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VOLUME 18, NUMBER 1, WHOLE NUMBER 206 DECEMBER 2000

District
Distr court
ict cour interpr
t inter pre
pr feder
ets f ederal
eder crop
al crop
insurance
insur arbitration
ance arbitr ation cclause
lause
In a decision it characterized as one of first impression, a federal district court has
interpreted the import and scope of the arbitration provision in federal crop insurance
policies. Nobles v. Rural Community Ins. Servs., No. CIV.A. 00-D-375-S, 2000 WL
1785089 (M.D. Ala. 2000) (pagination unavailable). At issue was whether losses to
cotton on about 5,000 acres were covered under two multi-peril crop insurance policies.
The policies, which were sold by a private insurance company, were reinsured by the

INSIDE Federal Crop Insurance Corporation (FCIC), and their provisions were consistent with
the standards established by the USDA Risk Management Agency (RMA). After the
cotton crop was lost, the insurance company refused to pay an indemnity. It based its
refusal on its determination that the land had not been planted and harvested during
• The basics of federal one or more of the previous three crop years as required by the policy. In turn, the
farm program plaintiffs, invoking the federal court’s diversity jurisdiction, brought suit against the
company alleging breach of contract, misrepresentation, and other state law claims
payment limitation seeking compensatory and punitive damages.
and eligibility law The insurance company moved to compel arbitration. Its motion relied on a
provision in the insurance contract that provided, in relevant part, as follows: “If you
[the insured] and we [the insurer] fail to agree on any factual determination, the
disagreement will be resolved in accordance with the rules of the American
Arbitration Association.... No award determined by arbitration ... can exceed the
amount of liability established or which should have been established under the
policy.” Id. (quoting policy ¶ 20(a), (b) published at 7 C.F.R. § 457.8). In their
opposition to the motion, the plaintiffs contended that arbitration was optional.
They supported their contention with another provision of the policy that provided,
in part, as follows: “You [the insured] may not bring legal action against us [the
insurer] unless you have complied with all the policy provisions.” Id. (quoting policy
¶ 25(a) published at 7 C.F.R. § 457.8).
The court ruled that the arbitration of factual determinations was mandatory. It
Solicitation of articles: All AALA found nothing in the language of the policy’s arbitration provision that suggested
members are invited to submit that arbitration was in any way optional. It also concluded that the right to sue
articles to the Update. Please in- contemplated by the policy was predicated on the insured first complying with all
of the policy’s provisions, including its arbitration provision. As to the question of
clude copies of decisions and leg-
whether plaintiffs’ cotton crop was insured, the court ruled that this question was
islation with the article. To avoid
a factual determination subject to mandatory arbitration irrespective of whether the
duplication of effort, please no- plaintiffs disputed the company’s determination that a crop had not been planted
tify the Editor of your proposed and harvested in any of the three years previous or whether the crux of plaintiffs’
article. claim was that they had relied in good faith on the representations of the company’s
agent that the crop was insured.
Having concluded the arbitration was mandatory, the court offered several

IN FUTURE observations about the arbitration contemplated by the policy. First, the court noted
that the policy’s arbitration provision required the arbitration to be conducted under
the rules of the American Arbitration Association (AAA) but did not require the use

I SSUES of an AAA arbitrator. Second, it observed that the policy limits an arbitration award
to the amount established or which should have been established under the policy,
thus precluding the award of additional damages or attorney’s fees. Third, the court
noted that notwithstanding this limit an arbitrator could grant recovery for losses
• Agriculture and the not covered by the policy if the insured could establish that he or she relied in good
Federal Tort faith upon a misrepresentation of an insurance agent. Citing 7 C.F.R. § 457.6 and
Claims Act 56 Fed. Reg. 1345, 1347 (1991) for the proposition that the “FCIC has a long standing
policy of honoring the misinformation provided by its agents to [an] insured as long
the statutory requirements of the Federal Crop Insurance Act are followed ..., the
court opined that “even if the terms of Defendant’s policy do not insure against losses
on some 5,000 acres of Plaintiffs’ cotton crop, the arbitrator may nevertheless award
relief as if they do.” Id.
