KY Supreme Court Clarity

Kentucky Supreme Court Offers Clarity on Future Advances and Priority of Security Interests

by John T. McGarvey and Kami E. Griffith Morgan Pottinger McGarvey

The Kentucky Supreme Court has rendered an opinion providing clarity on certain basic concepts of UCC Article 9: attachment; perfection and priority; and collateral securing future advances. The Court affirmed a Court of Appeals decision that reached the correct result but for the wrong reasons. The Kentucky Bankers Association, in conjunction with the Commercial Law Amicus Initiative, requested Morgan Pottinger McGarvey file an Amici Curiae brief in the case, Versailles Farm Home And Garden, LLC v. Harvey Haynes, et al., 2021-SC-0161-DG (June 16, 2022), which was cited in the opinion.

There were no disputed facts. In 2012, Harvey Haynes signed a security agreement giving Jerry Rankin d/b/a Farmers Tobacco Warehouse (“Farmers”) a security interest in his 2012 tobacco crop. The agreement did not contain a future advances clause. To perfect its security interest, Farmers filed a financing statement with the Kentucky Secretary of State on October 30, 2012. In June 2013, Haynes signed another security agreement granting Farmers a security interest in Haynes’ 2013 tobacco crop. Farmers made several advances to Haynes throughout 2012 and 2013.

In July 2013, Haynes granted a security interest in his 2013 tobacco crop to Versailles Farm Home and Garden (“VFHG”). VFHG filed its financing statement with the Kentucky Secretary of State the next month. When Haynes defaulted on his loan from VFHG, VFHG initiated an action against Haynes and Farmers, arguing that because Farmers did not include a future advance clause in its security agreement, VFHG’s security interest was entitled to priority on the 2013 crop.

The Woodford Circuit Court ruled in favor of Farmers, rejecting VFHG’s argument that a security agreement must contain a future advance clause if the parties intend that the agreement cover future advances. The Court of Appeals affirmed the trial court’s decision; however, the Court of Appeals opinion was grounded on a critical misstep in the application of Article 9. The Court suggested that VFHG could not rely on the absence of a future advance clause because VFHG failed to search the Secretary of State’s UCC records and to examine Farmers’ security agreement.

In their Amici Curiae brief, the KBA and CLAI argued that Farmers held the first priority security interest on Haynes’ 2013 tobacco crop under Article 9’s first-to-file-or-perfect rule. The Supreme Court agreed and found, as argued by the amici, that the intent of the parties determines attachment of a security interest in after-acquired collateral. More importantly, the KBA and CLAI brief made it clear that whether a later secured party reviewed a security agreement of a prior creditor is not a factor to be considered when determining priority of security interests. Article 9 does not require a secured party to provide anyone a copy of its security agreement. The brief also criticized the Court of Appeal’s reliance on KRS 355.9-210 (debtor requests for information regarding obligations secured by collateral), arguing that is not part of the priority structure of Article 9. Following these arguments, the Supreme Court held “[a] prior lender’s filed financing statement gives prospective lenders all they need to protect themselves.”

The Kentucky Supreme Court, expressly referencing arguments made by the amici, held that Article 9 does not require a secured lender to look at a previously signed security agreement or search for a previously filed financing statement. In doing so, the Court overruled ITT Industrial Credit Co. v. Union Bank and Trust Co., 615 S.W.2d 2 (Ky. App. 1981), a case decided under an outdated version of Article 9. The Supreme Court found that if a financing statement was filed in the correct office pursuant to KRS 355.9-501, subsequent lenders are on notice of the filing. “Failure to exercise due diligence means that lenders move forward at their peril.” The Court also noted that the Court of Appeals’ approach disregarded a core principle of Article 9 on the priority of security interests, the first-to-file or perfect rule. KRS 355.9-322.

The Kentucky Supreme Court affirmed the trial court’s summary judgment in favor of Farmers and disregarded the rationale of the Court of Appeals. It found that the course of dealing between Farmers and Haynes was enough to expand the written agreement between the parties to cover the advances at issue. It further clarified that its decision was not based on VFHG’s failure to inspect Farmer’s security agreement or search for a financing statement.

Thank you to the Kentucky Bankers Association and the Commercial Law Amicus Initiative for committing their resources to helping ensure Kentucky’s banking industry has clear direction on the application of the priority principles of Article 9 when taking security interests to collateralize loans.