Pub. 6 2017 Issue 2

l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s 6 P RIOR TO 1986, there was a special UCC Article 9 rule regarding farm products. Under that special rule, if a borrower sold farm products which had been pledged as collateral for a loan, to a buyer in the ordinary course of business (typically a grain elevator or livestock market), the bank’s security interest in those farm products followed the farm products. If the borrower sold the farm products and failed to turn the proceeds of the sale over to the bank, the bank could sue the buyer for its loss. That all changed in 1986 when Congress passed, as part of the Food Security Act of 1986, a provision that overrode Article 9. Under this provision, a buyer in the ordinary course of business takes farm products free of the bank’s security interest unless the bank takes special steps to notify the buyer of the bank’s security interest. In Kansas, the method of notification to potential buyers is called “prenotification.” It requires banks to notify all potential buyers of the bank’s security interest in the farm products. Banks must send a prenotification statement to entities or individuals that the borrower and the bank identify as potential buyers of those farm products. If the borrower sells farm products to a notified buyer and fails to remit the proceeds to the bank, the bank can sue the buyer for its loss. However, if the borrower sells to a buyer that has not been prenotified, the bank cannot recover its loss from that buyer. Buyers that have received prenotification statements are required to make checks for the proceeds of the sale, payable to both the borrower and the notifying bank. This requirement for joint payees helps assure that the proceeds will be applied against the loan for which the farm products served as collateral. Recently, we have learned that many buyers of farm products are no longer paying by check but are choosing to automate the payments for purchases by using ACH transfers. Payments by ACH cannot be issued jointly. The transfer can only be sent to one account. Herein lies a huge risk for both bankers and buyers: if a bank has not prenotified a buyer of its security interest in farm products, the buyer will take the product free of its security interest and the buyer has no liability for issuing payment directly to the borrower’s account. In that instance, the bank must rely on the integrity of its customer to do the right thing with the proceeds. On the other hand, if a bank has prenotified a buyer of its security interest in farm products and the buyer issues the payment directly to the borrower’s account through ACH, the buyer will be liable to the bank for that payment. Then, if the borrower does not remit the proceeds to the bank as agreed, the bank can seek payment from the buyer — who may end up paying twice for the same product. As we enter these uncertain economic times for many agricultural producers, and in light of this practice of using ACH payments, it would be prudent for all bankers to review their policy and procedures with regard to prenotification of potential buyers. Now more than ever there is good reason to protect the bank’s security interest by taking this additional step and sending prenotification statements . ACH PAYMENTS AND RENOTIFICATION UNDER THE FOOD SECURITY ACT OF 1986 By Kathy Taylor, SVP-General Counsel, Kansas Bankers Association