The court also observed that state law claims against a private insurance company
Continued on page 3
PAYMENT LIMITATION/CONTINUED FROM PAGE 7

sion giving the equipment owner the right “permitted” entities must provide notifi- fraud70 and other offenses.
to use the equipment on demand. cation of the entities through which the
The “substantive change rule” applies individual will receive payments.62 The 1
The most recent changes, minor ones
when the number of “persons” in a farm- FSA, however, imposes a significant pa- relating to the limit for Environmental
ing operation increases from the preced- perwork requirement by conditioning the Quality Incentives Program payments,
ing crop year. The increase will be recog- receipt of payments on the voluntary the submission of required forms, and
nized only if there was a “bona fide and submission of various forms and sup- FSA compliance reviews of farming op-
substantive” change in the farming op- porting documentation. The basic pay- erations, do not appear in the 2000 edi-
eration. For example, a twenty-percent ment limitation form is known as the tion of the Code of Federal Regulations.
increase in total cropland is deemed to be “CCC Form 502.” This form is styled as a They can be found at 65 Fed. Reg. 36,550,
such a change. The regulations list other “farm operating plan,” and it must be 36,561 (2000) (to be codified at 7 C.F.R. §§
changes that can qualify.59 The change completed before payments can be re- 1400.1(g), 1400.2(e), (h)).
2
must take place by April 1 of the appli- ceived. The form asks for information See 7 C.F.R. § 1400.2(f).
cable program or fiscal year.60 regarding the producer’s contributions to 3
See, e.g., Jones v. Espy, No. 90-2831-
The bulk of the substantive change rules the farming operation that generally cor- LFO, 1993 WL 102641 (D.D.C. Mar. 17,
are found in 1-PL (Rev. 1).61 These rules relates to the “actively engaged in farm- 1993) (unreported decision). The APA’s
are among the most imprecisely drafted ing” requirements. If the operation has rulemaking procedures require publica-
directives in 1-PL (Rev. 1), but they must not changed from the preceding year, tion of the proposed and final rules in the
be consulted given the brevity of the regu- producers may so certify on an abbrevi- Federal Register and an opportunity for
lation in comparison to the lengthy proce- ated form. public comment. See 5 U.S.C. § 553.
4
dures found in 1-PL (Rev. 1). The CCC Form 502 is submitted in the 120 S. Ct. 1655 (2000) (ruling that
The only payment limitation paper- name of the farming operation, and the unpublished agency interpretations of
work requirement expressly imposed by Form varies depending on whether an an ambiguous federal statute were only
Congress is a notification requirement individual, general partnership, entity, entitled to deference commensurate with
related to the “three entity rule.” Under trust, or estate is conducting the opera- their “power to persuade,” a standard
this requirement, an individual who has tion. For example, farming operations articulated in Skidmore v. Swift & Co, .
an interest in more than the number of conducted by an individual complete a 323 U.S. 134 (1944)).
5
502A while general partnerships com- 113 S. Ct. 1913 (1993) (ruling that an
plete a 502B. agency’s interpretation of its own legisla-
The farming operation must be in ex- tive regulations is binding on the courts
istence as of the “status date” for each unless the interpretive rule is inconsis-
program year, which is either April 1 of tent with the legislative rule, violates the
the crop year or the fiscal year, depend- Constitution or a federal statute, or is
ing on the program63 The number of “per- plainly erroneous).
6
VOL. 18, NO. 1, WHOLE NO. 206 December 2000 sons” on a farming operation may not be The funding for the production flex-
AALA Editor..........................Linda Grim McCormick
increased after the status date. The num- ibility contract program included sums
Rt. 2, Box 292A, 2816 C.R. 163 ber of “persons” may be decreased, how- from the refund of unearned deficiency
Alvin, TX 77511 ever, based on the farming operation’s payments from previous years and for-
Phone: (281) 388-0155
FAX: (281) 388-0155 “status” on or before the date of the last feited production contract payments. 7
E-mail: lgmccormick@teacher.esc4.com program crop harvested.64 U.S.C. § 7213((c)(1), (2). Production flex-
Contributing Editors: Christopher R. Kelley, University The FSA conducts “end-of-year reviews” ibility contract payments made from these
of Arkansas, Fayetteville, AR; Shane Morris, Katija of selected producers to determine funds are subject to a $50,000 limit ex-
Blaine, Doug Powell, Department of Plant Agriculture,
University of Guelph.
whether they followed their respective tending for the seven-year term of the
farm operating plans. These reviews usu- production flexibility contracts. 7 U.S.C.
For AALA membership information, contact William ally require those producers to provide § 7213(e).
