Rights in Grain When Warehouses Fail
by Jacob T. Merkel
Local grain warehouses are essential to Minnesota agriculture. They allow farmers to store their grain for later use or until prices are favorable, and some farmers even view stored grain like a savings or retirement account. Warehouses must maintain the quantity and quality of the grain farmers have stored, and their failure to do so may have catastrophic effects on farms they serve. This article discusses a legal ambiguity that the state legislature should resolve to better protect farmers’ interest in their stored property. Specifically, Minnesota should follow other states in specifying that a person who stores grain at a public grain warehouse has a lien on all grain held by the warehouse in an amount equal to the value of the grain maintained by such person at the warehouse.
State and federal laws protect stored grain in a variety of ways. Federal regulations allow the United States Department of Agriculture to close a federally regulated warehouse and liquidate its inventory to prevent loss to depositors.[1] State law likewise allows the Minnesota Department of Agriculture to sell all grain owned or stored in a locally regulated warehouse and place the combined proceeds in a special fund for payment to warehouse receipt holders.[2] Both state and federal authorities may also take less drastic steps, such as requiring a warehouse to correct a deficiency in a particular kind of grain.[3] If these measures fail to compensate depositors for their stored grain, a grain storage bond will also provide a measure of relief.[4]
These laws regulating warehouses become difficult to apply when they interact with other bodies of law. When a warehouse declares bankruptcy, its lender may assert a secured claim in the warehouse’s grain inventory. Can the USDA or the state use the entire grain inventory to make depositors whole in those circumstances? The following hypothetical scenario illustrates the problem:
Grain depositors stored 100,000 bushels of corn and 50,000 bushels of wheat in a small federally regulated grain warehouse. The warehouse also owned grain, intermingled with grain stored by depositors. After its lender called a major loan, the warehouse suddenly declared bankruptcy and ceased operation. The United States Department of Agriculture then entered the warehouse and found only 200,000 bushels of corn. The USDA liquidated all the grain in the warehouse and is holding the proceeds.
Under the warehouse’s licensing agreement, claims for validated storage obligations have first priority to the proceeds of grain liquidation. [5] The USDA therefore intends to use the proceeds to make depositors whole. It plans to pay any remaining funds to the bankruptcy trustee for distribution to others, including secured creditors. The warehouse’s lender objects, based on its perfected security interest in all the warehouse’s property. The lender admits depositors are entitled to the proceeds of 100,000 bushels of corn,[6] but the lender claims proceeds of the other 100,000 bushels.
In summary, the dispute is whether, in the bankruptcy context, depositors’ claim for the value of their missing wheat is superior to the claim of the warehouse’s secured creditor with respect to the proceeds of all liquidated grain. The above-referenced regulatory schemes suggest depositors should prevail, but other law points to a different outcome. It is unclear how a bankruptcy court would decide the case.
On the one hand, the depositors owned and stored wheat. The warehouse never mixed wheat with corn, so laws governing rights in commingled goods seem inapplicable. There is no apparent reason depositors’ ownership interest in any wheat stored at the warehouse would give them ownership of corn. If the warehouse owned 100,000 bushels of surplus corn, the lender’s security interest could attach to this property. So even though wheat depositors never extended credit to the warehouse, they arguably have nothing more than an unsecured claim against the bankruptcy estate for the value of their wheat.
On the other hand, the law specifically governing liquidation of stored grain and distribution of the proceeds should prevail in a conflict with more general law regarding security interests. Grain-warehouse law clearly favors depositors, but bankruptcy law complicates the analysis. The USDA’s licensing agreement concedes that the terms for disbursement of liquidated inventory proceeds may be subject to the bankruptcy court’s jurisdiction.[7] And even without this concession, federal statutes would have the greater weight of authority than the license agreement in the event of a conflict.
