Q&A: What Happens with a Loss of Operating Credit and Loan Subordination

Q&A: What Happens with a Loss of Operating Credit and Loan Subordination

March 4, 2016

The recent drop in crop prices has put a financial squeeze on some Nebraska producers. What happens if you lose your operating credit? UNL agricultural law specialist Dave Aiken recently discussed this issue on Market Journal and shares the following Q&A.

Q: If a producer's operating loan is cut off, what happens next?
A: That depends on whether the lender moves into loan foreclosure. If that happens, you need to contact an attorney immediately. If the lender does not foreclose, you'll need to find new operating credit from suppliers (seed dealer, fuel dealer, chemical dealer, etc.) or even from family members. The important point to realize is that the new creditors may not be protected on the new crop. So the producer may need to negotiate what is called a “subordination agreement” with the previous lender.

For example, on the operating loan, the producer buys inputs and puts in the crop. The operating lender takes that new crop as collateral (or security) for the operating loan. After harvest the producer pays off the operating loan and the process repeats itself.

Q: How does loan subordination affect that?
A: If the producer's operating credit is cut off, the “old” operating lender will still likely have any new crop produced as collateral for the old, unpaid operating loan. That's why steps are needed to protect the new creditors.

Let's look at one example. The operating lender cut off operating credit with an unpaid loan balance of over $100,000 but didn’t foreclose. The farmer’s brother-in-law loaned the farmer $46,000 to put in the next crop. The farmer, brother-in-law and the lender agreed that the lender would receive the first $20,000 from the new crop before the brother-in-law got paid. If this agreement had not been made, the brother-in-law would not have received anything from the new crop – the previous lender would have gotten everything from the new crop.

Q: How would this work for input suppliers?
A:  It would be similar. The producer would have to negotiate to get the old operating lender to agree to share the proceeds from the new crop with the new operating creditors.

Q: Are subordination agreements easy to negotiate?
A: No. In all likelihood there won’t be enough revenue from the new crop to pay everyone in full. So everyone—particularly the new
creditors—should go into this with their eyes open.

Q: How do you make the operating agreement?
A:
Be sure to get it in writing and work with an attorney.

Q: Where can producers get further help with these issues?
A:
There are three main resources:

  1. Nebraska Farm/Ranch and Rural Response Hotline, a project of Legal Aid of Nebraska and Interchurch Ministries of Nebraska, at 800-464-0258 offers financial, legal and emotional counseling. It also offers confidential, one-on-one financial and legal counseling at sites across the state. Watch CropWatch.unl.edu for monthly locations. See March 2016 Clinic dates.
  2. The Nebraska Department of Agriculture Ag Solutions Negotiations Program offers legal and financial counseling and farm credit mediation.
  3. Legal Aid of Nebraska offers legal counseling and representation.

Q: What is mediation?
A:
A neutral third party—the mediator—tries to get parties to negotiate a compromise. Mediation can be used to negotiate loan subordination agreements and to avoid foreclosure and bankruptcy. The Nebraska Department of Agriculture offers a farm mediation service through the Ag Solutions Negotiations Program to assist agricultural borrowers and lenders resolve ag debt issues. Call 800-446-4071 for assistance. 

Q: What about Farm Service Agency borrowers?
A: FSA has a detailed, borrower-friendly process to deal with financial distress, including mediation.

David Aiken
UNL Agricultural Law Specialist