P. Babione, Office of the Executive Director, Robert A. 7
Leflar Law Center, University of Arkansas, nearly all of their operation’s records for Beginning with the 2000 crop year
Fayetteville, AR 72701. that crop year. On occasion, the USDA and at the participant’s option, market-
Agricultural Law Update is published by the Office of Inspector General (OIG or IG) ing assistance loan gains can be realized
American Agricultural Law Association, Publication conducts audits of farming operations without limitation through the use of
office: Maynard Printing, Inc., 219 New York Ave., Des
Moines, IA 50313. All rights reserved. First class
either on its own initiative or at the commodity certificates. See Agriculture,
postage paid at Des Moines, IA 50313. request of the FSA. Rural Development, Food and Drug Ad-
The payment limitation and eligibility ministration, and Related Agencies Ap-
This publication is designed to provide accurate and
authoritative information in regard to the subject statute prohibits “schemes or devices” propriations Act, 2000, Pub. L. No. 106-
matter covered. It is sold with the understanding that having the “purpose” of evading the pay- 78, tit. VIII, § 812, 113 Stat. 1135, 1181;
the publisher is not engaged in rendering legal,
accounting, or other professional service. If legal advice ment limitation rules.65 The regulations FSA Notice LP-1723 (Feb. 15, 2000).
8
or other expert assistance is required, the services of significantly expand this prohibition by For the 1999 and 2000 crop years
a competent professional should be sought.
Views expressed herein are those of the individual
prohibiting such actions that have the only, this limit was increased to $150,000.
authors and should not be interpreted as statements of “effect” of evading the rules.66 A person Agriculture, Rural Development, Food
policy by the American Agricultural Law Association. who adopts or participates in a prohib- and Drug Administration, and Related
Letters and editorial contributions are welcome and ited “scheme or device” is ineligible for Agencies Appropriations Act, 2000, Pub.
should be directed to Linda Grim McCormick, Editor, payments in that year and the following L. No. 106-78, tit. VIII, § 813(a), 113 Stat.
Rt. 2, Box 292A, 2816 C.R. 163, Alvin, TX 77511.
year.67 Although the regulations appear 1135, 1182; Agriculture, Rural Develop-
Copyright 2001 by American Agricultural Law to require a “scheme or device” to involve ment, Food and Drug Administration,
Association. No part of this newsletter may be
reproduced or transmitted in any form or by any means,
intentionally fraudulent or deceitful con- and Related Appropriations Act, 2001,
electronic or mechanical, including photocopying, duct,68 the meaning of the phrase is the Pub. L. No. 106-387, tit. VIII, § 837, 114
recording, or by any information storage or retrieval subject of disagreement. Stat. 1549, 1549A-155.
system, without permission in writing from the 9
publisher. False statements made in seeking farm Farmer A cannot have more than a
program benefits can also lead to civil or 50% interest in either LLC. If he does, the
criminal liability under the False Claims LLC(s) in which he has more than a 50%
Act69 and criminal prosecution for mail interest will be “combined” into him. See

2 AGRICULTURAL LAW UPDATE DECEMBER 2000
PAYMENT LIMITATION/Cont. from p. 7 v. U.S. Dep’t of Agric., 876 F.2d 994 (D.C. “commensurateness” requirement, the
7 C.F.R. § 1400.101(a). Also, Farmer A Cir. 1989), cert. denied, 493 U.S. 1019 assumption must be made. Otherwise,
needs to be sure that neither LLC is (1990). This case is sometimes referred the required mathematics might devour
organized in a manner that will result in to as the “WIFE case,” a reference to the the points this example illustrates.
49
a “combination” under 7 C.F.R. § plaintiff’s acronym. In the “real world,” depending on the
24
1400.101(b). This is why the members of 7 C.F.R. § 1400.105(a). relative value of the contributions, the
25
the LLCs are “AB” and “AC,” respec- 7 C.F.R. § 1400.105(a)(1). spouses might be able to qualify for equal
26
tively. Neither “B” nor “C” can be Farmer See 7 C.F.R. § 1400.3 (defining “Sub- shares.
50
A’s spouse, minor child, or trust for the stantial beneficial interest”). See 7 C.F.R. § 1400.207.
27 51
benefit of Farmer A’s minor children. See 7 C.F.R. § 1400.105(a)(2). See 7 C.F.R. § 1400.208.
28 52
Otherwise, a “combination” will result See 7 C.F.R. § 1400.201. See 7 C.F.R. § 1400.209.
29 53
under 7 C.F.R. § 1400.101(a). See 7 C.F.R. § 1400.203(b). See 7 C.F.R. § 1400.207.
10 30 54
Individual B in this example could be See 7 C.F.R. § 1400.204(a). See, e.g., 7 C.F.R. § 1412.303(a)(3).
31 55
completely “passive” with respect to the See 7 C.F.R. §§ 1400.205(a) (Trusts), See 7 C.F.R. § 1400.211.
56
farming operation if the “significant con- 1400.206(a) (Estates). See, e.g., 7 C.F.R. § 1412.303(a)(2).
32 57
tribution” of capital, equipment, or land See 7 C.F.R. § 1400.207. See 7 C.F.R. § 1400.401(a).
33 58
was made by the partnership and indi- See 7 C.F.R. § 1400.204(b). See 7 C.F.R. § 1400.401(a).
