Low commodity prices over the past couple of years for many commodities, particularly in the Midwest and the Great Plains, have resulted in financial stress for many farmers. For example, in 2015, farm income in Kansas was the lowest since 1985. Prices have dropped and are volatile and subject to economic conditions around the world. In addition, the cost of production has continued to rise. All of this has an impact on a farmer’s ability to repay debt. That repayment capacity has dropped dramatically in the past two to three years. All of this makes marketing important as well as the proper utilization of crop revenue insurance. Ultimately, continued low prices will also have an impact on land values and, in some areas, that impact is already being noticed.
An associated concern is the strain placed on grain elevators. If an elevator fails, what’s the impact on farmers who have deposited grain and on the agricultural community? What are the rights that a farmer has when an elevator fails? How much can be recovered, and when can it be recovered? Are there any legal remedies? These issues are the focus of today’s post.
Stored Grain
A farmer who has stored grain at an elevator that files bankruptcy is not a creditor of the elevator. That’s because the grain in storage is the farmer’s property. The farmer’s ownership of the grain is evidenced by a warehouse receipt or a scale ticket. Both of those serve as prima facie evidence of the farmer’s ownership of the stored grain. So, the farmer’s relationship with the elevator is not a creditor/debtor relationship, but a bailee/bailor one. Uniform Commercial Code (U.C.C.) §7-102(a)(1). In addition, that relationship is not impacted just because the elevator will return to the farmer’s grain of like quality rather than the identical grain that the farmer delivered to the elevator. See 54 A.L.R. 1166 (1928).
Under the UCC, commingled grain that is stored in an elevator is owned in common by the persons storing the grain. U.C.C. §7-207(b); see also, United States v. Luther, 225 F.2d 499 (10th Cir. 1955), cert. den., 350 U.S. 947 (1956); In re Bucyrus Grain, Co., Inc., 78 B.R. 296 (Bankr. D. Kan. 1987). So, if there isn’t a grain shortage when an elevator fails, a farmer with grain stored at the elevator can get his grain in accordance with his warehouse receipt or scale ticket. The bankruptcy trustee can’t retain farmer-stored grain in the bankruptcy estate if there isn’t a shortage. The trustee only succeeds to the rights the that bankrupt elevator had and, as noted above, stored grain is not the elevator’s property. Under the Bankruptcy Code, the bankruptcy trustee, after notice and hearing, can dispose of property in which an entity other than the bankruptcy estate has an interest. 11 U.S.C. §725. This all means that once a farmer establishes ownership of the grain and pays the associated storage costs, the farmer is entitled to his grain.
But, what if there isn’t enough grain in the elevator to cover all of the claims of farmers who have warehouse receipts or scale tickets? If that is the case at the time the elevator files bankruptcy, the farmers holding those indicia of ownership share pro rata in the remaining grain. In this situation, what typically happens is that the bankruptcy trustee will sell all of the grain that is in storage and make a pro rata distribution of the proceeds of sale along with any bond money that the elevator’s bonding company might have. If, after the pro rata distribution, a farmer has not been made whole, the farmer becomes a general, unsecured creditor of the elevator to the extent of the shortfall.
Farmer Priority in Bankruptcy
In the shortfall situation, there is a bit of relief that the Bankruptcy Code provides. Under 11 U.S.C. §507(a)(6), an unsecured claim of a farmer (grain producer) in an amount of up to $6,325 against a grain storage facility (e.g., grain elevator) has priority. The priority is a sixth-priority claim. It’s after domestic support obligations, administrative expenses, certain types of other specified unsecured claims, “allowed” unsecured claims, and unsecured claims for contributions to an employee benefit plan, but before certain unsecured claims of individuals and governmental units. For purposes of the priority provision, a “grain producer” is someone (“an entity”) that engages in the growing of wheat, corn flaxseed, grain sorghum, barley, oats, rye, soybeans, other dry edible beans, and rice. 11 U.S.C. §557(b)(1). “Grain storage facility” means a site or physical structure used to store grain for producers or to store grain acquired from producers for resale. 11 U.S.C. §557(b)(2).
While the $6,325 provision is likely to be of limited assistance, the Bankruptcy Court for the District of Kansas, affirmed by the Kansas Federal District Court, has held that the priority provision also gives priority status ahead of secured creditors with respect to grain owned by farmers that the elevator stores. In re Esbon Grain Co., 55 B.R. 308 (Bankr. D. Kan. 1985), aff’d., First National Bank v. Nugent, 72 B.R. 528 (D. Kan. 1987). That means that the financier of the elevator cannot participate in the pro rata distribution of the elevator’s remaining grain to the farmers who stored grain in the elevator at the time the elevator filed bankruptcy. The court reached its decision based on a Kansas statutory provision that gives grain depositors priority over a warehouse owner and the owner’s creditors in the grain stored in the elevator. Kan. Stat. Ann. §34-2,107. A different court in a different state could reach a different conclusion.
There is also another bankruptcy priority provision that can aid a farmer with grain stored in an elevator that fails. 11 U.S.C. §503(b)(9) includes as an administrative expense, entitled to first-tier priority, “the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.” If a farmer can qualify for this provision, it is much stronger than the sixth-priority claim under 11 U.S.C. §507(a)(6). That’s because it is an administrative expense under the definition of 11 U.S.C. §507(a)(1) which makes it a first-tier priority. It also is not subject to the limit of $6,325 noted above that applies to sixth-priority claims.
There is also an expedited procedure for determining ownership of the grain that is stored at an elevator at the time the elevator files bankruptcy. 11 U.S.C. §557(c).
Grain Sold on Contract
One of the perils of grain contracting is the financial instability of the buyer. For grain that has been sold on contract to an elevator that then files bankruptcy before the delivery date specified in the contract, the farmer-seller can refuse to deliver the grain if the elevator is insolvent. The only exception to that rule is if the elevator can make a cash payment. U.C.C. §2-702. If delivery has already been made as specified in the contract (whether under a forward, deferred payment, or deferred pricing contract) and then the elevator files bankruptcy, the farmer-seller is an unsecured creditor and also is ineligible to participate in state indemnity/insurance funds or elevator bonding protection. See e.g., Iowa Code §203D; In re Woods Farmers Co-op Elevator Co., 107 B.R. 678 (Bankr. N.D. 1989). While ownership of grain stored under a warehouse receipt or scale ticket remains with the farmer, delivery of grain that is sold under a contract causes title to the grain to pass to the elevator. As noted, that makes the outcome different.
Legal Remedy?
As noted in my blog post on July 19, co-op directors are subject to fiduciary duties of obedience, loyalty, and care. If a breach of any of those duties can be tied to the elevator’s failure, that might provide a legal remedy for disaffected farmers. However, that could be a difficult connection to make, and takes time and money to establish it.
Conclusion
Tough economic times can lead to numerous legal issues. The failure of a grain elevator can cause large problems for farmers and for the local community it serves. A farmer who knows their rights and where they stand if an elevator fails can be in a better position than those farmers who aren’t as well informed.
Written by Roger A. McEowen. Originally published Thursday, July 27, 2017.
