Consumption of a Security Interest in Feed Fed to Livestock:Security Interest Worth Manure?
In the current agricultural economic climate, where more farmers and ranchers are looking at refinancing and other lending sources, it is important to recognize some of the specifics contained in security agreements. Often in a livestock feeding operation, the operator may finance or collateralize feed purchased for livestock. An interesting problem arises in this situation when the feed is fed to and consumed by livestock. The question is whether a perfected security interest in feed survives after consumption of the feed by cattle in which the secured party has no interest.
This article will examine a silence in Section 315 and Section 336 of Article 9 of the Uniform Commercial Code (UCC) which determines how far a security interest in a good extends when the goods are consumed or transformed; specifically, what is considered “proceeds” of the collateral (feed) when it is fed to livestock.
This narrow issue is best framed in First National Bank of Brush v. Bostron, a Colorado Appellate case from 1977 whose holding has been adopted in several other states. UCC Section 9-315 states “Proceeds that are commingled with other property are identifiable proceeds: (1) if the proceeds are goods, to the extent provided by section 9-336.” UCC Section 9-336(b) states that “…a security interest may attach to a product or mass that results when goods become commingled goods.” (emphasis added).
For a security interest in goods (feed) to continue in the product or mass, (a) the goods must be so manufactured, processed, assembled, or commingled that their identity is lost in the product or mass; or (b) a financing statement covering the original goods also must cover the product into which the goods have been manufactured, processed or assembled. In Bostron, the court decided that once eaten, the feed ceases to exist and does not become a part of the mass (livestock).
A 1987 Iowa court applied the Bostron court’s holding and decided section 315 of Article 9 of the UCC “does not seem to apply since the goods (feed) have not been manufactured, processed or commingled. Rather, their identity has been lost through ingestion, a process apparently not contemplated by section 9-315.” The Iowa case was one where the feed was fed to hogs; in a similar 1994 Wisconsin case, the court held “hogs are not proceeds of their feed”.
In another case involving cattle, the lender argued it was not claiming the cattle as proceeds of the feed, but rather once the debtor had sold the cattle, the cash proceeds could be split into portions including a portion for the collateral (feed) attributable to the proceeds from the feed fed to the cattle. The court rejected this argument saying for the lender to argue their security interest in feed would disappear when fed to the cattle but reappear upon the sale of the cattle “seeks a result that is outside the law”. “Once lost, the characterization of proceeds cannot be regained by the sale of the cow which consumed the feed.” In re Pelton.
Another part of Bostron decided in the negative was the issue of whether the financing statement specifically covered the product ‘into which the goods have been manufactured, processed or assembled’. Bostron, 39 Colo. App. 107, 109 (1977). The secured party argued its inclusion of “proceeds” of the collateral in the financing statement extended to the cattle which were fed the collateral feed. The court analyzed the UCC’s definition, “’Proceeds’ includes whatever is received when collateral or proceeds is sold, exchanged, collected, or otherwise disposed of …” saying, “the collateral was consumed, and there were no traceable proceeds to which the security interest may be said to have attached.” Bostron, 39 Colo. App. 107, 110 (1977).
The policy of distinguishing how far a security interest extends to goods when the collateral is transformed or consumed is necessary to protect the interests of the secured party while also providing protection from encumbrance for the consumer of the good. Without this distinction, as the Bostron court pointed out, proceeds could then be extended “to the parts of the butchered animal, into the supermarket, and ultimately into the hands of the consumers.”
One commenter compared using of the holding in Bostron, which dealt with livestock, to inputs used in crops saying,
“Other than section 9-315, no Code provision clearly suggests a contrary result, and section 9-315 does not seem to apply since the goods have not been manufactured, processed, or commingled. Rather, their identity has been lost through ingestion, a process apparently not contemplated by section 9-315. [. . .] It is therefore advisable for the feed or other supplier also to take a security interest in the final product (e.g., the livestock or crop), perfect that interest, and work out a subordination or other priority arrangement with any prior secured parties. Failure to do so may have the effect of turning the otherwise perfected interest into manure (or fodder).”
If a lender wanted to obtain a security interest in a debtor’s feed, they should be advised that the security interest in the feed would likely not continue into the livestock once the feed has been consumed. The best chance of the security interest surviving the consumption would be to also collateralize the livestock the feed is being fed to in the security agreement and properly file a financing statement specifying this relationship.
The comment from the Hawkland publication above mentioned, was probably meant as a joke. However, with lucrative sales contracts where the good being sold is the manure from a large-scale animal feeding operation becoming a more commonplace source of income for those types of operations, could the idea of the security interest in feed extend to the proceeds received from the sale of manure? Applying Bostron, the court was concerned with the sale of the livestock as proceeds of the feed, not the sale of manure as the proceeds of the feed. Although, the main point of Bostron was that a security interest in feed is terminated upon consumption of the feed and therefore does not extend to the livestock that consume the collateral feed, this reasoning incomplete because it did not consider the sale of the manure as proceeds of the feed.
Disclaimer: The information in this article is intended for general informational purposes only. This information is not intended to be, nor should be interpreted as, legal advice or a legal opinion. The reader should not consider this information to be an invitation to an attorney-client relationship, should not rely on the information presented here for any purpose, and should always seek the legal advice of counsel in the appropriate jurisdiction.