Enforceability of the Producer’s Lien in Bankruptcy
POSTED BY Ory Sandel, Carol Kingery Ritter, John Trinidad, and Chris Kuhner
Grape growers and wineries are facing a difficult and uncertain market environment. Anyone driving through California’s winegrowing regions during the latter part of harvest season likely would have noticed a lot of fruit left hanging. And the industry news has been filled with stories about the headwinds wineries are facing due to a softening in demand and other market pressures.
Unfortunately, we are likely to see numerous situations where distressed wineries are unable to pay their growers for grapes delivered. This does not mean that grape growers are without recourse, though. California law provides protection for growers through a “producer’s lien” that not only helps secure payment for grapes delivered to wineries, but also improves their position among other creditors in the unfortunate event that a grape purchaser declares bankruptcy.
What is a lien?
In simple terms, a “lien” is a claim or legal right to the property of a debtor (someone who owes you money) equal to amount owed by the debtor. In the context of the so-called “producer’s lien”, the property in question is the farm product that was sold to a debtor “processor”. In that sense, the farm product itself is “collateral” or “security” to secure payment for the farm product that was sold and is in the possession of the debtor “processor.” If payment is not made, the creditor (the grower/producer/farmer) can, through the court system, legally seize and sell the collateral to make payment against the debt owed.
California’s statutory producer’s lien
California Food & Agriculture Code Sections 55631–55653, the producer’s lien law, is part of a California statutory scheme created to provide financial protection to the producers of farm products by making them secured creditors of the farm-product processing companies. In re Churchill Nut Co. (Bankr. N.D. Cal. 2000) 251 B.R. 143, 148; In re Loretto Winery Ltd. (9th Cir. 1990) 898 F.2d 715, 720.
Specifically, Food & Agriculture Code Section 55631(a) provides that every “producer” of “any farm product that sells any product that is grown by him or her to any processor under contract . . . has a lien upon that product and upon all processed or manufactured forms of that farm product” to the extent of the agreed price or, if there is no agreed price nor any method for determining the agreed price, then for the value of the farm product as of the date of the delivery. See Alvernaz Farms, Inc. v. Bank of California (In re T.H. Richards Processing Co.) (9th Cir. 1990) 910 F.2d 639, 643.
Put simply, if you farm grapes and sell them to a winery, the winery is the “processor”, and the wine is the processed form of the “farm product”, i.e., the grapes. You have a lien on the grapes as well as the wine made from your grapes, up to the amount owed (meaning that the processor can sell the grapes or wine the value of which is in excess of the amount owed). See Frazier Nuts, Inc. v. Am. Ag Credit (2006) 141 Cal.App.4th 1263, 1271 (citing Cal. Food & Agric. Code §§ 55631, 55638). The lien attaches on delivery, or if there is a series of deliveries, it attaches from the date of the last delivery. Cal. Food & Agric. Code §§ 55632, 55635.
A lien not in need of perfecting
A creditor must generally “perfect” its lien to make the lien effective. If the lien is not perfected, then the creditor is not secured, that is, the creditor will not have a preferred right to the collateral. Perfection is usually accomplished by taking legally-required steps that are intended to provide notice to others of the creditor’s claimed lien, e.g., recordation of a document with the County Recorder or filing a document with the Secretary of State.
A producer’s lien has no formal requirements for perfection. In re Loretto Winery Ltd. (9th Cir. 1990) 898 F.2d 715, 722. The lien automatically becomes effective upon the last date of delivery of the farm product. This is why the producer’s lien is also referred to as a “secret lien”, cf. id. at 719 – there is no publicly-available documentation that would put other creditors on notice that the producer has such a lien.
Following the lien through bankruptcy
What happens to the producer’s lien if the winery/processor files for bankruptcy?
If the grapes sold to the winery, or wine resulting from those grapes, remains in the processor’s possession, the grower has a producer’s lien on the product. In order to exercise its lien rights over the grapes or wine in the processor’s possession, the grower will need to seek relief in the bankruptcy court. If a grower wishes to immediately pursue the collateral, it would have to file a motion for relief of the automatic bankruptcy stay. We recommend that any grower wishing to do so consult with bankruptcy counsel.
But what if the wine has been sold and is no longer in processor’s possession? Does the grower have any right to the proceeds of the sale of that wine now that the winery has filed for bankruptcy? Federal bankruptcy courts and California state courts have issued differing opinions on this front.
In 1998, a California federal bankruptcy court concluded that once a processor has sold the farm products to a third party and is no longer in possession of the products, a producer’s lien does not shift from the farm products to the sale proceeds. See generally In re Sargent Walnut Ranches, Inc. (Bankr. E.D. Cal. 1998) 219 B.R. 880, 883-886. [Note, however, that the Sargent Walnut Ranches case was a lower bankruptcy court opinion which is not binding on any other federal bankruptcy or district court.]
But in a later 2006 case, a California state appellate court held that processors are legally obligated to use the sale proceeds to pay producers. Frazier Nuts, Inc. v. Am. Ag Credit (2006) 141 Cal.App.4th 1263, 1275.
