The Idaho Supreme Court will soon consider a case involving an issue that may have significant consequences for the agricultural industry. The purpose of this article is to consider the public policy implications that are at the heart of the case, not the merits of the legal arguments on either side of the case.
The fundamental policy question deals with who should bear the risk and financial loss under the following scenario: Business A extends unsecured credit to Business B for the purpose of purchasing a product from Business A. Subsequently, Business B goes bankrupt before the debt is paid, and the product for which the credit was extended has been used up and cannot be reclaimed by the creditor. The specifics of the case involve a feed seller that extends credit to a dairy.
Today, a feed seller may claim a priority lien for feed that has been delivered on credit to a dairy, but has not yet been consumed. The case on appeal addresses what happens to that priority lien after the feed is consumed. Does it attach to the cows or the milk the cows produce? In almost all circumstances, the cows and the milk have already been fully pledged as collateral for the dairy’s bank loan. The resolution of this issue is important, because whoever has the priority lien gets paid first in the event of a bankruptcy.
When any business extends “unsecured” credit, it is taking the risk that it may never be paid. An unsecured loan means there is either no collateral, or the only collateral is the product itself for which the credit was extended. To compensate for the risk the creditor is taking, the creditor may charge a higher price for the product, or charge interest until the debt is paid.
If feed sellers are allowed to retain a priority lien after the feed has been consumed, the public policy encouraging sound credit practices is upended, and the business concepts of risk and reward are overturned. Feed sellers would be incented to provide credit without considering a borrower’s creditworthiness, as they would not have to bear the risk and the potential loss in the event of a bankruptcy, while still enjoying the reward of charging a higher price for feed sold on credit.
Beyond setting an incentive for poor credit practices, an even bigger problem emerges. Under the scenario of a feed seller retaining a priority lien after the feed is consumed, the value of a bank’s collateral in the cows will be jeopardized; as such, the bank’s risk increases. In response, the bank will need to subtract some percentage of the value of the cows off the dairy’s list of assets, meaning the amount of money available for a loan would be reduced. It may mean some dairies will find it impossible to get sufficient credit to continue their operations.
A feed seller has a choice whether to extend credit, how much credit, for how long and to whom. If a seller is not held responsible for a bad credit decision, it will encourage careless credit decisions. Requiring a “previous” creditor (i.e., bank) to pay the price for a seller’s bad credit decision sets a dangerous public policy precedent.
Good policy should strive to promote economic fairness and encourage best practices when businesses choose to extend credit. Both the risk and reward of extending credit should remain with the business that makes the decision to extend the credit.
Dawn Justice is the president and CEO of the Idaho Bankers Association.