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Agricultural operations are capital intensive, often requiring producers to take out loans to fund operating costs. Producers may receive loans from the Farm Credit System (\u201cFCS\u201d), commercial banks, processors, input suppliers, equipment dealers, or the Farm Service Agency (\u201cFSA\u201d). Due to the cyclical nature of agriculture, producers are \u201cprice-takers\u201d and susceptible to market fluctuations, increased input costs, unpredictable weather conditions, deadly disease outbreaks, and trade disruptions. If a farmer is unable to generate enough revenue from their operation, they may struggle to repay their loan obligations.<\/p>\n
When a borrower fails to repay their loan or violates their loan agreement, this is known as defaulting.\u00a0 At that point, the lender may require immediate payment of the entire outstanding loan, and if the borrower cannot pay the entire balance, the lender may foreclosure or liquidate the collateral pledged to secure the loan. As discussed in the first article<\/a> of this series, the roadmap to foreclosure of a farmer\u2019s debt depends on the type of loan, collateral, loan agreement, and lender.<\/p>\n This article examines the initial loan status determinations that must be made for an FSA borrower to be eligible for loan servicing options or for the lender to start foreclosure proceedings. Producers may experience financial difficulties from time to time that could result in missed loan payments. Therefore, it is important for producers to be aware of the warning signs so they can work with their lender to repay their loan and prevent foreclosure.<\/p>\n Lending Basics<\/strong><\/p>\n When a lender issues a loan to a borrower, the goal is to assist the borrower by providing financing while at the same time, recouping that money plus interest through scheduled loan payments. Generally, the borrower must pledge collateral<\/em> as security for the loan, meaning that if the borrower fails to pay off the loan, the lender can sell the collateral to cover the debt.<\/p>\n Collateral types can include real property, tangible personal property, and intangible personal property. Real property includes real estate or land. Tangible personal property includes farm products, crops, farm equipment, or livestock. Intangible personal property includes items like accounts receivable, crop insurance payments, federal farm program payments, or grower contract proceeds.<\/p>\n A loan is considered \u201csecure\u201d when the borrower pledges collateral in exchange for the loan funds- in other words, when the lender has a security interest or a lien in the collateral. This security interest<\/em> gives the lender the right to take possession of the collateral and foreclose or sell the collateral to pay the debt. A lien<\/em> is a \u201clegally enforceable claim\u201d on real or personal property that is used to secure repayment of a debt, or it can be \u201can encumbrance on property to enforce payment of an obligation.\u201d 7 C.F.R. \u00a7 761.2<\/a>.<\/p>\n To formalize the lending agreement, the parties must enter into certain legally binding documents that provide for the repayment terms, remedies for default, and terms and conditions of the loan. First, the parties will sign a promissory note<\/em>, which records the borrowers\u2019 promise to repay the certain loan amount by a specific date.<\/p>\n Promissory notes include information such as the principal loan amount, interest rate, schedule of loan payments, and duration of the loan. \u00a0In other words, a borrower agrees to repay the principal loan amount plus interest to the lender on a pre-determined schedule for the duration or term of the loan.<\/p>\n FSA interest rates for direct loans are set in accordance with the Consolidated Farm and Rural Development Act. 7 C.F.R. \u00a7 761.9<\/a>. FSA sets interest rates for direct loans and institutes maximum interest rates for guaranteed loans. FSA is barred by statute from setting interest rates that exceed the \u201ccurrent average market yield on outstanding marketable obligations of the United States with remaining periods to maturity comparable to the average maturities of such loans.\u201d 7 U.S.C. \u00a7 1927<\/a>.<\/p>\n The promissory note may also include terms like late payment penalties, a default clause, an acceleration clause, an after-acquired clause, cost of collection, an assignment, and a due on sale clause. However, some lenders may utilize a separate legal agreement called a loan agreement<\/em>, in addition to the promissory note, that includes customized terms, conditions, and covenants.<\/p>\n Conditions <\/em>are events that must occur prior to the loan being funded by the lender. A common condition is that the borrower must meet certain financial metrics prior to the distribution of funds.