Argument Report: Does a Notice of Security Interest on Crops Require Strict Compliance?

Our reports on the civil oral arguments of the Illinois Supreme Court's November term continue with State Bank of Cherry v. CGB Enterprises, Inc. Our pre-argument preview of State Bank of Cherry is here.  Watch the oral argument here.

State Bank arises from a farmer's note to the plaintiff bank, using certain crops as security. After the farmer sold the crop to a grain elevator, the bank sent the grain elevator a Notice of Security Interest, citing the Food Security Act, 7 U.S.C. § 1631(e). When the grain elevator paid the farmer rather than the bank, the bank sued.

The defendant moved to dismiss, pointing out that the plaintiff bank's Notice of Security Interest omitted one mandatory disclosure -- the county in which the crops were located. The Circuit Court denied the motion to dismiss, but a divided panel of the Appellate Court reversed, holding that the state Commercial Code (which required substantial compliance only) was preempted by the Food Security Act. The Food Security Act required strict compliance, the Appellate Court held, and the plaintiff's Notice of Security Interest was therefore ineffective.

Based upon the oral argument, it appears relatively likely that the Supreme Court will affirm. Counsel for the plaintiff began by pointing out that omitting the exact location of the crops had no effect on anything, since the crops were brought to the defendant grain elevator. Justice Burke asked whether, since the Food Security Act created limited exceptions to the general rule that good faith purchasers take free of any security interest, the Court should require strict compliance. Counsel responded that the plaintiff had substantially complied with the requirements of the Act, and that strict compliance would elevate form over substance. Counsel pointed out that the defendant grain elevator had issued two drafts for the subject crops, the first including the name of the bank as a co-payee, before issuing a second to the farmer alone. Justice Garman asked counsel if Congress intended that substantial compliance should be sufficient, why didn't it say so? Justice Garman followed up by asking whether Congress had acted to overrule the holding in Farm Credit Midsouth, PCA v. Farm Fresh Catfish Co., the Eighth Circuit case on strict compliance relied upon by the Appellate Court. Counsel conceded that Congress had not yet acted to overrule the decision. Justice Thomas pointed out that Congress had failed to challenge Farm Fresh despite having made several amendments to the Food Security Act in the intervening years, and counsel conceded that that was so.

Counsel for the defendant grain elevator challenged the plaintiff's argument that the statute was merely intended to facilitate interstate commerce; rather, counsel argued, the principal purpose of the Act was to protect the buyers of farm products and make the requirements applicable to farm security interests uniform throughout the country. Justice Garman asked whether it made any difference that the defendant had known about the bank, and initially issued a check to both the bank and the farmer.   Counsel responded that the Act clearly stated that the notice requirements are not waived by actual notice. Justice Freeman asked why the name of the county in which the crops were found was so important -- what could possibly go wrong if the county name was missing? Counsel responded that whatever Congress' reason for requiring the name of the county, the form used by the bank for its security interest contained a blank for the county - which was not filled in. Justice Karmeier pointed out that the bank's form contained a box under the county blank stating that, when the box is checked, products are covered "wherever located" -- does that mean that once the box is checked, notice is sufficient statewide?   Counsel responded that the form was the lender's, not one that flowed directly from the statute. Justice Burke pointed out that the law was hardly uniform if everyone was permitted to make up their own form. Counsel responded that strict compliance applied to the categories of information that had to be reported, not the form in which disclosure was made. Both Justices Garman and Thomas asked what the logical reason was for requiring strict compliance for direct notice - given to the buyer -- but accepting substantial compliance for central notice. Counsel responded that central notice is intended merely to put buyers on inquiry notice, where direct notice is intended to give buyers every fact necessary under the statute.

During rebuttal, Justice Freeman asked a two part question: would a ruling for the plaintiff bank spawn a lot of litigation, and what should be the test for determining substantiality? Counsel responded that logic and equity dictated that if the buyer had all the information it needed to identify the protected crops, that should be enough, and follow-on litigation should not concern the Court.

The Court will likely file an opinion in State Bank in four to six months.

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