Under bankruptcy statutes, a claim based on a lien is a secured claim,[8] with priority over unsecured claims.[9] Whether a lien exists on assets of a debtor’s estate is generally a question of state law.[10] Under state law, a security interest is property interest effective against other creditors[11] and meets the requirements for a lien.[12] The lender in the scenario discussed here has a lien on the warehouse’s corn. Wheat depositors may need to demonstrate a superior lien to escape the plight of unsecured creditors.
The USDA’s licensing agreement and state law both imply depositors do have a lien on all grain held by the warehouse. Both require liquidation of all the warehouse’s grain, and both require liquidation proceeds be distributed to depositors based on value of their stored grain, regardless of whether the liquidated grain was the kind of grain a depositor stored. If depositors had no property rights beyond the kind of grain they stored, these procedures would be unworkable and easily defeated.[13] Even if a warehouse’s liquidation did not involve a dispute with the warehouse’s secured creditor, depositors could challenge pro rata distributions on the ground that claims and liquidation proceeds must be segregated by the kind and quality of grain. For example, if the USDA lost the dispute with the lender in the scenario described here, corn depositors could resist sharing any proceeds of corn with wheat depositors, based on an argument similar to the lender’s. At the extreme, a depositor of U.S. No. 1 Grade Yellow Corn might not recover any proceeds if the warehouse held only inferior grades of corn at the time of liquidation.
Unfortunately, neither the license agreement nor state statute expressly describes depositors’ interest as a “lien.” One could argue both are mere insolvency procedures. That conclusion would render the state statute useless because a bankruptcy action preempts state insolvency proceedings.[14] The effect of bankruptcy on the USDA’s liquidation procedures is less clear, but the USDA may not actually have the power to create a lien for the benefit of depositors.
Depositors may have means to establish a lien on warehouse-owned property independent of warehousing law. If the warehouse breached a fiduciary duty by converting their wheat, an equitable lien or constructive trust should attach to the proceeds of their converted property.[15] These equitable mechanisms could give wheat depositors rights in specific warehouse-held property superior to the lender’s security interest because the lender, as the warehouse’s assignee, would have no greater rights than the warehouse to the proceeds of conversion. For example, if a buyer received wheat from the warehouse and still owed payment, a court would likely find depositors were entitled to the unpaid funds. Tracing proceeds of the wheat to a source of recovery could nonetheless be impossible in some cases.
A grain storage bond is likely to offer depositors some compensation for loss of their grain, but there is no guarantee the bond will be adequate to cover the entire amount. Moreover, if depositors have a first-priority lien on all the warehouse’s stored grain, it may reduce or eliminate their loss. The validity of a bond claim depends, therefore, on the underlying issues discussed here.
The state legislature could clarify depositors’ property rights by amending the grain storage statutes. Similar statutes have already been enacted by Illinois, Nebraska, North Dakota, and Ohio.[16] The law should specify that a person who stores grain at a public grain warehouse has a lien on all grain held by the warehouse to the extent of the value of the grain the person stored and has not sold or removed. To avoid a conflict with innocent third-parties, the lien should not follow grain that leaves the warehouse’s control. Moreover, the lien must become effective before insolvency, otherwise it may be subject to the avoidance power of a bankruptcy trustee.[17] An important consideration is whether to grant this statutory lien only to persons holding valid warehouse receipts or to everyone to which the warehouse owes storage obligations.
The lien would not place additional burdens on warehouse operators because warehouses already must keep enough grain on hand to meet their storage obligations.[18] Lenders also could not reasonably complain because they have no legitimate expectation that a warehouse impair its storage obligations to bolster the lender’s collateral. A lender should not expect to benefit from conversion of property placed in a warehouse’s care. Moreover, if a lender is determined to have a first-priority interest in warehouse grain, it could do so by obtaining warehouse receipts. Those receipts would allow the lender to share all the rights of depositors but would protect other depositors by requiring the warehouse to keep more grain in storage.
Legislative action to protect farmers’ property interests in their stored grain would significantly reduce disputes following a warehouse’s failure, even if a warehouse is regulated by the federal government. Farmers would have a better chance of recovering the value of their grain, and they would receive payment sooner. Moreover, the legislation would not disrupt any party’s legitimate expectations. The measure could prevent substantial loss to local farms.