34 59
vidual A made a “significant contribu- See 7 C.F.R. § 1400.205(b). See 7 C.F.R. § 1400.109.
35 60
tion” of “active personal labor” or “active See 7 C.F.R. § 1400.206(a). See 7 C.F.R. § 1400.100(b).
36 61
personal management” as an individual See 7 C.F.R. § 1400.3 (defining “Ac- See 1-PL (Rev. 1) ¶¶ 93-97.
62
and as a 50% member of the LLC. See 7 tive personal labor” and “Active personal See 7 U.S.C. § 1308-1(a).
63
C.F.R. §§ 1400.203(b), 1400.204(b). In management”). See 7 C.F.R. § 1400.100(a).
37 64
other words, assuming the land and pro- See 7 C.F.R. § 1400.204(b). See 7 C.F.R. § 1400.100(b).
38 65
duction of the farming operation will See 7 C.F.R. § 1400.3 (defining “Ac- See 7 U.S.C. § 1308-2.
66
generate the payments, A can receive up tive personal management”). See 7 C.F.R. § 1400.5(a).
39 67
to 150% of a single limit simply by finding Also, under the “landowner” rule See 7 C.F.R. § 1400.5(b).
68
a “warm body” to participate as an equal discussed in the text below, a “person” The regulation provides that ex-
member in the LLC. can be deemed to be “actively engaged in amples of a scheme or device include
11
But see supra note 23 (providing an farming” merely by contributing land to “[c]oncealing information ..., [s]ubmitting
example in which an individual retains the farming operation. See 7 C.F.R. § false or erroneous information, or
complete control over a farming opera- 1400.207. Thus, a New York City resi- [c]reating fictitious entities for the pur-
tion in which another individual receives dent who owns a farm in Alabama and pose of concealing the interest of a person
payments indirectly as a member of an share-leases the farm is “actively en- in a farming operation.” 7 C.F.R. §
LLC). gaged in farming.” 1400.5(a).
12 40 69
See 7 C.F.R. § 1400.3 (defining “Per- See 7 C.F.R. § 1400.3 (defining “Sig- 31 U.S.C. §§ 3729-31 (civil); 18 U.S.C.
son”). nificant contribution”). §§ 286-87 (criminal).
13 41 70
Corporations, limited liability com- See 7 C.F.R. § 1400.3 (defining “Ac- See 18 U.S.C. § 1341.
panies, and limited partnerships have tive personal management”).
42
the advantage over general partnerships See 7 C.F.R. § 1400.3 (defining “Capi-
of being able to compensate their share- tal,” “Equipment,” and “Land”).
43
holders or members for their “significant See 7 C.F.R. § 1400.3 (defining “In- ARBITRATION CLAUSE/Cont. from p. 3
contribution” of “active personal labor” terest in a farming operation”). are not preempted by the Federal Crop
44
or “active personal management.” See 7 See 7 C.F.R. § 1400.3 (defining “Capi- Insurance Act or its implementing regu-
C.F.R. § 1400.204(b). Members of gen- tal,” “Equipment,” and “Land”). lations. Id. (citing Williams Farms of
45
eral partnerships cannot receive a salary See 7 C.F.R. § 1400.3 (defining “Capi- Homestead, Inc., v. Rain & Hail Ins.
or other guaranteed payment for these tal,” “Equipment,” and “Land”). Serv., Inc., 121 F.3d 630 (11th Cir. 1997),
46
services to the farming operation. They See 7 C.F.R. § 1400.2 (defining “In- and other authority). It noted that an
can only be entitled to receive their re- terest in a farming operation”). 1-PL (Rev. arbitrator’s findings are subject to judi-
spective distributive share of the part- 1) has a more complete definition of “in- cial review and enforcement under the
nerships net earnings. terest in a farming operation.” For ex- Federal Arbitration Act, specifically, 9
14
See 7 C.F.R. § 1400.3 (definition of ample, unlike the regulation, 1-PL (Rev. U.S.C. §§ 9, 10. Therefore, according to
“Person”). 1) provides that shareholders in a corpo- the court, state law claims might still be
15
See 7 C.F.R. § 1400.101(a). ration do not have an interest in the heard by a court following arbitration but
16
Corporations and similar limited li- farming operation of the corporation. 1- only to the extent that such claims were
ability entities are subject to two combi- PL (Rev. 1) ¶ 91(B). not precluded by the arbitrator’s find-
47
nation rules. See 7 C.F.R. § 1400.101(a), The FSA Handbook permits all of the ings. In this case, however, the court
(b). members of a joint operation to guaran- declined to rule on which, if any, of the
17
See 7 C.F.R. § 1400.103. The pay- tee a loan to the joint operation without plaintiffs’ state law claims might remain
ment limitation and eligibility rules spe- violating a “financing rule.” See, e.g., 1- justiciable after arbitration because the
cifically define an “irrevocable trust.” 7 PL (Rev. 1), ¶ 296(C). Since this is not issue was not before it. Nevertheless, it
C.F.R. § 1400.3 (defining “Irrevocable permitted by the regulations, reliance on declined to “rule out the likelihood that,
trust”). Not every trust that is an “irrevo- the Handbook directive is potentially under the doctrine of claim preclusion, at
cable trust” under state law will satisfy perilous. least some of the arbitrator’s findings
48
this definition. This is an entirely unrealistic as- can serve as the basis for Plaintiff’s com-
18
See 7 C.F.R. § 1400.104. sumption because the dollar values of the mon law claims raised against Defen-
19
See 7 C.F.R. § 1400.105. land, equipment, and capital will almost dant in court.” Id. at n.6.
