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Business Law Today

A Horse is a Horse (of Course)
Equine Collateral
By Katherine Simpson Allen
Each year, millions of dollars worth of thoroughbred horses bolt from the starting gate, flash by the finish line, pose for the cameras, parade past the bidders, and do their best to propagate the species at stud farms and broodmare barns. There is a lot of money riding on those horses, not just at the track, but also at the bank, where a loan secured by equine collateral is supposed to be a sure thing, not a long shot. Up close, a horse may look like a good solid piece of collateral, but here is a tip: the Uniform Commercial Code (UCC) characterization of this kind of collateral is not so certain and can determine whether the lender's final position is win, place, or show. Some kinds of equine collateral may be goods in some circumstances and general intangibles in others; some may be different kinds of goods (equipment, inventory, farm products, livestock) in different circumstances; and some may be evidenced by or protected by certificates resembling instruments. The different types of collateral are subject to different perfection and priority rules.

Various types of transactions involve collateral consisting of horses and other equine interests. Financial institutions may make working capital loans to trainers, breeders, stud farms, racetracks, and other businesses. Sellers and third-party lenders finance purchases of specific horses, which may then be transferred to others. One of the front-runners for the 2007 Kentucky Derby, for instance, was subject to a heated dispute between his owner and a bank claiming a lien on the horse (and its winnings) as collateral for an outstanding loan to the horse's prior owner.

A thoroughbred racehorse has two kinds of value--as a racing machine and, even more important, as a breeding machine. A thoroughbred horse must be the product of a live, physical mating between two thoroughbreds in order to take a place in the bloodlines and must be registered with the Jockey Club in order to take a place at the starting gate. The value of equine collateral may depend on proof that these conditions have been met, as a factual matter, and on the UCC characterization of the collateral, as a legal matter.

Why Does the Type of Collateral Matter?
Courts have wrestled with the question of proper characterization of the assets in various contexts. Why does it matter? Most obviously, the method of perfecting a security interest, or its priority, may depend on the characterization of the collateral.

Creation and Perfection. For Article 9 purposes, collateral can be described in various ways, by using the Article 9 categories or otherwise. If a security agreement describes collateral only as goods, for instance, it will be effective to create a security interest in collateral constituting goods, but not in collateral characterized as general intangibles. A security agreement can, of course, create a valid security interest in a particular item of collateral by using a detailed description, not the Article 9 category. A valid security interest can still be unperfected, however, if the secured party decides to use only an Article 9 category in the financing statement but chooses the wrong category.

Buyers in Ordinary Course. If collateral consists of goods, a "buyer in the ordinary course of business" or a "lessee in the ordinary course of business" will take the collateral free of the security interest created by the seller or lessor. In addition, if the goods constitute "farm products," the federal Food Security Act provides in general that most buyers from farmers take free of security interests created by the farmer, unless the state has adopted a special filing system or the secured party has given notice to potential buyers, all as required by the statute.

PMSI Priority. A lender financing a debtor's purchase of goods can have a purchase money security interest (PMSI) in the goods and can achieve priority over existing perfected security interests by jumping through the correct hoops. If the goods are not inventory or livestock, the secured party can simply file financing statements within 20 days after the debtor acquires rights in the goods. If the goods are inventory or livestock, however, the secured party must file before the debtor gets possession of the goods and also give notice to other inventory (or livestock) lenders. The notice is good for five years for inventory, but only for six months for livestock. If the collateral does not consist of goods, the PMSI priority is not available.

Agricultural Liens. Farm products may be subject to "agricultural liens," which are essentially statutory nonpossessory liens on farm products. In the equine world, these kinds of liens include stud liens, agisters' liens (liens created by some state statutes in favor of keepers of horses and other livestock), and veterinarian liens.

Are Thoroughbred Horses Goods?
UCC Article 9 defines "goods" as things that are moveable when a security interest attaches. Horses (even bad ones) clearly constitute goods, but that is where the clarity stops. Usage of trade may affect these determinations, and the thoroughbred industry carries centuries of traditions (see the sidebar for an abbreviated equine glossary).

Fractional Shares. Courts have generally held that fractional shares in a horse, whether held through a syndication or otherwise, are goods. The fractional share represents an undivided cotenancy in the chattel, and thus is the same as the chattel itself. In Kentucky, the long-standing "Keeneland rule" is a nonuniform version of the UCC definition, providing that horses and fractional interests in horses are not only goods, but farm products, regardless of how they are used or who has possession. (Keeneland, the race track and auction house in Lexington, Kentucky, hosts some of the most prestigious annual auction sales in the thoroughbred industry.)

