Losing Your Operating Credit and Loan Subordination
The recent drop in crop prices has put a financial squeeze on Nebraska producers. What happens if you can’t pay your operating loan and your lender doesn’t extend credit for next year’s crop? Normally operating loans are paid in full after harvest. But with low crop prices, the producer may not have been able to pay the entire amount due.
When this happens a lender may:
- roll the unpaid loan balance forward into next year’s operating loan;
- suggest financing the unpaid balance on a short-term note separate from the operating loan, with land, machinery, livestock or other property clear of debt as loan security; or,
- as a last resort, declare a loan default and foreclose on the property securing the loan.
Another option is for the operating lender to not provide any additional operating credit for the new crop but also to not declare a loan default. Then the farmer tries to find new operating credit from other sources—another lender, input suppliers, FSA, or family members. If operating credit is cut off after harvesting the 2016 crop and the producer finds operating credit elsewhere, the old crop lender usually still has the first legal claim on the 2017 crop. So the new crop creditors must take specific legal steps to protect themselves. If they don’t, they will lose all or most the new crop proceeds to the old crop lender.
For example ...
A 1985 Nebraska Supreme Court decision illustrates how a subordination agreement could work (220 Neb. 443).
The operating lender decided not to extend the operating loan (which had a balance due of $108,000), but did not declare a loan default. The farmer’s brother-in-law loaned the farmer $46,000 to put in the new crop. The farmer, brother-in-law and lender all agreed ahead of time that the lender would receive the first $20,000 from the new crop before the brother-in-law got paid.
If this subordination agreement had not been made, the brother-in-law would not have received anything from the new crop.
Negotiating a Subordination Agreement
What steps can be taken? The old crop lender needs to sign a subordination agreement in which the old crop lender agrees to share the revenue from the new crop with the new crop creditors. The old crop lender is not legally required to do this. The old crop lender typically won’t agree to have the new crop creditors paid before the old crop lender is paid at least in part. Unless there is a bumper crop or high prices, there probably won’t be enough new crop revenue to pay off both the new crop creditors and the old crop lender.
Negotiating a subordination agreement on the new crop revenue may be challenging. The new crop creditors will probably need to assume some risk of not being paid in full to get a subordination agreement with the old crop lender. Farm credit mediators or your attorney can facilitate negotiating a subordination agreement. If an agreement is reached, it should be written up by your attorney and signed by all the parties.
If your operating loan is not renewed, you are in a challenging situation. You need to frankly explore your options with your lender. A helpful resource is the Nebraska Farm Hotline at 800-464-0258. It can connect you with financial, legal and family counseling services and referrals, including mediation. Each month the hotline sponsors free Farm Finance and Ag Law Clinics across the state where growers can discuss their situation in confidential sessions with an ag lawyer and/or accountant. Locations are announced monthly in CropWatch.
Note: This information is provided for educational purposes. It is not intended as legal advice.