Financing the Farm Operation
Phillip L. Kunkel, Attorney
Scott T. Larison, Attorney
Hall & Byers, P.A.
St. Cloud, MN
Copyright ©
2009 Regents of the University of
Minnesota. All rights reserved.
There are many factors to consider when financing a modern farming operation. Type of farming operation, commodities produced, parties involved, and capital requirements of the business all affect the nature and structure of the financing. Regardless of these factors, however, there are several fundamental models that should be considered when assessing financing options for any farming operation.
Loan Classifications
Farm operators should be familiar with the various types of loans available for financing a modern agricultural operation. These loan classifications correspond roughly to the manner in which liabilities are classified for financial reporting purposes. They also are relevant when comparing and evaluating a creditor's legal status.
Land Acquisition Loan
The first type of loan arrangement with which a farm operator should be familiar is a land acquisition loan. Somehow the farm operator must arrange financing for land that will be used to grow cash crops or to grow crops to feed livestock. Such loans generally require at least annual payments of principal and interest, and are typically secured by a mortgage on the real estate and improvements located on the property.
In Minnesota, the largest lender of long-term land acquisition money for farmers is Farm Credit Services, a member of the Farm Credit System. In addition to loans for acquiring farmland, Farm Credit Services can make rural housing loans. Farm Credit Services may make real estate loans that are secured by first mortgages in an amount not to exceed 85 percent of the appraised value of the real estate. Typically, the loans carry a term of not less than five years and no more than 30 years. Interest rates on such loans may be fixed or may bear a variable rate of interest. To obtain a loan from Farm Credit Services, the borrower must purchase stock in the organization in an amount between two and five percent of the original principal balance of the loan.
The seller of the land also may serve as a source of land acquisition money. Sellers may be willing to finance the sale of their land because it allows them to receive payment over a period of years, thus providing income tax advantages. In addition, the seller may be able to obtain a secure rate of return through such an installment sale. Finally, sellers may be willing to sell property by a contract for deed, understanding that should the purchaser be unable to make the payments, the seller rather than a mortgage holder, would take back the property.
Sellers who are reluctant to finance the sale of real property may be able to obtain additional security through the Minnesota Family Farm Security Act. Under this act, a portion of a loan to a young farmer may be guaranteed by the State of Minnesota. Besides providing a guarantee to the seller, participation in this program may provide the seller significant income tax benefits.
Insurance companies, the Farm Service Agency, and commercial banks also may finance the acquisition of farmland. Regardless of the lender, the legal issues surrounding the creation and enforcement of a loan secured by real property remain the same. The legal issues associated with creating and enforcing land security agreements are discussed in other fact sheets in this series: Contracts, Notes, and Guarantees, Mortgages and Contracts for Deed, Mortgage Foreclosures, and Termination of Contracts for Deed.
Intermediate Term Loan
The second type of loan arrangement with which a farm operator deals is an intermediate term loan. Typically, such loans are used for purchasing equipment and breeding livestock, and are payable over shorter periods of time than real estate loans. Sources of intermediate term loans include Farm Credit Services, the Farm Service Agency, commercial banks, and the financing arms of equipment manufacturing companies. Often, intermediate term loans are extended by the lender that provides operating financing to the farm operator. Occasionally, new equipment costs are included in the farm operator's operating loan in the year of acquisition. If this cost were included in the farm operator's annual budget, the normal cash flow of the farming operation would be insufficient to repay the operating loan at the end of the crop year. As a result, it is generally preferable to structure loans for such purposes over a longer period of time, generally corresponding to the useful life of the collateral.
Operating Loan
In its purest form an operating loan is one that is tied to the production cycle of a farm commodity. Typically, such a loan is made at the beginning of the production cycle, with advances made under the loan during the production cycle, and is due and payable in full at the end of the production cycle. Farm operators should note several characteristics of farm operating loans. One significant characteristic is that lenders who make operating loans require broad security interests to secure the credit advanced the farm operator. At the beginning of the production cycle the value of the commodity to be produced is very low, therefore the lender requires a security interest in all crops as well as any stored crops the farm operator has on hand. The lender also considers the inherent risks of farming. Hail, wind, or too much or too little rain can result in significant losses to the farm operator, and hence to the lender. Thus the lender usually requires a lien on the equipment used in the farming operation as additional collateral.
Because of this broad security interest, most farm operators are forced to look to a single lender for all of their operating financing. Operating lenders do not want to finance merely a portion of a farmer's crops or livestock. Problems of priorities and intermingling in the context of farming operations are difficult to resolve.
As security for intermediate term and operating loans, lenders look to personal property—livestock, crops, machinery, and equipment—as primary collateral, and may also seek a second mortgage on the farmer's real property. The legal issues dealing with creating and enforcing security interests in personal property are discussed in other fact sheets in this series: Security Interests in Personal Property, and Termination of Security Interests in Personal Property.
Financial Arrangements with Suppliers
Besides the secured lenders who finance land and personal property acquisitions, farm operators regularly deal with suppliers of feed, seed, fertilizer, fuel, and chemicals. Generally, the farm operator maintains an account with such suppliers, as well as with service suppliers. In times of financial distress, the farm operator may be subject to legal actions initiated by such suppliers. Suppliers' rights are discussed in another fact sheet in this series, Rights of Unsecured Creditors.
Farm Leases
Yet another financing arrangement with which farm operators may deal is the farm lease, which may involve either real or personal property. The legal considerations involved in leasing arrangements are discussed in the fact sheet, Farm Leases.
Production Contracts
While many farm operators may not consider them a financing device, agricultural production contracts relating to the production of specialized crops or the feeding of livestock represent another form of farm financing. Some types of such production contracts have been part of the agricultural economy for several years (e.g., vegetable growing contracts). Others, especially in livestock industries, originated more recently. The legal issues of such contracts are discussed in the fact sheet, Agricultural Production Contracts.
Responses to Financial Distress
When confronted with financial difficulties, farm operators have several options. Creditors may agree to accept partial payments under various credit agreements. Liquidating all or a portion of the farming operation is another option. Or, the farm operator may seek protection under the Bankruptcy Code for either a reorganization or liquidation. Regardless of which course of action is taken, the farm operator must carefully consider the tax consequences. Legal issues involved in bankruptcy situations are discussed in Bankruptcy: The Last Resort; Bankruptcy: Chapter 7 Liquidations; Bankruptcy: Reorganizations; and Tax Considerations in Liquidations and Reorganizations.
Conclusion
This series of fact sheets provides basic information to farm operators and their advisers regarding creditor remedies and debtor rights in the farming context. Each case is unique and the information presented is not meant to provide the last word on every issue that might arise in an individual case. A financially distressed farm operator should seek competent legal, accounting and financial advice before undertaking any course of action.
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