Sunshine Heifers, LLC v. Citizens First Bank (In re Purdy)

• Decision Date: 03 September 2014
• Docket Number: No. 13–6412.,13–6412.
• Citation: 763 F.3d 513
• Parties: In Re Lee H. PURDY, Debtor. Sunshine Heifers, LLC, Appellant, v. Citizens First Bank, Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

763 F.3d 513

In Re Lee H. PURDY, Debtor.

Sunshine Heifers, LLC, Appellant,

v.Citizens First Bank, Appellee.

No. 13–6412.

United States Court of Appeals,Sixth Circuit.

Aug. 14, 2014.

Rehearing Denied Sept. 3, 2014.

ON BRIEF:David A. Warfield, Thompson Coburn LLP, St. Louis, Missouri, for Appellant. Scott A. Bachert, Ashley D. Belcher, Harned Bachert & McGehee PSC, Bowling Green, Kentucky, for Appellee.

Before: MOORE and COLE, Circuit Judges; DRAIN, District Judge. ^*

MOORE, J., delivered the opinion of the court, in which COLE, J., joined. DRAIN, D.J. (pp. 521–24), delivered a separate dissenting opinion.

OPINION

KAREN NELSON MOORE, Circuit Judge.

Between 2009 and 2012, Sunshine Heifers, LLC (“Sunshine”) and Lee H. Purdy, a dairy farmer, entered into several “Dairy Cow Leases.” Purdy received a total of 435 cows to milk, and, in exchange, he paid a monthly rent to Sunshine. Unfortunately, Purdy's dairy business faltered in 2012, and he petitioned for bankruptcy protection. When Purdy filed this petition, Sunshine moved to retake possession of the leased cattle. Citizens First Bank (“CitizensFirst”), however, had a perfected purchase money security interest in Purdy's equipment, farm products, and livestock, and it claimed that this perfected security interest gave Citizens First priority over Sunshine with regard to the 435 cattle. In particular, Citizens First argued that the “leases” between Sunshine and Purdy were disguised security agreements, that Purdy actually owned the cattle, and that the subsequently acquired livestock were covered by the bank's security interest. The bankruptcy court ruled in favor of Citizens First, finding that the leases were per se security agreements. Given that the terms of agreements expressly preserve Sunshine's ability to recover the cattle, we disagree, REVERSE the bankruptcy court's decision, and REMAND for further proceedings consistent with this opinion.

I. BACKGROUND

Purdy operated his dairy farm in Barren County, Kentucky. In 2008, he entered into a loan relationship with Citizens First, using his herd of dairy cattle as collateral. Purdy refinanced his loan on July 3, 2009, executing an “Agricultural Security Agreement” in exchange for additional principal in the amount of $417,570. R. 20–11 at 1 (2009 Security Agreement) (Page ID # 326). As part of the security agreement, Purdy granted Citizens First a purchase money security interest in “all ... Equipment, Farm Products, [and] Livestock (including all increase and supplies) ... currently owned [or] hereafter acquired....” Id. Three days later, Citizens First perfected this purchase money security interest by filing a financing statement with the Kentucky Secretary of State. R. 20–12 at 1 (2009 Financing Statement) (Page ID # 333). Purdy and Citizens Bank executed two similar security agreements in August 2010 and May 2012. See R. 20–13 at 1–7 (2010 Security Agreement) (Page ID # 335–41); R. 20–15 at 1–6 (2012 Security Agreement) (Page ID # 343–48). Citizens First perfected these purchase money security interests as well. See R. 20–14 at 1 (2010 Financing Statement) (Page ID # 342); R. 20–16 (2012 Financing Statement) (Page ID # 349).

Shortly after refinancing his loan with Citizens First in 2009, Purdy decided to increase the size of his dairy-cattle herd. He contacted Jeff Blevins of Sunshine regarding the prospect of leasing additional cattle. Sunshine was amenable to the idea, and on August 7, 2009, Purdy and Sunshine entered into the first of five contracts, three of which are relevant here: (1) a July 21, 2011 agreement, involving fifty head of cattle; (2) a July 14, 2012 agreement, rolling up two prior agreements and involving 285 head of cattle; and (3) another July 14, 2012 agreement, involving 100 head of cattle. See R. 20–17 (50 Cattle Agreement) (Page ID # 351); R. 20–18 (285 Cattle Agreement) (Page ID # 369); R. 20–19 (100 Cattle Agreement) (Page ID # 386).¹

Each of these agreements is titled a “Dairy Cow Lease,” and under their terms, Purdy received a total of 435 cattle for fifty months in exchange for a monthly rent. See, e.g., R. 20–17 at 2 (50 Cattle Agreement) (Page ID # 351). The agreements prohibited Purdy from terminating the leases, and Purdy agreed to “return the Cows, at [his] expense, to such place as Sunshine designate[d]” at the end of the lease term. Id. at 2–3 (Page ID # 352). Additionally, Purdy guaranteed “the net sales proceeds from the sale of the Cows ... at the end of the Lease term [would] be [a set amount between $290 and $300] per head (the ‘Guaranteed Residual Value’).” Id. at 11 (Page ID # 360). Purdy further promised to maintain insurance on the cattle, to replace any cows that were culled from the herd, and to allow Sunshine the right to inspect the herd. Id. at 3 (Page ID # 352). When the parties signed these contracts, they also executed security agreements, and Sunshine filed financing statements with the Secretary of State. See, e.g., id. at 13–18 (Page ID # 362–367).