20
See 7 C.F.R. § 1400.106. always significantly exceed the monetary —Christopher R. Kelley, University of
21
See 7 C.F.R. § 1400.107. value of the contributed labor and man- Arkansas School of Law,
22
See 7 C.F.R. § 1400.108. agement. Nonetheless, for simplicity in Fayetteville, AR
23
Women Involved in Farm Economics illustrating the importance of the

DECEMBER 2000 AGRICULTURAL LAW UPDATE 3
feder
T he basics of f edera
eder farm
al f prog
arm pr ogr
og payment
ram payment limitation and
law
eligibility law
By Christopher R. Kelley ments. Recent notices relating to 1-PL number of “entities,” such as corpora-
(Rev. 1), which often are later incorpo- tions and limited liability companies,
This article provides an overview of the rated into amendments, can be found on through which an individual may receive
federal farm program payment limita- the FSA site on the USDA’s web page, program payments. As discussed below,
tion and eligibility rules. Because all or http://www.usda.gov. the rule imposing this limit is commonly
some of these rules govern eligibility for The federal courts have consistently called the “three entity rule.” This rule is
the most economically significant com- ruled that the Handbook’s directives do controversial because it permits the dou-
modity programs, they are an important not have the force and effect of law be- bling of the payment limits.
part of federal farm program law. This cause they are not promulgated as legis- Payment limitation and eligibility law
overview, however, is not intended to lative rules under the Administrative also defines who may receive certain
serve as a substitute for a close study of Procedure Act (APA).3 Nonetheless, the program payments. In other words, it
the rules or competent advice and assis- FSA historically has treated the imposes eligibility requirements. The
tance with respect to compliance with Handbook’s directives as if they were general purpose of these requirements,
them. legally binding rules. This does not particularly the rules limiting eligibility
The payment limitation and eligibility present serious problems when the par- to individuals and entities “actively en-
statutes are codified at 7 U.S.C. §§ 1308- ticular directive being treated as a le- gaged in farming,” is to prevent “passive”
1308-5. Some program payment limits, gally binding rule is consistent with the investors from receiving program pay-
however, are contained in separate stat- statute and regulations. Not all of the ments. The “person” and “actively en-
utes. For example, the $50,000 limit for directives are consistent, however. gaged in farming” rules are a central, but
Conservation Reserve Program (CRP) To the extent that the directives are complex, feature of payment limitation
payments is found at 16 U.S.C. § inconsistent with these statutes and regu- law.