Severed Breeding Rights.Breeding rights are a little trickier. Courts have generally agreed that a lifetime breeding right transferred separately from the horse does not in itself constitute goods, or an interest in or lien on the horse itself, but is more in the nature of a service contract. For Article 9 purposes, therefore, severed lifetime breeding rights and breeding seasons transferred independently of their underlying shares are likely to be treated as general intangibles.

Unsevered Breeding Rights. On the other hand, where the stallion has not been syndicated and the breeding rights have not yet been severed, the breeding rights may not be general intangibles. One Texas case, In re Blankinship-Cooper, Inc., 43 B.R. 231 (Bankr. N.D. Tex. 1984), involved a dispute between the seller of a particular horse, with a perfected security interest in the horse, and the buyer's lender, with a perfected security interest only in the buyer's general intangibles. Both creditors asserted prior interests in the horse's breeding rights, which had not yet been put up for sale separately. The court held that the breeding rights were still a part of the horse and constituted goods, so that the seller had priority over the buyer's lender. Unsevered breeding rights thus will probably be treated as goods, not general intangibles.

North Ridge Farms
These issues are nicely illustrated in North Ridge Farms, Inc. v. Trimble, a 1983 Kentucky court of appeals case involving Affirmed (the 1978 Triple Crown winner), after his syndication for breeding purposes. North Ridge Farms, Inc. v. Trimble, 1983 Ky. App. LEXIS 364 (Ky. App. 1983), aff'd 700 S.W.2d 396 (Ky. 1985).

At issue in the case was fractional share number 17, which "Anita" purchased in the syndication in 1979 for $400,000. The majority of the consideration she paid was in the form of a promissory note payable to the syndicate. The syndicate took a security interest in fractional share number 17 to secure repayment of the note and attempted to perfect the security interest by filing. In 1980, Anita sold share number 17's nomination (i.e., the right to bring a mare to the stallion) for the 1982 season to North Ridge Farms. Anita then defaulted on the syndication agreement and the note, and, in late 1981, the syndicate manager foreclosed on fractional share number 17. "Dan" and "Sam" purchased fractional share number 17 at the foreclosure sale later in 1981 and asserted a prior right to that share's nomination for the 1982 breeding season.

The court acknowledged that the parties' respective rights hinged on the UCC collateral characterization of the nomination for the 1982 breeding season.

Perfection. The court first looked closely at the syndication agreement and concluded that the fractional share was an interest in the horse itself, thus constituting goods and not general intangibles. Also, since the horse was through racing and was only going to be used for breeding, the court found this fractional share constituted "farm products" and determined that the syndicate had therefore properly perfected its security interest in the fractional share by filing in the county office under Kentucky's version of old Article 9. (This case was decided before Kentucky's enactment of the Keeneland Rule mentioned above.)

Buyer in Ordinary Course. North Ridge Farms next argued that it took the 1982 season (or nomination) free of the syndicate's perfected security interest because it was a buyer of goods in the ordinary course of business under former UCC § 9-307 (now UCC § 9-320). The court rejected this argument, finding that the individual season, once severed from the fractional share in the stallion, no longer constituted goods but became a general intangible. North Ridge Farms therefore could not qualify as a buyer in the ordinary course of business.

Authorized Transfer. Even though the collateral did not constitute goods, however, the court found an alternative way to give North Ridge Farms the same kind of protection as a buyer in ordinary course. The court held that North Ridge Farms took the 1982 nomination free of the syndicate's security interest, under former UCC § 9-306 (now UCC § 9-315). The syndicate agreement allowed the fractional shares to be transferred, and the court read the agreement to say that the secured party—the syndicate manager—had thus authorized the sale. This option would probably not be available to a court under revised Article 9, which protects the purchaser in such case only if the secured party authorizes the sale free of its security interest, and a court might look more closely at the buyer in ordinary course approach.

Farm Products, Inventory, Equipment, Livestock, and Consumer Goods
Once equine collateral is determined to constitute goods, a lender faces further questions as to the type of goods. For instance, collateral can be either farm products (including livestock) or inventory, but not both.

Article 9 defines "farm products" as goods, including "livestock, born or unborn" where the debtor is "engaged in farming operations," which means "raising, cultivating, propagating, fattening, grazing or other farming operations." Do racehorses fit? They do in Kentucky under its nonuniform Article 9 provisions. Even outside Kentucky, equine goods could still be farm products (and thus livestock) in some circumstances. Stud farms and breeding farms could be engaged in farming operations since they are clearly engaged in the propagation of the thoroughbred bloodlines. Horses are expressly included in the definition of farm products under the federal Food Security Act. If the horse, or a share in the horse, is owned by an investor not engaged in farming, however, it probably would not constitute farm products.