[1] 7 C.F.R. § 735.6(d) (2017); WA-402, Licensing Agreement for Grain and Rice Warehouse Operators, § R.1, 4 (2011).
[2] Minn. Stat. § 232.22, subd. 7(c) (2016); Minn. R. 1562.2000 (2017).
[3] WA-402 §§ E.2.L, N.2.C; Minn. R. 1562.2000.
[4] 7 U.S.C. § 245 (2016); Minn. Stat. § 232.22, subd. 4.
[5] WA-402 § R.5.
[6] 7 U.S.C. § 248(b) (2016); Minn. Stat. § 336.7-207(b) (2016); Hall v. Pillsbury, 43 Minn. 33, 36, 44 N.W. 673, 674 (1890).
[7] WA-402 § R.6.
[8] 11 U.S.C. § 506(a) (2016).
[9] Pearlman v. Reliance Ins. Co., 371 U.S. 132, 135-36, 83 S. Ct. 232, 234–35 (1962) (“The Bankruptcy Act simply does not authorize a trustee to distribute other people’s property among a bankrupt’s creditors.”); In re Buckles, 189 B.R. 752, 766 (Bankr. D. Minn. 1995) (“[P]roperly perfected liens against a debtor’s assets survive a bankruptcy filing.”); see also 11 U.S.C. §§ 363(f) (2016 (restricting the bankruptcy trustee’s power to sell property free and clear of interests held by entities other than the estate).
[10] Butner v. United States, 440 U.S. 48, 54, 99 S. Ct. 914, 918 (1979).
[11] Minn. Stat. §§ 336.1-201(b)(35), .9-201 (2016).
[12] See 11 U.S.C. § 101(37) (2016).
[13] Cf. N. Dakota Pub. Serv. Comm’n v. Valley Farmers Bean Ass’n, 365 N.W.2d 528, 540 (N.D. 1985) (“[W]e do not believe the Legislature intended that the trust provisions of § 60–04–02, N.D.C.C., could be defeated by a lender taking a security interest in an insolvent grain warehouseman’s inventory.”).
[14] State of Mo. v. U.S. Bankr. Court for E.D. of Arkansas, 647 F.2d 768, 776 (8th Cir. 1981); see also Int’l Shoe Co. v. Pinkus, 278 U.S. 261, 265, 49 S. Ct. 108, 110 (1929) (“States may not pass or enforce laws to interfere with or complement the Bankruptcy Act or to provide additional or auxiliary regulations.”).
[15] See Lassen v. First Bank Eden Prairie, 514 N.W.2d 831, 838 (Minn. Ct. App. 1994) (setting out the elements of conversion); State v. Barry, 77 Minn. 128, 136, 79 N.W. 656, 658 (1899) (acknowledging that a bailee holds a bailor’s property in a fiduciary capacity); Lipinski v. Lipinski, 227 Minn. 511, 519, 35 N.W.2d 708, 712–13 (1949) (stating that “a fiduciary should not be allowed to profit by exploiting those who have placed their trust and confidence in him”); Wright v. Wright, 311 N.W.2d 484, 485 (Minn. 1981) (“[W]henever the legal title to property is obtained . . . by taking improper advantage of a . . . fiduciary relationship, a constructive trust arises in favor of the person equitably entitled to the property.”).
[16] See, e.g., 240 Ill. Comp. Stat. 40/20-10 (2016); Neb. Rev. Stat. § 88-547.01(2) (2016); N.D. Cent. Code § 60-02-25.1 (2016); Ohio Rev. Code Ann. § 926.021 (2016).
[17] 11 U.S.C. § 545 (2016).
[18] WA-402 §§ E.1.A , .2.L, .15.B(4), .16, F.1.A(2); Minn. Stat. § 232.22, subd. 5(e); see also 7 U.S.C. § 251(a) (2016); 7 C.F.R. §§ 735.110(a), .300(b) (2017).