3834(f)(1). lations, a court is not likely to enforce As a general rule, payment eligibility
The payment limitation and eligibility them. Otherwise, if they can be fairly is limited to “persons” who are “actively
regulations are found at 7 C.F.R. Part deemed to interpret ambiguous or incom- engaged in farming.” There are excep-
1400. Except for some relatively minor plete provisions in the statutes and regu- tions, however. The following table indi-
changes,1 these regulations have been in lations, there is the possibility that a cates which programs are subject to the
effect since the 1989 crop year. They were court may defer to them under one or the “person” and “actively engaged in farm-
codified at 7 C.F.R. Part 1497 until 1996. other of the deference doctrines an- ing” rules:
The payment limitation and eligibility nounced in Christensen v. Harris County4
rules are administered by the USDA and Stinson v. United States.5 Program Applicable Rules
Farm Service Agency (FSA). Most pay- In the broadest sense, payment limita- Production flexibility contracts
ment limitation and eligibility determi- tion and payment eligibility law serves “Person” and
nations are initially made by county or the three basic functions of limiting (a) “actively engaged
area FSA committees. However, deter- the dollar amount of certain farm pro- in farming”
minations involving farming operations gram payments a “person” can receive in Marketing assistance loans (no gain)
conducted by general partnerships or a crop or fiscal year; (b) the number of Not applicable
joint ventures having more than five “entities” through which an individual Marketing assistance loan gains
members are made at the state FSA may receive payments; and (c) payment “Person” and “actively
committee level.2 eligibility to “persons” who are “actively engaged in farming”
The county, area, and state FSA com- engaged in farming.” Loan deficiency payments
mittees have been instructed to follow The per-person dollar limits are pro- “Person” and “actively
the directives contained in the FSA Hand- gram-specific. The following table sets engaged in farming”
book, the agency’s internal procedures forth the current limits for the most 1988 & 1999 crop loss assistance
manual. The Handbook volume contain- economically significant programs: “Person” only
ing the payment limitation and payment Program Payments Limit Non-Insured Crop Loss Assistance
eligibility directives is known by its “short- Production flexibility “Person” only
reference,” which is “1-PL (Rev. 1).” contract payments $40,0006 Conservation Reserve Program
Because the county, area, and state Marketing assistance “Person” and “actively
FSA committees and their staff use 1-PL loan gains7 and loan engaged in farming”
(Rev. 1) in making their determinations, deficiency payments $75,0008
1-PL (Rev. 1) is an important reference. 1998 & Multi-Year The “person” and “actively engaged in
Most FSA offices will permit program Crop Loss Assistance farming” rules do not directly limit the
participants or their representatives to Program $80,000 number of “persons” who can qualify for
review their copy. A copy can also be 1999 & 2000 Crop payments from a single farming opera-
obtained without cost from the FSA’s Loss Assistance tion. To the contrary, they encourage
Information Office in Washington. Since Program $80,000 farming by multiple-member general
1-PL (Rev. 1) is amended frequently, Non-Insured Crop partnerships. Farming through a gen-
maintaining a current copy requires pe- Disaster Assistance eral partnership is the most effective
riodic requests for the most recent amend- Program (NAP) $100,000 way for multiple “persons” to receive
Conservation Reserve payments from a single farming opera-
Program (CRP) $50,000 tion. In addition, the rules permit an
Christopher R. Kelley is Assistant Profes- individual to receive payments from up
sor, University of Arkansas School of In addition to imposing per-“person” to three “entities.”
Law and Of Counsel to the Vann Law dollar limits on payments, payment limi- Under the so-called “three entity rule,”
Firm, Camilla, GA. tation and eligibility law restricts the an individual who receives payments as

4 AGRICULTURAL LAW UPDATE DECEMBER 2000
an individual cannot receive program can be structured so that more “persons” maintain funds or accounts separate from
payments from more than two entities. receive payments than are in true control that of any other individual or entity for
An individual who does not receive pay- of the operation. Elaborate methods for such interest.14 General partnerships and
ments as an individual may receive pro- doing this often use trusts as sharehold- joint ventures may satisfy these require-
gram payments from up to three entities, ers in multiple corporations which, in ments on behalf of their members. Al-
hence the name, “three entity rule.” turn, form a general partnership to con- though these requirements are tersely
The three entity rule allows the pay- duct the farming operation. In such a worded, they are very important for their
ment limits to be doubled. For example, farming operation, the trustees (or the violation leads to payment ineligibility.
assume that Farmer A farms as an indi- person who selected them), who are fewer If, for example, the personal funds of a
vidual. In addition, he holds a 50% inter- in number than the number of “persons” general partner are commingled with the
est in two limited liability companies, AB in the farming operation, essentially con- funds of the farming general partnership
LLC and AC LLC.9 Each of these LLCs trol the farming operation. or vice versa, the partner will be denied
has a farming operation that is separate For payment limitation and eligibility “person” status.
from the other LLC’s farming operation purposes, a “person” is separately en- Under a collection of payment limita-
and from Farmer A’s farming operation. titled to receive payments up to the ap- tion rules known as the “combination
Also assume that in his individual capac- plicable limit. Thus, the terms “person” rules,” some individuals are deemed to
ity Farmer A will receive the full limit of and “separate person” are sometimes used be too economically interdependent with
$40,000 in production flexibility contract interchangeably. In the payment limita- other individuals or entities to be sepa-
payments and the full combined limit of tion and eligibility regulations, for ex- rate “persons.” These combination rules
$75,000 in marketing loan gains and loan ample, the term “person” is usually syn- deny separate “person” status to “per-
deficiency payments. Each of the LLCs onymous with “separate person.” sons” who would otherwise be eligible for
will also receive these amounts through Individuals and certain common forms a separate limit.