The term "inventory" excludes farm products but includes goods held for sale or lease or to be furnished under a contract for services. Stallions are certainly furnished, at least temporarily, under contracts for services. Yearlings are often held for sale, and various kinds of lease arrangements are common in the field.

The term "equipment" is something of an "everything else" category, consisting of goods other than inventory, farm products, or consumer goods. A court deciding the issue under the similar definition in former Article 9 found that the debtor's racehorses constituted "equipment," as opposed to consumer goods or farm products, when the horses had been purchased for business use in racing and breeding and the debtor was not a "farmer." In re Bob Schwermer & Associates, Inc., 27 B.R. 304 (Bankr. N.D. Ill. 1983).

The term "consumer goods" means goods that are purchased or used primarily for personal, family, or household purposes. This label might fit your old pony, but not the 10 horses your sister purchased for her family harness racing business. Thoroughbred racehorses are even less likely to fit in this category.

One significant effect of this characterization is in the way to achieve PMSI priority. Notice to other secured parties is required for PMSI priority in inventory and livestock (farm products) but not for equipment or consumer goods. The PMSI notice is good for five years for inventory but only for six months for livestock. A PMSI in consumer goods is perfected automatically upon attachment, without filing. We do not recommend relying on automatic perfection for a multi-million dollar racehorse, though!

Are Equine Certificates Subject to Perfection by Possession?
Moving beyond goods, remember that the thoroughbred business involves several kinds of "certificates" that resemble instruments or documents of title or other papers in which security interests historically were perfected only by possession. A security interest in an instrument can now be perfected by filing, but a security interest in the same collateral, perfected by possession, can still have priority in certain circumstances.

An "instrument" is defined in relevant part as a writing that evidences a right to the payment of a monetary obligation and is of a type that in the ordinary course of business is transferred by delivery with any necessary endorsement or assignment. A negotiable document of title, among other things, must be issued to a bailee, not to the owner of the goods.

Neither a stallion service certificate (proof of a live mating) nor a Jockey Club registration certificate evidences a right to the payment of a monetary obligation, and therefore neither can be an Article 9 instrument. Each of these is issued to the owner of the horse, not to a bailee, and therefore neither can be a negotiable document of title. Under the same rules of former Article 9, however, one court in Tennessee had held that possession of a registration certificate was effective to perfect, under amorphous equitable principles, even though the court acknowledged that the certificate did not fit the definition of an "instrument." Lee v. Cox, 1976 U.S. Dist. LEXIS 17146 (M.D. Tenn. 1976). Fortunately for secured parties, a more recent Texas bankruptcy case found that, since a bona fide purchaser of a horse can obtain a replacement certificate if necessary, a registration certificate is not a separate instrument but simply follows title to the horse. In re Blankinship-Cooper, Inc., 43 B.R. 231 (Bankr. N.D. Tex. 1984).

What about the stallion service certificate? Is it some kind of separate collateral even if it is not an "instrument"? A Florida court avoided having to actually decide this issue in a case where a lender had made loans to a stud farm, secured by all of its assets. Shields v. Equine Capital Corporation, 607 So. 2d 468; 1992 Fla. App. LEXIS 10434 (Fla. Ct. App. 1992). The stud farm was allowed to enter into breeding contracts but was supposed to deliver the stud fees to the lender. A customer bred his mare to one of the farm stallions, but was unable to get the stallion service certificate when the foal was born because the lender had taken possession of the certificate and demanded payment of unrelated fees before it would release the certificate. The customer sued the lender and the farm, asserting that his breeding right constituted "goods" that the customer had purchased free of the lender's security interest as a buyer in ordinary course. The lower court found that the lender had a security interest in the stallion service certificate itself and did not have to release it. The appeals court questioned whether a stallion service certificate could even be an item of collateral in itself, since it is only a confirmation of the live mating. The court avoided the need to decide the issue, however, by using the same approach under former Article 9 that the Kentucky court used in the North Ridge Farms case. The security agreement authorized sales of breeding rights and the court held that the lender's authorization of the sale of the breeding right implicitly authorized the delivery of the customary documentation—the stallion service certificate.

The problem with both these certificates is not so much perfection or priority as enforcement. Without the original registration certificate, the horse cannot race and cannot be sold for racing or breeding. So a secured lender will want to be able to get the registration certificate if it has to repossess the horse. The lender cannot just take possession of the certificate in advance, however, because the horse then will not be able to race and thus will lose value. A valid stallion service certificate has to be produced before the Jockey Club will issue a registration certificate, and the stud farm generally will not release the stallion service certificate until the stud fee is paid. So, in order to enforce its security interest, the secured party may have to pay the stud fee to get the stallion service certificate to get the Jockey Club registration certificate to get its collateral out on the race track or to the auction house.

