United States v. Walter Dunlap & Sons, Inc., in 85-1671. United States of America v. New Holland Sales Stables, Inc., in 85-1673

800 F.2d 1232

• Court: Court of Appeals for the Third Circuit
• Decided: November 24, 1986
• Docket: 85-1671, 85-1673
• Status: Published

Opinions

OPINION OF THE COURT

WEIS, Circuit Judge.

The question in this appeal is whether federal agency regulations or state law give content to federal law in determining the status of a lien on collateral for a loan made by the Farmers Home Administration. The district court chose the agency regulations as appropriate, but we decide that the controlling Supreme Court decision requires resort to state law. We also conclude that even under its own regulations, the Farmers Home Administration is not entitled to prevail. Accordingly, we will reverse the summary judgment in favor of the government and direct entry of judgment in favor of defendants.

The parties filed cross-motions for summary judgment. After consideration of the material in the record, the district court granted the government’s motion but denied the defendants’. The court also declined reconsideration and defendants have appealed.

Defendants are commission brokers in Pennsylvania who sell livestock at auctions. Customarily, the farmers bring livestock to defendants the day before the scheduled sale, and in accordance with the dictates of the Packers and Stockyards Act, 7 U.S.C. § 228b (1982), the brokers pay the farmers in full within twenty-four hours of the sale.

The controversy here stems from the defendants’ sale of livestock owned by Mark Noll, which was collateral for loans from the Farmers Home Administration (FmHA).¹ In August 1979, Noll borrowed $90,000 from the FmHA as an operating loan for his farm in Lancaster County, Pennsylvania, and in December 1980, he secured $230,360 as an emergency loan. As part of the transactions, Noll granted FmHA a security interest in existing and after-acquired livestock, crops, and farm equipment. FmHA filed financing statements in the local court office in accordance with state law.

Noll signed a form which provided that the collateral could “not be sold, transferred, or encumbered ... without the written consent of the Government.” Included in the form was another provision that obligated him to “comply with such farm and home management plans as may be agreed upon from time to time by Debtor and Secured Party.”

Noll and the local representative of FmHA prepared a “Farm and Home Plan”, form No. FmHA 431-2, which listed in detail the debtor’s assets, liabilities, living expenses, and other expenditures including feed and supplies. That document also projected selling dates for cattle and crops, anticipated receipts, and outlined repayment of the FmHA loans. The plan authorized Noll to sell the cattle as they became ready for market and to pay FmHA as per a schedule.² Receipts in excess of the payments to FmHA were available for normal farm operating and living expenses.

Defendants did not have actual knowledge of the FmHA liens, and they, along with other brokers, sold all of Noll’s cattle in 1981.³ After deducting commissions, they paid Noll $224,791.39. He in turn deposited the funds in his bank account, and remitted $155,000 to FmHA and $21,-486 to an approved secured creditor. He used the balance of $42,485.39 to purchase livestock feed and pay farm and living expenses.

Because of falling cattle prices, the actual receipts were less than those outlined in the Farm and Home Plan. In August 1981, the FmHA county supervisor met with Noll to discuss the status of the loan in view of the amount still due after the sale of all the cattle. Noll asked for another loan to pay for the expenses of harvesting his tobacco crop but that request was denied.

Soon afterward, Noll filed a petition in bankruptcy and in due course the FmHA debt was discharged. The government then filed these actions for conversion against defendants to recover the gross proceeds each had received from the sale of the cattle.

In addressing the cross-motions for summary judgment, the district court concluded that whether FmHA’s security interest in the cattle had been released was a matter to be determined under federal law. However, since no relevant federal legislation existed, the court applied FmHA regulations governing the disposition of collateral as the rule of decision rather than state law.

The court rejected use of the Uniform Commercial Code because in its view United States v. Kimbell Foods, Inc., 440 U.S. 715, 99 S.Ct. 1448, 59 L.Ed.2d 711 (1979), permits the invocation of state law only in the absence of a controlling federal rule. When, as here, FmHA regulations specifically addressed the release of collateral, the district court believed it had no choice but to incorporate those regulations as the rule of decision. The district judge cited this court’s precedent in United States v. Kennedy, 738 F.2d 584 (3d Cir.1984), and United States v. Sommerville, 324 F.2d 712 (3d Cir.1963), as generally supporting this conclusion.

The district court found that even though FmHA had acquiesced in the sales, the government’s security interest nonetheless was not released because the proceeds from the cattle had not been applied in accordance with 7 C.F.R. §§ 1962.17 and 1962.18 (1985). Finding that the cattle were “basic” rather than “normal” security, as defined by the regulations, the district court ruled that the proceeds could not be used to pay routine living and farm maintenance expenses.

