Pub. 8 2013-2014 Issue 2

www.nebankers.org 14 Extraordinary Service for Extraordinary Members. Managing Risk in Custom-Feeding Lending: A Case Study Stinking Up Negotiability Part III of III Gene Summerlin & Allan Williams , Husch Blackwell LLP T his is the last in a three-part series inspired by a recent case that brought to light some of the risks involved in lending to custom cattle feeding operations. The first installment addressed lan- guage that made a promissory note something other than a negotiable instrument, and the problems that cre- ated in enforcing the note. The second installment dis- cussed the risk the bank incurred when it failed to provide an authenticated notice of assignment to the debtor after the feedlot assigned the note to the bank. Today, we look more deeply at these issues and examine how the bank could have avoided some of the problems and risks associated with these loans. Quick Recap of the Facts The case involved three par- ties: a bank (that financed the feedlot’s opera- tion), a feedlot (that custom- fed cattle and provided financ- ing to cattle owners), and cattle owners (who borrowed funds to finance their purchase of cattle and feed). Early on, the bank de- cided it wanted the feedlot to be its customer, not the cattle owners. To accomplish this, the bank drafted standard form promissory notes that cattle owners executed in favor of the feedlot. COUNSELOR’S CORNER The feedlot assigned the notes to the bank and the bank advanced money under the notes to the cattle owners (through the feedlot). Because the cattle owners didn’t need the full amount of the notes im- mediately when their cattle came into the feedlot, the notes were set up to allow the feedlot (but really the bank) to advance funds under the notes for a percentage of the purchase price of the cattle when they were brought into the yard. Then, the bank advanced ad- ditional amounts each month as feed bills became due. When the cattle were sold, the feedlot received the proceeds and was supposed to pay off the notes at the bank, sending the remaining proceeds to the cattle owners along with a closeout statement identifying the income and expenses (including the principle and interest on the notes) incurred in feeding the cattle. Everything went fine until the feed- lot fell behind in preparing closeout statements. Suddenly, funds accumu- lated in the feedlot’s cattle account while notes became delinquent. When the notices of default started rolling in, the feedlot began paying off the most delinquent notes frompacker proceeds checks without regard to whether the money used to pay off the note came from the pen of cattle that related to the note being paid. The feedlot also began sending “profit” checks to cattle owners based on estimates without be- ing completely sure that the closeouts were accurate. You can see where this is going, right? Houston, We Have a Problem Every Ponzi scheme eventually leaves someone holding an empty bag. Here, it was the bank. Importantly, though, it didn’t have to end up that way. Let’s spend the rest of this article looking at what the bank could have done to better protect its interests. As an assignee of a non-negotiable instrument, the bank faced three big problems.