And the stallion syndication certificate? Is that an instrument? It might be seen as evidencing a right to payment of monetary obligations, among other things, and the certificate is generally physically delivered to a purchaser of the shares. Courts have not ruled on this issue, but a secured party can take possession of this kind of certificate, as a precautionary measure, without affecting the collateral value, since separating the certificate from the horse does not keep the collateral from performing.

Those outside the industry may wonder if a stallion syndicate share might constitute a UCC Article 8 "security" in particular circumstances. After all, an Article 8 security is defined in part as a share in an issuer or property or an enterprise of an issuer. Maybe a stallion is an issuer or property of an issuer? In light of those centuries of trade usage, though, and the cases treating fractional shares as goods, it is unlikely that a cotenant's fractional share in a particular piece of horseflesh would translate into a UCC Article 8 security.

Understanding the legal nature of the collateral is the first step in the attempts of a secured party to get its arms around the collateral (figuratively, in this instance.) Horses are goods and fractional shares are likely to be treated as goods, while breeding rights may start out as goods and turn into general intangibles when severed. Lenders should make sure that collateral descriptions in security agreements and financing statements include both types of collateral. Protecting equine collateral against buyers in the ordinary course may require both diligent monitoring of the collateral and also compliance with the federal Food Security Act (although we hope the horses are not food). Lenders financing the purchase of horses or fractional shares in stallions can take advantage of PMSI priority rules, but may have to send notices every six months (for livestock) instead of every five years (for inventory). Lenders financing stallion syndications may want to look closely at the language in the syndication agreement to see if transfers of shares are permitted. Finally, lenders should resist any inclination to rely only on possession of equine certificates for perfection purposes but may want to take possession of stallion syndication certificates. Lenders should also monitor the location of the original certificates in case they are needed for enforcement purposes. By going through its paces properly, though, a secured lender can still enjoy the ride in comfort.


A lender seeking to acquire equine collateral and protect its value must first understand the nature of the collateral. The Uniform Commercial Code (UCC) recognizes that the usage of trade can influence a particular transaction, if customs are so regularly observed in an industry that it is reasonable to expect them to be observed in the transaction. The thoroughbred industry is saddled with centuries of such practices, both written and unwritten, and the racing world is an exclusive club in some ways. Without an understanding of the customs and terminology, the lender might as well be wearing blinkers.

Foals are either colts (males) or fillies (females). A thoroughbred foal turns one year old on December 31 of the year in which it was born, then becomes a yearling and then a two-year old, which is when it may begin racing. At age five, a colt becomes a horse and a filly becomes a mare. A horse that is capable of breeding (i.e., not neutered) is a stallion. A pregnant mare is a broodmare.

The breeding season is February to June each year in the Northern Hemisphere, and the reverse in the Southern Hemisphere. Mares will be delivered to the stallion for breeding, then returned to their homes to give birth some 11 months later. The stallion owner or stallion manager issues a stallion service certificate, certifying that the identified stallion has mated with the identified mare on the stated date(s).

A thoroughbred foal is registered with the Jockey Club when it becomes a yearling, or earlier if it is sold, but in any event before its first race. In order for the Jockey Club to issue a registration certificate for the foal, the owner must submit the stallion service certificate. The original registration certificate must be submitted to the track each time a horse races.

Thoroughbred stallions are often owned in fractional shares (or just shares). A share is an undivided fractional interest in the horse, owned in a cotenancy. As cotenants, the owners share in the horse and everything that derives from the horse—mainly profits from breeding or racing—and also share in the expenses.

A fractional share in a stallion carries with it lifetime breeding rights consisting of the right to bring a mare to mate with the stallion once during each annual breeding season. The right to bring a mare to mate with the stallion in a designated breeding season is called a season or a nomination. Seasons can also be severed and transferred separately from the horse and from each other.

Fractional shares are usually issued and held in a stallion syndication. A syndication usually consists of 40 to 100 shares, reflecting the number of mares that the stallion might expect to breed with in a given breeding season. The share owners enter into a syndicate agreement describing the rights and duties of ownership, and appointing a syndicate manager, who manages the day-to-day business of the stallion's breeding activities and general maintenance. The syndicate often issues certificates representing the shares held by the respective syndicate members. Shares are sometimes assignable, but often may be subject to transfer restrictions, such as rights of first refusal.
Allen is a member in the Nashville office of Stites & Harbison PLLC. Her e-mail is katherine.allen@stites.com. The author thanks her Kentucky colleagues, Richard A. Vance and David E. Longenecker, for their equine expertise and other contributions.

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