their respective farming operations. Be- of business organization such as corpora- For example, a corporation and its
cause Farmer A’s distributive share is tions, limited liability companies, lim- shareholders are generally considered to
50% of each LLC’s payments, he will ited partnerships, and trusts may be be separate “persons.” Thus, a corpora-
receive $77,500 ($20,000 + $37,500) from “persons.” General partnerships, joint tion may receive program payments based
each LLC. As a result, the $115,000 he ventures, and cooperative marketing as- on its fulfillment of the “person” and
receives directly as an individual will be sociations, however, are not eligible for “actively engaged in farming” require-
doubled by the amount he receives indi- “person” status. In addition, trusts, es- ments, and its individual shareholders
rectly as a member of the two LLCs. The tates, charitable organizations, and states may receive program payments from
result would be the same for Farmer A if, and their agencies may be “persons.”12 separate operations in which they are
instead of farming separately, Farmer A, General partnerships and joint ven- “persons” who are “actively engaged in
AB LLC, and AC LLC farmed as a general tures are called “joint operations” in the farming.” So long as none of the share-
partnership. payment limitation and payment eligi- holders holds more than a fifty percent
The three entity rule is not always bility regulations. Joint operations may interest in the corporation, the
used to double an individual’s effective not be “persons.” However, their indi- corporation’s and each shareholder’s pay-
limit. To the contrary, it is most often vidual members may be “persons.” As a ments will be separately limited. If, how-
used to capture a payment amount some- general rule, general partnerships and ever, one of the corporation’s sharehold-
where between the single limit amount joint ventures are more advantageous for ers holds more than a fifty percent inter-
and the doubled limit amount. For ex- payment limitation and eligibility pur- est in the corporation, one of the “combi-
ample, in a farming general partnership poses than corporations, limited liability nation” rules will “combine” the corpora-
consisting of A, an individual, and AB companies, and limited partnerships. tion with the majority shareholder.15
LLC, a limited liability company equally While a corporation, limited liability com- When this combination occurs, the corpo-
owned by individuals A and B, A would be pany, or limited partnership will be only ration is subject to the same limit as the
relying on the three entity rule to be one “person” irrespective of the number majority shareholder. If the majority
eligible for payments up to 150% of a of its shareholders or members, each of shareholder has already reached his or
single limit.10 Likewise, if the general the partnership’s or joint venture’s mem- her payment limit, the corporation will
partnership consisted of individual A, bers may be a separate “person” unless not be eligible to receive payments. For
individual B, and AB LLC, both A and B there is a “combination” of “persons” un- this reason, farming operations seeking
would be using the three entity rule to der one of the so-called “combination to “maximize” program payments must
receive payments directly as individual rules.” Therefore, more “persons” are pay careful attention to the combination
partners and indirectly though AB LLC. potentially available to a farming opera- rules.
The three entity rule does not limit the tion conducted by a general partnership One or more combination rules apply
number of “persons” in a farming opera- than to a farming operation conducted by to corporations and similar limited li-
tion who are eligible to receive payments. a corporation, limited liability company, ability entities, 16 trusts, 17 estates, 18
In theory, a hundred-member general or limited partnership.13 Of course, one spouses,19 minor children,20 governmen-
partnership could conduct a farming op- trade-off is that all of the members of a tal bodies,21 and charitable organiza-
eration in which all of its members were general partnership that conducts a farm- tions.22 These rules must be carefully
“persons” who were “actively engaged in ing operation will be jointly and severally considered in farm program planning.
farming.” Thus, the number of “persons” liable for the partnership’s liabilities On occasion, a farming operation might
in a farming operation is primarily con- under state law. This disadvantage can be structured in a manner that will re-
strained by the practical difficulties as- be mitigated to some degree by forming a sult in one or more combinations because
sociated with operating a farm with partnership of single-member limited li- the loss of payments to the resulting
multiple “persons.” These difficulties in- ability companies in lieu of individuals if combined person(c) will be offset by other
clude coordinating farm program plan- state law permits single-member limited gains.
ning with tax, estate, and general busi- liability companies. Of all the combination rules, the gen-
ness planning. Other difficulties include A separate “person” must (1) have a eral rule combining spouses has pro-
the problems that can arise from ceding separate and distinct interest in the land duced the most controversy, including
control of the farming operation to oth- or the crop involved; (2) exercise separate litigation in which the combination of
ers.11 Nevertheless, farming operations responsibility for such interest; and (3)
Continued on p. 6

DECEMBER 2000 AGRICULTURAL LAW UPDATE 5
PAYMENT LIMITATION/Cont. from p. 5 ticular farming operation nificant contribution” of “active personal
spouses was upheld.23 The general rule is 1. a “significant contribution” of labor” or “active personal management.”37
that spouses are one “person.”24 There (a) land, capital, equipment, or a com- On the other hand, partners cannot re-
are two exceptions. The first and more bination thereof, and ceive a guaranteed wage or salary by the
longstanding exception applies to spouses (b) “active personal labor,” “active per- partnership for their labor or manage-
who farmed separately before their mar- sonal management,” or a combination ment. If they are paid, none of their labor
riage and who continue to farm sepa- thereof; and or management will qualify as a “signifi-
rately after their marriage.25 Very few 2. the “significant contributions,” to- cant contribution” of “active personal la-
spouses can satisfy the requirements of gether with other qualifying contribu- bor” or “active personal management.”