In Frazier Nuts, a group of almond growers brought an action in the state court against secured creditor American Ag. Credit (“AAC”) to recover the pre-bankruptcy petition crop proceeds which the debtor had used to pay the secured claims of AAC. The almond inventory and related crop proceeds were part of AAC’s collateral under the terms of AAC’s loan and security documents with the debtor. AAC also held personal guarantees from some of the debtor's officers and directors who made the decision to pay AAC instead of the growers, as required by the California Food & Agriculture Code. The trial court dismissed the growers’ claims against AAC on the grounds that the growers’ statutory producers’ lien did not extend to the crop proceeds.
The growers appealed the decision, and the appellate court conducted an independent analysis of California’s producer’s lien law. First, the court found that the legislative purpose behind the lien law was to assure producers of full payment for their farm products. Id. at 1278. Second, the court held that California Food & Agriculture Code Section 55638 imposes an enforceable legal duty on processors to use the proceeds from the sale of farm product subject to a producer's lien to pay the producer; the producer has the right to be paid with those proceeds; and such right “constitutes a lien on the proceeds.” Id. at 1276-1277. The court then went on to hold that the producer’s rights to the sale proceeds had priority even over the debtor processor’s secured creditors. Id. at 1279.
In other words, Frazier Nuts held that, because the producer’s lien is a preferred lien “prior in dignity to all other liens, claims, or encumbrances” excepting wage and salary claims and a warehouseman’s lien, Cal. Food & Agric. Code § 55633, in the line of creditors claiming liens on a debtor’s property, the holder of a producer’s lien gets priority even over liens that attached prior to the delivery of the grapes.
The Court of Appeals consequently reversed the lower court, holding that the statutory producers’ lien does extend to the crop proceeds, and, further, that the producers’ lien trumped AAC’s contractual lien; thus, the use of the crop proceeds to pay AAC’s loan ahead of the growers was wrongful. See In re Cent. Valley Processing, Inc. (Bankr. E.D. Cal. Mar. 16, 2007) No. 03-11610-B7, 2007 WL 840500, at *7, fn.4 (summarizing Frazier Nuts).
The as-yet unresolved conflict between Frazier Nuts and federal case law
Courts look to state law to determine the “underlying property interests and commercial arrangements” at issue in bankruptcy proceedings. In re Loretto Winery Ltd. (9th Cir. 1990) 898 F.2d 715, 718. Under the Frazier Nuts precedent, the failure of a bankruptcy trustee to recognize the seniority of the producer’s lien would not only undermine the legislative purpose of Section 55638, but also conflict with California state law.
While avoidance of liens established under state law is possible under section 545(1) of the Bankruptcy Code, the California producer’s lien statute is not avoidable. See, e.g., In re Alco Stores, Inc. (Bankr. N.D. Tex. 2015) 536 B.R. 383, 410 (reviewing California producer’s lien law).
Again, federal bankruptcy and district courts are required to follow Frazier Nuts until, or unless, the California Supreme Court weighs in. See Owen By & Through Owen v. United States (9th Cir. 1983) 713 F.2d 1461, 1464. However, as yet, no federal bankruptcy or district court has specifically addressed the holding of Frazier Nuts to permit the producer’s lien to extend to the proceeds of sale.
In addition, when a bankruptcy case is filed by a winery, the debtor may be in possession of the grapes and/or wine and/or will be owed money from the sale of the grapes and/or wine in the form of pre -petition accounts receivable. Once in bankruptcy, a debtor cannot use pre -petition receivables or post -petition receivables from the sale of the grapes or wine (“Cash Collateral”) absent consent of the lienholder or order of the bankruptcy court. See 11 U.S.C. § 363(c)(2). Once a case is filed, the debtor will file a motion for authorization for use of Cash Collateral and will ask that the motion be heard on an interim basis in the first few days of the case. To obtain authority to use Cash Collateral, the debtor must show that the lienholder is “adequately protected,” which includes monthly payments on the lien, a replacement lien on post -petition receivables and/or proving that there is adequate equity in the collateral compared to the amount of the secured claim. Since this happens very quickly, it is critical to retain bankruptcy counsel once you learn of a debtor’s bankruptcy filing.
Finally, a debtor has the ability to value the secured claim, including a producer’s lien, based on the value of the collateral. See 11 U.S.C. § 506(a). This could result in the secured claim being reduced after notice and hearing if the debtor submits evidence of fair market value. These types of motions are filed and heard on 21 or 28 days’ notice and service by first class mail, which, again, emphasizes the importance of retaining bankruptcy counsel as soon as possible.
Bottom line: California’s producer’s lien law can provide protections for grape growers, even if a winery files for bankruptcy, but if that occurs, growers should retain bankruptcy counsel to enforce their lien rights.
Disclaimer: This blog post is provided for general informational purposes and does not constitute legal advice. Reading this post does not create an attorney-client relationship. Bankruptcy law is complex and fact specific. For questions about your particular circumstances, please consult a qualified bankruptcy attorney.
Thank you to Chris Kuhner, a partner in the bankruptcy group of Kornfield, Nyberg, Bendes, Kuhner & Little P.C., for co-authoring this blog post with members of DP&F’s Litigation, Business, and Alcohol Beverage Law and Compliance practice groups.
For more information about legal issues surrounding alcohol beverage producer/trade buyer relationships and transactions, reach out to DP&F. For more information regarding bankruptcy law, please reach out to Chris Kuhner at Kornfield Law.