Following conferences with the court on damages, the parties stipulated the amounts due, and judgments were entered against defendants.

On appeal, defendants contend that the district court erred in failing to adopt state law as the rule of decision. In the alternative, they argue that even if the FmHA regulations were applicable the court erred in not characterizing the collateral as “normal income security.” Under such a designation, Noll would have been permitted to apply the proceeds as he did. Defendants further assert that the prompt payment provisions of the Packers & Stockyards Act exempt them from liability, and that market conditions, not the cattle sales per se, were the cause of FmHA losses.

Preliminarily, we believe it important to put the holdings in Kennedy and Sommer-ville in context.

Kennedy presented a very narrow question — whether the complaint stated a claim for conversion against the buyer of collateral that secured FmHA loans. Applying the rule of conversion enunciated in Som-merville, we held that “under the general federal law the Government’s complaint ... alleged sufficient facts to withstand [a] motion to dismiss.” Those facts included the purchase of collateral by defendants, the debtors’ failure to apply all of the proceeds toward repayment of the loan, and the defendants’ refusal to pay the amount the debtors misapplied. The procedural posture of the case required that the allegations of the complaint be construed in favor of the government. Reading the complaint in that fashion permitted an inference that despite knowledge of the FmHA lien, the purchaser nevertheless made some payments directly to the debtor and ignored the FmHA’s interest.

After resolving the issue presented, the panel went on to discuss why state law was inapplicable.⁴ Referring to Kimbell and Sommerville, the panel noted that “[b]ecause we are not acting in the absence of an existing federal rule, we are not at liberty to adopt state law as the measure of the federal rule. Instead, we must apply the federal rule [of conversion] as articulated in Sommerville.” 738 F.2d at 586 n. 3. That statement, being unnecessary to the holding in Kennedy, was dictum which has led to some uncertainty. Therefore, a detailed discussion of Kimbell and Sommerville may help clarify those misconceptions.

The debtor in Sommerville had an auctioneer sell livestock encumbered by an FmHA loan. But unlike the situation in this case, FmHA had not approved the sale and did not have any knowledge of the transaction at the time.

Citing Clearfield Trust Co. v. United States, 318 U.S. 363, 63 S.Ct. 573, 87 L.Ed. 838 (1943), Sommerville stated that the need to protect the United States fisc required the application of federal law to questions arising under FmHA programs. In determining what principles to incorporate as the content of that federal law, the Court concluded that the “interest of the United States in the administration of the loan program would be undermined and its power to protect its purse limited if disparate laws of individual states were applied to substantially identical loan transactions.” 324 F.2d at 716.

Although it conceded that the Uniform Commercial Code in effect in Pennsylvania would set the conditions for recordation of the security agreement and perfection of the lien, the panel expressly rejected use of any other state law. The court noted that “absent express congressional declaration of intent that state law shall be applicable, we are reluctant to subject federal rights and duties to the exceptional uncertainty and heterogeneity which may ensue in many cases. We will not do so.” 324 F.2d at 717.

Sommerville thus adopted general federal common law as the content of the rule of decision. This court was joined in that approach by the Sixth, Ninth, and Tenth Circuits.⁵ Two courts of appeals held that priority conflicts should be determined under state law.⁶ One other court, the Court of Appeals for the Fifth Circuit in United States v. Hext, 444 F.2d 804 (5th Cir.1971), used the Uniform Commercial Code as the source of federal law. For a review of the disagreement among the circuits, see Clark, The Law of Secured Transactions Under the Uniform Commercial Code If 8.4[3][d] (1980); Note, Adopting State Law as the Federal Rule of Decision: A Proposed Test, 43 U.Chi.L.Rev. 823 (1976).

In United States v. Kimbell Foods, Inc., 440 U.S. 715, 99 S.Ct. 1448, 59 L.Ed.2d 711 (1979), which involved the priority of federal and private liens, the Supreme Court resolved the conflict among the courts of appeals. In conformity with Clearfield Trust, the Court held that the issues had to be decided with reference to federal law. To that extent, the Supreme Court approved the Sommerville approach.

However, Kimbell disagreed with the premise that nationwide standards were necessary for the federal lending programs and hence disapproved Sommerville’s creation of federal common law principles. Rather the Court concluded that “state law may be incorporated as the federal rule of decision” because “state commercial codes ‘furnish convenient solutions in no way inconsistent with adequate protection of the federal interest.’ ” 440 U.S. at 729, 99 S. Ct. at 1459. Furthermore, the Court declined “to override intricate state laws of general applicability on which private creditors base their daily commercial transactions.” Id.

