[EDITOR’S NOTE – SPW Legal Editor Tiffany Comprés practices with the renowned international produce trade law firm, Sandler, Travis & Rosenberg, P.A in Miami. We welcome your questions about produce law – just address them to firstname.lastname@example.org and look for the answers here.]
Many buyers and importers give loans to their growers to enable the grower to produce the product, essentially financing the operation. But often, these buyers don’t take the same care in protecting their interests in this transaction as a bank would, and are left holding the bag when the grower goes out of business or can’t pay. What’s the solution? Secure the loan.
What does “securing a loan” mean anyway?
Securing a loan means obtaining collateral to guarantee that if the borrower doesn’t pay, the lender can still get back the money owed by taking ownership of the collateral and (usually) selling it. Think of a mortgage – except that almost anything can be collateral. Receivables, equipment, crops, stocks, inventory, intellectual property (like trademarks) … all of these can be collateral.
How do you secure a loan?
In the United States, Article 9 of the Unified Commercial Code (UCC) governs secured loans. The trick is, the UCC is anything but unified. Each state has its own version. If the buyer/lender and grower/borrower are in different states or countries you will have to make sure you’re working under the correct law. In general, the process works as follows:
- Creation and attachment
First you must create the security interest and legally attach it to the designated collateral so the interest becomes enforceable against the grower/borrower. This usually requires a written agreement signed by the grower/borrower. Some value must be given by the lender/buyer to the grower/borrower (this is usually the loan). The grower/borrower must also have rights to the collateral (i.e., own it, and have a right to use it as collateral).
This is the step with the most pitfalls. “Perfection” means making sure the security interest is enforceable against unsecured creditors who want to be paid from the grower/borrower’s assets, so they can’t use your collateral as payment. Generally, this is accomplished by filing a UCC-1 Financing Statement. The place of filing the UCC-1 is tricky
and depends on the kind of collateral, the location of the collateral and the borrower, where the borrower is legally organized, and the state law that applies. Some forms of perfection are better than others with respect to certain kinds of collateral. It is also vital that the UCC-1 Financing Statement be perfect – no errors in the legal name of borrower, etc., because any mistake could reduce or eliminate the lender’s rights to the collateral. The problem is compounded when the borrower is in a different country altogether, because the UCC may not apply at all.
- Priority and Enforcement
This aspect is also a bit tricky, because the applicable state UCC can be different from the one used to “perfect” the security interest, depending on the type of collateral involved. Nonetheless, it is critical. Priority means the relative rights of one creditor with a security interest in the borrower’s assets vis‐à‐vis other creditors with claims to the same assets. This is the same as having multiple mortgages, where the oldest (with most priority) is paid first, and so on. There may be nothing left for the last in priority.
How does it all fit together?
Let’s say the grower is legally organized in Florida and has its chief executive office in South Carolina, and the buyer is looking to secure an interest in grower’s inventory that is in California, Mexico, and Surinam, and accounts receivable. The documents evidencing the accounts receivable (“instruments” and “chattel paper” in legal speak) are located in the grower’s fiscal offices in New Jersey. As part of the deal, the existing instruments and chattel paper are sent to the buyer’s office in New York.
- Security interest in Inventory
Perfection of a security interest in goods is generally governed by the borrower’s place of organization. In this case, grower/borrower is in Florida, so the UCC-1 should be filed in Florida, and this will perfect buyer/lender’s security interest in inventory located in California, and to the extent the UCC applies, also in Mexico and Surinam. However, the law applicable to priority of the security interest in the inventory is governed by the law of the location of the inventory – so the laws of California, Mexico, and Surinam will govern priority of the inventory located in each respective place (again, to the extent the UCC governs at all in Mexico and Surinam).
- Security Interest in Accounts Receivable
Perfection of a security interest in accounts receivable is also governed by the borrower’s place of organization – here, Florida. The buyer/lender must file a UCC-1 in Florida. In this case, priority will also be governed by Florida law, as the place of organization of the borrower/grower determines priority for accounts receivable.
- Security Interest in Chattel Paper and Instruments
I usually advise clients that seek a security interest in accounts to also obtain a security interest in the paper evidencing the accounts as a safeguard. Here there are 2 concerns: (1) the location of the chattel paper/instruments and (2) whether the buyer/lender has taken possession of the collateral. If the buyer/lender is in possession of the chattel paper/instruments, then the location of the collateral is the place where the UCC-1 must be filed, and that state’s law will govern priority as well. In this case, that would be the law of New York. If the buyer/lender does not take possession, then the buyer/lender must file the UCC-1 in the grower/borrower’s jurisdiction – here, Florida. However, in that case priority will be subject to New Jersey law.
If all of this sounds confusing, you are not alone. As I will explain in a later article, this analysis becomes even more challenging when the grower is abroad. They key is to be prepared – have a well-written security agreement, and make sure you’ve got the correct governing law for all aspects.
[This column is published for the purposes of providing a general understanding of the law. It is in no way a substitute for individual legal consultation and anyone with a legal problem should not rely on these answers but should instead consult their attorney. If you have a legal problem and do not know an attorney, call your local Bar Association’s Lawyer Referral Service.]