\u00a0 A covenant<\/em> states requirements that must occur after the loan is funded by the lender. This may include affirmative covenants, which state \u201cthe borrower shall,\u201d or negative covenants which state \u201cthe borrower shall not.\u201d<\/p>\n A default clause<\/em> may list certain parameters or events that trigger a default determination. The Federal Reserve Bank of Kansas City defines a loan default as \u201cfailure to repay a loan.\u201d \u00a0However, a lender may also issue a default declaration if the borrower breaches a covenant in the loan agreement, even if they have kept up with their payments. For example, if the buyer sells the listed collateral without the lender\u2019s approval, that may be grounds for a default determination. An acceleration clause<\/em> permits the lender to require the borrower to pay the entire balance of the loan if the loan is in default. An after-acquired clause<\/em> gives the lender a security interest in any property the borrower acquired after the signing of the loan documents, even if the lender did not provide the financing. Loan agreements may be customized by the lender to fit the needs and financial circumstances of the borrower.<\/p>\n Next, depending on the type of collateral and type of loan the borrower needs, an additional legal document may be needed to establish a security interest. These documents may include a mortgage, security agreement, installment contract, personal guarantee, or operating loan agreement. The promissory note and any additional legal documents make up the borrower\u2019s loan file. To learn more about the specific loan documents, click here<\/a> to read \u201cFinancing the Farm: A Law Bulleting Series on Legal Arrangements for Farm Financing.\u201d<\/p>\n A mortgage<\/em> is commonly used to secure an interest in real property and is used in conjunction to the promissory note. In other words, if the borrower breaks their promise in the promissory note, then the mortgage enables the lender to go after the collateral listed in the mortgage to pay the debt. Therefore, it is important to understand the rights and responsibilities created in each loan document.<\/p>\n A security agreement<\/em> is a loan document used in a secured transaction which occurs when one party provides credit to another in exchange for a security interest in property or the performance of and agreed upon action by the borrower.<\/p>\n Article 9 of the Uniform Commercial Code (\u201cUCC\u201d), as adopted in each state, is a set of model laws that cover aspects of commercial transactions in the U.S. It applies to secured transactions concerning tangible or intangible personal property and fixtures. Under Article 9, tangible personal property includes farm products, equipment, inventory, consumer goods, and fixtures, while intangible personal property includes items like deposit accounts or accounts receivable. To learn more about secured transactions in agricultural lending, click here<\/a> to check out NALC\u2019s series, \u201cLending for Livestock, Credit for Crops: The Basics of Secured Transactions in Agriculture.\u201d<\/p>\n Delinquent, Past Due, and Default<\/strong><\/p>\n Borrowers must make periodic payments on their loan as part of a repayment schedule created with their lender. A loan is considered delinquent<\/em> when a payment is even one day late, and past due<\/em> based on the loan repayment terms in the loan documents.\u00a0 Missing a loan payment puts the borrower in violation of the loan agreement and may lead to a default determination.<\/p>\n A loan is in default<\/em> when the borrower has failed to repay the debt. According to the Federal Reserve Bank of Kansas City, \u201c[t]ypically, a loan must be delinquent for 90 days or more before a lender will declare that the loan is in default.\u201d A default determination allows the lender to call due the entire balance of the loan or take legal action to recoup the debt. A borrower that defaults on a loan agreement may be vulnerable to a foreclosure or liquidation action by their lender.<\/p>\n Drivers of Financial Stress <\/strong><\/p>\n Producers are subject to changes in market prices, input costs, and weather conditions. These changes may have an adverse impact on a farmer\u2019s financial resources and result in loan default. Additionally, crop failure, disease, trade, natural disaster, input costs, and market competition may impact a farmer\u2019s ability to pay back their loan. However, off-farm financial stressors may also contribute to loan delinquency such as illness, death, personal debt, and lack of succession planning. Unfortunately, missed loan payments may lead to more lasting consequences depending on the lender and the terms of the loan agreement.<\/p>\n From Past Due to Default: Farm Service Agency <\/strong><\/p>\n The FSA serves as the \u201clender of last resort\u201d for farmers and ranchers that are unable to receive credit from other lenders. With that, though, comes a statutory mandate for FSA to establish a plan to \u201cpromote the goal of transitioning borrowers to private commercial credit and other sources of credit in the shortest period of time practicable.\u201d 7 U.S.C. \u00a7 1993<\/a>.<\/p>\n One type of FSA loan is the Direct Loan Program, which offers farm ownership, operating, and emergency loans. This program is funded and administered directly by FSA. However, FSA also offers farm ownership, operating, and conservation loans under the Guaranteed Loan Program. A guaranteed loan is one that is \u201cmade and serviced by a lender\u201d that FSA has signed a Lender\u2019s Agreement with and issued a Loan Guarantee.\u201d 7 C.F.R. \u00a7 761.2<\/a>. To read about FSA\u2019s loan options, click here<\/a> to read the previous article in the series.<\/p>\n Loan documents for both direct and guaranteed loans include a promissory note and may include a mortgage or a lien, depending on the collateral. Under an FSA loan, an after-acquired clause is included in the loan documents if the collateral is personal property. FSA requires borrowers under the direct or guaranteed loan programs to obtain and maintain insurance on all loan collateral. 7 C.F.R. \u00a7 764.108<\/a>; 7 C.F.R. \u00a7 762.123<\/a>. FSA loans can be secured by collateral such as real estate, farm products, equipment, or livestock, depending on the type of loan.<\/p>\n If FSA borrowers are unable to make scheduled payments on their farm loan programs debt, they become a \u201cdelinquent borrower<\/a>,\u201d and federal statutes and regulations outline the next steps. After a borrower is 90 days past due on their loan, FSA will provide notice to the borrower of \u201cprimary loan servicing programs, preservation loan service programs, debt settlement programs, and appeal procedures, including the eligibility criteria, and terms and conditions of such programs and procedures.\u201d 7 U.S.C. \u00a7 1981d(b)<\/a>.\u00a0 The goal of these programs is to get the borrower back to making regular loan payments.<\/p>\n However, if a borrower realizes that they will be unable to make their scheduled loan payments but is not yet 90 days past due, they may pre-emptively request the notice, in the form of a \u201cservicing packet.\u201d The servicing packet provides information to the borrower on how to apply for the servicing programs, deadlines, and any applicable forms. 7 U.S.C. \u00a7 1981d(b)<\/a>.<\/p>\n A \u201cprimary loan servicing program\u201d means any combination of loan consolidation, rescheduling, reamotization, interest rate reduction, or loan restructuring. 7 U.S.C. \u00a7 1991(b)<\/a>. Loan restructuring includes \u201cdeferral, set aside, or writing down of the principal or accumulated interest charges, or both, of the loan.\u201d 7 U.S.C. \u00a7 1991(b)<\/a>. A borrower will be eligible for loan servicing if:<\/p>\n After receiving the notice from FSA, the borrower must respond within 60 days with a completed application to be considered for loan servicing programs. 7 U.S.C. \u00a7 1981d(e)<\/a>. FSA loan servicing programs aim to restructure the debt and provide the borrower with the best options for repayment. If a restructuring plan is not feasible, the loan may be in default, and the lender can move forward with additional recovery actions as designated by statute. These additional actions will be outlined in upcoming posts.<\/p>\n Concluding Thoughts <\/strong><\/p>\n Agricultural producers face unique financial pressures, and periods of financial stress do not necessarily mean that foreclosure is inevitable. Understanding the terms of loan agreements, recognizing early warning signs of delinquency, and communicating with lenders can help borrowers identify options before financial difficulties worsen. For FSA borrowers, federal law provides several servicing and restructuring opportunities designed to return producers to a financially viable position when possible. However, if restructuring is not feasible, borrowers may still have options before foreclosure occurs. Because loan agreements, lender requirements, and available remedies vary, producers experiencing financial difficulties may benefit from seeking legal, financial, or tax advice early in the process to better understand their rights and obligations.<\/p>\n Upcoming Articles & Resources <\/strong><\/p>\n The next article will explore a loan default under the Farm Credit System, and what constitutes a distressed borrower.<\/p>\n To read the first article in this series, click here<\/a><\/strong>.<\/p>\n For more National Agricultural Law Center resources on finance and credit, click\u00a0here<\/strong><\/a>.<\/p>\n For more National Agricultural Law Center resources on bankruptcy, click\u00a0here<\/strong><\/a>.<\/p>\n\n