The Court emphasized that “had Congress intended the private commercial sector, rather than taxpayers, in general to bear the risks of default entailed by these [specialized loan] programs, it would have established a priority scheme displacing state law.” 440 U.S. at 735, 99 S.Ct. at 1462. “The prudent course [therefore] is to adopt... state law as the federal rule of decision until Congress strikes a different accommodation.” Id. at 740, 99 S.Ct. at 1464. Hence, the Court held that in the absence of “a congressional directive, the relative priority of private liens and consensual liens arising from these Government lending programs is to be determined under nondiscriminatory state laws.” Id.

Kimbell is not a conversion case, but its discussion and holding undermine the validity of Sommerville’s rejection of the Uniform Commercial Code as a source of the federal rule of decision. Accord United States v. Progressive Farmers Marketing Agency, 788 F.2d 1327 (8th Cir.1986); United States v. Tugwell, 779 F.2d 5 (4th Cir.1985); United States v. Public Auction Yard, Billings, Mont., 637 F.2d 613 (9th Cir.1980); United States v. Southeast Miss. Livestock Farmers Ass’n., 619 F.2d 435 (5th Cir.1980); United States v. Friend’s Stockyard, Inc., 600 F.2d 9 (4th Cir.1979). Clark, The Law of Secured Transactions 118.4[3][d] (1980). Cf. United States v. Missouri Farmers Ass’n., Inc., 764 F.2d 488 (8th Cir.1985); United States v. Farmers Co-Op Co., 708 F.2d 352 (8th Cir.1983).

Relying on Kimbell, defendants here cite § 9-306 of the Uniform Commercial Code, which states that “a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party in the security agreement or otherwise.” 13 Pa.Cons.Stat.Ann. § 9306(b) (1984).

The evidence is undisputed that the FmHA plan contemplated sales of the secured cattle and use of proceeds to defray farm expenses as well as to meet the loan repayment schedule. Any possible ambiguity on this score was clarified by the deposition of the FmHA county supervisor, Patrick Freeman. When questioned whether he had any discussion with Noll about sales, Freeman testified that “I was very emphatic that he was to sell [the cattle] and properly account for the proceeds.” When asked if Noll had to obtain consent before selling any livestock, Freeman replied, “No ... when the cattle [were] ready to go to market and the market [was] available, he was expected to sell them.”

Even before the Uniform Commercial Code was adopted in Pennsylvania, case law had established the general proposition that acquiescence in sale of collateral by a mortgagee constitutes waiver of a lien. East Central Fruit Growers Prod. Credit Ass’n. v. Zuritsky, 346 Pa. 335, 30 A.2d 133 (1943). This continues to be the law in Pennsylvania under the Uniform Commercial Code. Similar interpretations of the Code have been made by other courts. See United States v. Southeast Miss. Livestock Farmers Ass’n., 619 F.2d 435 (5th Cir.1980). Hence, when state law is incorporated as the content of the federal rule of decision, these defendants must prevail.⁷

The government, however, insists that the FmHA regulations should be adopted as the source of federal law. This argument is divided into several parts.

The FmHA asserts that 7 C.F.R. § 1962.-18(b) (1985) requires the proceeds of the sale to be applied in a specified manner before a lien can be lifted. In the government’s view and as the district court found, Noll did not apply the proceeds in the manner prescribed by the regulations.

Section 1962.18(b) states that when the debtor sells security, the sale will be subject to the FmHA lien,

“until the lien is released or the sale is approved by the County Supervisor and the proceeds are used for one or more of the purposes stated in § 1962.17. Purchasers of security who inquire should be informed that the property is subject to FmHA’s lien and will remain subject to it until they deliver any proceeds in cash to the County Supervisor or make checks payable jointly to the borrower and FmHA and the check has cleared.”

Relying on this provision, FmHA insists that until the sales are approved by the county supervisor and the proceeds used for specified purposes, the lien remains in effect.

In some circumstances, agency regulations have the force of law and to that extent may supply the rule of decision in federal question cases. Because of constitutional constraints, that source of law, however, is subject to definite limitations. For example, “interpretative” rules do not have the force and effect of law because they are statements of policy issued by an agency asserting its construction of a statute or regulation. In contrast, “substantive” regulations may have the force of law if they are authorized by Congress and promulgated by an agency to implement a statute. See Chrysler Corp. v. Brown, 441 U.S. 281, 302 n. 31, 99 S.Ct. 1705, 1717-18 n. 31, 60 L.Ed.2d 208 (1979).

The regulation at issue here is interpretive rather than substantive. It is directed principally to debtors and to those purchasers who inquire of FmHA and inferentially have actual notice of a lien. The regulation instructs FmHA employees how to answer those inquiries, but does not by its terms impose a legal duty on purchasers to issue checks to joint payees. The text of the regulation demonstrates that it is merely in the nature of a policy explanation and direction to agency employees rather than a legal mandate. A regulation which is to be treated as having the force of law, at a minimum, should have the definitiveness associated with statutory language when, as here, the conduct of third parties having no relationship with the agency is affected.

In this context, the testimony of Mr. Freeman, the county supervisor, is significant. He said Noll not only was authorized to receive the money in his own name but also was permitted to put it in his personal bank account and remit whatever amount was due FmHA on a periodic basis. This testimony shows that FmHA’s practices were inconsistent with an intent to impose more requirements on purchasers than are contained in the Uniform Commercial Code.

Even if the regulation were considered as substantive, it nevertheless would not be entitled to be treated as applicable “law.” Substantive regulations affect individual rights and obligations but do not without more have the “force and effect of law.” Chrysler Corp. v. Brown, 441 U.S. at 302, 99 S.Ct. at 1718. For that to occur, “it is necessary to establish a nexus between the regulations and some delegation of the requisite legislative authority by Congress.” Id. at 304, 99 S.Ct. at 1719.

It may be seen that by prescribing restricted application of the proceeds before the lien is released, even though the sale was approved, FmHA attempts to impose a burden on the purchaser beyond that required under state law. No federal statutory source is cited for this additional dictate, and the regulation appears to be an agency creation aimed solely at increasing the government’s collection efficiency.

Kimbell’s holding and rationale rest on the underlying premise that Congress “did not intend to confer special privileges on agencies that enter the commercial field.” 440 U.S. at 737, 99 S.Ct. at 1463. The Court noted that the stability of state commercial law should not be altered “in the absence of careful legislative deliberation.” Id. at 740, 99 S.Ct. at 1464. Since the government failed to advance “any concrete reasons for rejecting well-established commercial rules which have proven workable over time,” the Court resorted to state law. Id.

Kimbell reached that conclusion only after comprehensive citations to various regulations which had a bearing on the issues presented. See 440 U.S. at 731-33 , 737, 99 S.Ct. at 1460-61, 1463. The Court demonstrably was aware that agency regulations “were in the picture” but nevertheless chose state commercial law to give content to the federal rule of decision. That choice was fully informed, and the Court noted agreement with a comment in an opinion by Judge Friendly where he stated, “When the states have gone so far in achieving the desirable goal of a uniform law governing commercial transactions, it would be a distinct disservice to insist on a different one for the segment of commerce, important but still small in relation to the total, consisting of transactions with the United States.” Id. at 732 n. 28, 99 S.Ct. at 1460 n. 28, quoting United States v. Wegematic Corp., 360 F.2d 674, 676 (2d Cir.1966). It is obvious that giving the effect of law to a variety of regulations by a number of agencies would be particularly disruptive to the stability of commercial law.

Kimbell’s holding is in effect a finding that in the area of federal lending programs regulations such as 7 C.F.R. § 1962.18(b) (1985), enacted under a general enabling provision, do not constitute the sort of explicit “congressional directive” that will displace the application of state law as the federal rule of decision. The FmHA regulation is not a “congressional directive,” nor is there any evidence that it represents congressional policy. We therefore must heed Kimbell’s direction to “adopt the readymade body of state law as the federal rule of decision until Congress strikes a different accommodation.” 440 U.S. at 740, 99 S.Ct. at 1464.

The wisdom of pursuing that approach is demonstrated by the enactment of The Food Security Act of 1985, 7 U.S.C.A. § 1631 (1985), effective December 26, 1986 —the type of congressional directive referred to in Kimbell. That statute provides that a commission merchant shall not be subject to a security interest in products of others which he sells, unless he receives detailed written notice of the lien within one year before the sale. 7 U.S.C.A. § 1631(g).

Because the regulations on which FmHA relies do not have the force of a congressional directive and because there is no indication that Congress intended an agency regulation to supersede long-standing uniform state law in this area, we decline to accept the government’s position that the regulations control. See United States v. Central Livestock Corp., 616 F.Supp. 629 (D.Kan.1985).

Nevertheless, assuming arguendo that FmHA regulations govern, we conclude they do not entitle the government to prevail. At the time the repayments were made, 7 C.F.R. § 1962.17 provided for a number of permissible applications for proceeds depending on the characterization the agency applied to the security. This classification procedure had no specific statutory source and was an agency creation.

