of the debt will be nondischargeable in a bankruptcy—and it almost always costs the farmer a lot of time, energy, angst, and legal fees.

Act Now to Avoid Creditor Problems

If you think you might be short on income this year, contact Ag & Business Legal Strategies right away. We can help you analyze which creditors have your crop as collateral and try to negotiate a resolution that achieves your goals and helps you avoid trouble. Contact us now to discuss your situation, rather than later after damage may have been done.

At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our attorneys and financial strategist will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy.

Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow.