Agriculture Finance Law

Focus on Farm Credit Institutions

Family farm finance is complicated. Idyllic scenes of rolling hills, red barn, silo, and a quaint family dwelling do not tell the story of a "family farm" any longer.

All these concerns have come into sharp focus in recent days as a huge credit problem has developed surrounding a Kansas City, Missouri area cattle brokerage company. This article focuses on the farm credit system. Farm Credit Systems (FCS) is not involved significantly in the Kansas City matter. However, FCS finances so many former operations that awareness of the system’s evolving role is appropriate.

Domina Law Group is actively involved in this case representing the largest group of cattle investors. The complex banking arrangements that exist, as a result of unfortunate events unfolding in Kansas City, heighten concern.

Focus on Farm Credit Institutions

FCS is a system of farmer-owned cooperative lending associations and banks created to serve farmers’ needs. The Farm Credit Administration, which regulates the FCS, estimates that the Farm Credit System presently includes over 200 cooperative lending associations and eight banks – six Farm Credit banks, one bank for cooperatives, and one agricultural credit bank. The FCS enjoys a market share of approximately 26 percent of all agricultural loans. Commercial banks, which make the lion’s share of loans to agricultural operations, control approximately 40 percent of the loan market.

The Farm Credit System institutions pose the greatest threat to commercial banks. Congress created the FCS in an effort to improve "the income and well-being of American farmers and ranchers by furnishing sound, adequate and constructive credit and closely related services to them, their cooperatives, and to selected farm-related businesses necessary for efficient farm operations." One of the objectives of the Farm Credit System is to "continue to encourage farmer – and rancher – borrowers’ participation in the management, control, and ownership of a permanent system of credit for agriculture."

In addition, "loan(s) made by a Farm Credit Bank to farmers, ranchers, and producers...may be for any agricultural or aquatic purpose and other credit needs of the applicant." In 1995, the Farm Credit Administration proposed new regulations that expand the FCS’s reach. The FCA sought to modify eligibility requirements, and the scope of permissible lending, by eliminating unnecessary regulatory restrictions on lending that were not, in its view, required by statute. During the Proposed Rulemaking period for the new regulation, the FCA received over 300 comments from industry participants. When the FCA revised the rules in a second Proposed Rulemaking, it received over 1500 comments.

Lawsuit About Merits

Finally, in 1997, the FCA published its new regulations. The regulations broadened the qualifications used to determine a borrower’s eligibility for loans from FCS institutions. In response to these new rules, the Independent Bankers Association of America and the American Bankers Association filed a suit charging that the rules violated the plain language as well as the congressional intent of the statutes that originally created the FCS. The two associations claimed that with the promulgation of the new rules, the agency exceeded its authority to grant loans.

The United States District Court for the District of Columbia initially dismissed the lawsuit on its merits, holding that the challenged rules were reasonable and not in excess of the FCA’s authority. Specifically, the District Court found that the language in the Farm Credit System Act providing that loans "may be for any agricultural or aquatic purpose and other credit needs of the applicant" was permissive. Therefore, the Court held, among other things, that FCA had authority under FCS to grant loans to persons who were not farmers, but who furnished farm-related services directly to farmers.

The two banking associations appealed. In the end, the United States Court of Appeals for the District of Columbia affirmed the District Court’s decision, in part, and reversed it, in part. In substance, the Court of Appeals held that, with two exceptions, the final regulations were consistent with the statute. However, the Court of Appeals held that language in the Farm Credit System Act providing that loans "may be for any agricultural or aquatic purpose and other credit needs of the applicant" limited farm-credit bank lending to the specific purposes which are listed in the statute. Therefore, it held that the FCA could not permit loans for all "farm-related" business activities of a qualified "farm-related" service business.

Secondly, the Court of Appeals held that, with respect to loans for rural home financing under the Act, the FCA was not entitled to eliminate the requirement that applicants actually live in their rural residence.

In order to gain a greater share of the loan market, the FCS recently embarked upon a new venture called AgSmart. Specifically, AgSmart is a point-of-sale financing program that provides indirect financing to farmers who purchase goods at authorized input suppliers and equipment dealers. AgSmart was designed to help the Farm Credit System compete with lending by new "captive supply" companies that offer point-of-sale loans to farmers and ranchers through input and equipment dealers.

Essentially, with the AgSmart program, when a specific farm product or service supplier agrees to participate, it registers with the AgSmart office. Thereafter, its farm customers can apply for AgSmart financing of their purchases at the point-of-sale, as with the "captive supply" companies. The FCS makes the loan to the farmer indirectly, through the supplier. Where the farmer chooses a leasing option, the Farm Credit Leasing Corporation provides the financing. AgSmart provides a more streamlined service to farmers than normal loan procedures because the applicant/customer merely fills out a one-page form which is faxed to a processing center. The processing center evaluates the application by a computerized credit scoring system, and approval or denial usually is made within a few minutes.

The only real drawback with the AgSmart system is that it eliminates from participation those farmers who are "higher" credit risks. Because the AgSmart processing system is mechanized, it does not allow the applicant/customer to explain possible negative marks on his or her credit record.

The field of farm financing is an ever-changing map. Competition between entities such as traditional banking institutions, Farm Credit System cooperatives, and others, will become more heated as these entities compete for the "low-risk/high-quality" farmer/borrower. Unfortunately, farmers who need loans the most often present the highest risk of default. Thus, for them, the competition and new ventures in lending will serve little purpose. Institutions such as the Farm Service Agency only command about 5 percent of the total farm loan market. In any case, whether one is a high or low-risk borrower, the assistance of a good attorney is almost invaluable when attempting to navigate the new and changing tributaries of farm regulation.

Our Experience with Farm Financing and Lending

Domina Law Group has 60 years of combined experience with farm financing issues. The firm’s lawyers have handled as many Ag matters involving failed or failing financial institutions as anyone in the United States. Its bank failure experience extends back to 1973, and through numerous financial institution failures that heavily impacted farmers in the 1980s.

Domina Law actively represents small Ag lending banks, but generally focuses its work on the debtor side of the debtor/creditor relationship. Priority disputes, and litigation with lenders over good or bad faith decision making, are well within the firm’s traditional practice roles.

But the best role for Domina Law Group, and any competent lawyer to play in a debtor/creditor relationship, is avoidance. Early negotiation of documents, including form documents proposed by a bank, can make enormous differences in preserving and protecting a farmer’s assets. "An ounce of prevention is worth a pound of cure." So often, a one-three thousand dollar expenditure to review documents and give advice at the outset of a lending relationship, or at renewal time, could save the farmer tens or hundreds of thousands of dollars, or more, in the event complications develop.