That regulation described the collateral as either “basic” or “normal income security.” The importance of that designation lies in the fact that payment of routine living and farm operating expenses is permissible when normal income security is involved, but not when the collateral is basic security. The government conceded in the pretrial statement that the amounts Noll received in excess of that paid to a bank and FmHA “were used as operating credit by the Nolls to pay normal routine farm expenses.” Consequently, if the security here were treated as normal income security, the government would not be entitled to recover even under its own regulations because Noll correctly applied the proceeds.

The district court, however, believed the cattle were basic security, which is defined as “all equipment (including fixtures in UCC states) and foundation herds ... securing FmHA loans which serve as a basis for the farming or the operation outlined in ... the Farm and Home Plan ... and replacement of such property.” Normal income security is “all security not considered basic security including crops, livestock ... and other property ... which are sold in operating the farm.” 7 C.F.R. § 1962.17.

According to the regulations, “foundation herds” are basic security, but the cattle here cannot be characterized as such. The word “foundation” carries with it the notion of a base on which a structure is built. As used in the regulation, it would mean a herd used to supply milk products or to breed stock, not one intended for immediate sale.

Obviously livestock held for sale fall into quite a different category than equipment such as trucks and tractors that remain on the farm for a number of years. That type of collateral is basic security because it generally serves as a foundation for capital development as distinguished from articles held for sale.

Additional support for this interpretation of the regulatory classification is found in the designation of “crops” as normal income security. The absence of that type of collateral from the definition of basic security is a significant indication that normal security includes goods produced primarily for sale.⁸

The uncontradicted evidence in this case reveals that the cattle were to be sold as soon as they were ready for the market. The county supervisor testified to that, and the “Farm and Home Plan” prepared by the county supervisor on December 24, 1980, designates the steers as “livestock held for sale.” Clearly the record establishes that the cattle sold by Noll were “normal”, not “basic” security.

Consequently, we conclude that the district court erred in classifying the livestock as basic security. It follows that in light of the government’s concession in the pretrial statement that the proceeds of the sale were properly applied, even the regulatory requirement of consent was satisfied. Thus the foundation of the government’s case collapses.

Because there are no undisputed questions of material fact, this case is appropriate for summary judgment, and therefore will be remanded to the district court with instructions to enter judgment for defendants.

1 . The security agreements were signed by Mark and his wife, but for simplicity’s sake we will refer to the Nolls in the singular throughout the opinion.

2 . According to the supplementary payment agreement, Noll was to pay FmHA $40,000 in February; $21,000 in April; $143,500 in May; $56,000 in July; and $5,500 in December 1981. His payments were current until the spring of 1981.

3 . Defendants Walter Dunlap & Sons, Inc. sold 68 cattle for $46,780.16; New Holland Sales Stables, Inc. sold 97 cattle for $70,117.65; Vintage Sales Stables, Inc. sold 71 cattle for $50,-579.08; and Mayer Packing Co. sold 103 cattle for $59,265.

4 . We pointedly did not determine whether the district court’s interpretation of state law was correct.

5 . Cassidy Commission Co. v. United States, 387 F.2d 875 (10th Cir.1967); United States v. Carson, 372 F.2d 429 (6th Cir.1967); United States v. Matthews, 244 F.2d 626 (9th Cir.1957).

6 . United States v. Union Livestock Sales Co., 298 F.2d 755 (4th Cir.1962); United States v. Kramel, 234 F.2d 577 (8th Cir.1956).

7 . As noted earlier, Sommerville does not control here because there the FmHA did not consent to the sales, and the court’s refusal to use state law was disapproved in Kimbell. Although this court’s Internal Operating Procedure Chapter 8C provides that a panel may not overrule an earlier panel decision, we have recognized that this principle is inapplicable when the earlier opinion is in conflict with intervening Supreme Court precedent. See Rubin v. Buckman, 727 F.2d 71, 74 (3d Cir.1984). Sommerville, as well as Kennedy’s dicta, which affirmed its rationale, cannot co-exist with Kimbell and accordingly are not binding on us here. Consequently, because Sommerville is contrary to Kimbell this court’s IOPs do not require in banc consideration to align our jurisprudence with the Supreme Court’s teaching.

8 . The current regulations of FmHA no longer contain the classification “basic security” and "normal income security." The regulations now provide that proceeds from sales may be used for essential farm and family living expenses in accordance with the Farm and Home Plan. 7 C.F.R. §§ 1962.17(a) and (b)(2)(iv) (1986).