In the dairy business, farmers must “cull” a portion of their herd every year, replacing older and less productive cows with younger, healthier ones. Many times, dairy farmers will replace the culled cows with their calves. Purdy, in contrast, sold off the calves of Sunshine's cows and purchased more mature replacements.²See In re Purdy, 490 B.R. 530, 534 (Bankr.W.D.Ky.2013); R. 21–22 at 29:1–32:19, 73:24–75:16 (Hr'g Tr.) (Page ID # 1169–72, 1213–15). This practice contravened the terms of the leases, see, e.g., R. 20–17 at 3 (50 Cattle Agreement) (Page ID # 352), but Sunshine was aware of Purdy's behavior and acquiesced in it, see R. 21–22 at 74:1–75:16 (Hr'g Tr.) (Page ID # 1214–15). Nonetheless, the terms of the lease required Purdy to apply Sunshine's brand and a yellow ear tag to the original cows and their replacements. See, e.g., R. 20–17 at 3 (50 Cattle Agreement) (Page ID # 352). In contrast, Purdy applied a white ear tag to the cattle covered by Citizens First's security interest. In re Purdy, 490 B.R. at 535. By July 2012, Purdy had approximately 750 head of cattle on his farm. Of those cattle, 435 should have carried Sunshine's brand according to the terms of the leases.

In the fall of 2012, the price of cattle feed rose, and milk production became less profitable. Id. at 534. Purdy responded by selling off cattle, including many bearing Sunshine's brand, at a faster rate. Unfortunately, Purdy could not keep his operation above water, and on November 29, 2012, he filed a voluntary petition for Chapter 12 bankruptcy relief, and the bankruptcy court issued an automatic stay, preventing the removal of assets from the farm. Id. at 535. A week later, representatives of Citizens First and Sunshine inspected the 389 cattle still on the farm. Of the cows on the property, 289 had white ear tags (indicating that they were covered by Citizens First's security interest) and Sunshine's brand, 99 had only white ear tags, and one cow had neither a tag nor a brand. R. 21–22 at 46:2–14 (Hr'g Tr.) (Page ID # 1186). A short time later, another farmer returned forty-three cattle that had been taken in violation of the bankruptcy court's stay. Id. at 46:13–20 (Page ID # 1186). Sunshine claimed that thirty-nine of those cattle bore Sunshine's brand. Id. at 101:7 (Page ID # 1241).

Citizens First argued that Purdy owned all of these cattle and, therefore, that they were covered by the bank's perfected purchase money security interest. Sunshine contended that it maintained ownership of the cattle, that Purdy had only a leasehold interest in the cattle, and therefore that the cattle fell outside of Citizen First's security interest. Both Citizens First and Sunshine filed motions in the bankruptcy court for relief from the stay preventing the removal of the livestock.

On January 22, 2013, the bankruptcy court held a hearing on various motions. The dispute between Citizens First and Sunshine turned on whether the leases between Purdy and Sunshine were true leases or disguised security agreements. The bankruptcy court issued its decision on March 1, 2013, finding that

The original term of the Lease was for 50 months. Clearly, 50 months is longer than the economic life of the goods [the cows]. Uncontradicted testimony indicated that a dairy herd is culled annually at an approximate rate of 30 percent. Within three years an entire herd is extremely likely to have been entirely replaced and certainly before the end of 50 months. Because [Purdy] met this term of the statute, the transaction is a per se security agreement and the Court's analysis ends here.

In re Purdy, 490 B.R. at 536. Consequently, the bankruptcy court determined that Citizens First's “prior perfected liens attach[ed] to all cows on [Purdy's] farm on the date the Petition was filed,” and it denied Sunshine's motion to lift the stay. Id. at 540. The bankruptcy court eventually granted Citizens First relief from the stay, however, and the bank foreclosed on the herd. Citizens First auctioned the cattle for $402,353.54, and the bankruptcy trustee awarded these proceeds to Citizens First, which applied them toward Purdy's outstanding debt. See Appellant Br. at 9.

Sunshine appealed to the federal district court nine days after the auction sale. R. 1 at 48–55 (Notice of Bankr.Appeal) (Page ID # 48–55). Because the cattle had already been auctioned, Sunshine requested a percentage of the sale proceeds equivalent to its share of the cattle sold. Ultimately, the district court affirmed the bankruptcy court's decision on September 25, 2013. R. 54 at 1 (D.Ct.Op.) (Page ID # 2287). Sunshine now appeals.

II. STANDARD OF REVIEW

“When reviewing an order of a bankruptcy court on appeal from a decision of a district court, we review the bankruptcy court's order directly and give no deference to the district court's decision.” Hamilton v. Herr (In re Hamilton), 540 F.3d 367, 371 (6th Cir.2008). We review de novo the bankruptcy court's conclusions of law, and we ...