this exception. tions, must be “commensurate” with Partners must be compensated only
The second exception was authorized the individual’s claimed share of the through their partnership “draws” or dis-
by the 1990 farm bill, and it took effect in profits and losses of the farming opera- tributive shares.
the 1991 crop year. Under this exception, tion; and “Active personal management” need
a husband and wife may each be deemed 3. the contributions must be “at risk. ” not be performed on the farm.38 Thus, a
to be separate “persons” if person can contribute “active personal
(a) neither spouse has a “substan- An individual who farms as an indi- management” while residing on New York
tial beneficial interest”26 (usually, but vidual (i.e., as a sole proprietor) usually City’s Fifth Avenue.39
not necessarily, 10 percent or more) in has to satisfy all three of these contribu- In general, a “significant contribution”
another entity receiving farm program tion requirements. However, members of of land, capital, or equipment is a contri-
payments, and a general partnership or joint venture do bution equal in rental value (land and
(b) each spouse is a “person” who is not have to make individual “significant equipment) or cash value (capital) to fifty
“actively engaged in farming.”27 contributions” of land, capital, equipment, percent of the contributor’s commensu-
or a combination thereof. Instead, the rate share of the total value of those
This second exception limits the general partnership or joint venture may respective inputs necessary to conduct
spouses to one payment limit each, and it make the contribution for each of them.29 the farming operation. When these in-
precludes either of them from using the Otherwise, any member seeking to be puts are contributed in combination, the
three entity rule. In other words, if each deemed “actively engaged in farming” applicable percentage is thirty percent.40
spouse is participating in a federal farm must contribute the requisite quantity of A “significant contribution” of “active
program they each must receive their the qualifying input(s) to the personal labor” is 1,000 hours (one-half
respective payments directly, not indi- partnership’s or joint venture’ farming of a year’s worth of 40-hour workweeks)
rectly, to avoid their combination into operation. or at least fifty percent of the hours
one “person.” Thus, if H and W each farm With respect to corporations and other necessary to conduct a farm comparable
separately or as partners, neither can limited liability entities, the entity must in size to the individual’s share of the
have a “substantial” interest in a farming make the “significant contribution” or farming operation. A “significant contri-
entity that participates in a farm pro- one or more of the qualifying inputs.30 bution” of “active personal management”
gram through which he or she receives The same is true for trusts and estates.31 is a contribution that is “critical to the
payments indirectly. Subject to the landowner exception,32 profitability of the farming operation,
Spouses who seek separate “person” individuals who seek to be deemed “ac- taking into account the individual’s or
status typically farm in a general part- tively engaged in farming” must make a entity’s commensurate share in the farm-
nership or a joint venture either as co- “significant contribution” of “active per- ing operation.” A somewhat similar stan-
partners or in partnership with others. sonal labor,” “active personal manage- dard applies when labor and manage-
Depending on how they conduct their ment,” or a combination thereof. Like- ment are contributed in combination.41
operation, they may be able to claim wise, individual members of a general “Significant contributions” of land and
equal shares in the partnership or joint partnership or a joint venture must per- equipment can include owned or leased
venture. sonally make such a contribution. land or equipment, and owned or bor-
As a general rule, only “persons” who “Entities,” on the other hand, are inca- rowed capital.42 However, if the land,
are “actively engaged in farming” are pable of contributing personal services. equipment, or capital was acquired
eligible for program payments.28 The “ac- Therefore, corporations, limited liability through a loan made, guaranteed, or
tively engaged in farming” requirement companies, and limited partnerships secured by an individual or entity with
is intended to distinguish “active” par- seeking to be deemed to be “actively an “interest in the farming operation”43
ticipants in a farming operation from engaged in farming” must have one or its contribution cannot qualify as a “sig-
those who are merely “passive” inves- more of their shareholders or members nificant contribution.”44 Nonetheless,
tors. having a single or combined interest of at such contributions may be included in
The “actively engaged in farming” re- least fifty percent make the requisite the “commensurate” contribution calcu-
quirement is grounded on the notion that quantity of the qualifying services.33 A lation if certain requirements are met.45
“real farmers” contribute land, capital, similar rule applies for trusts with re- The so-called “financing rules” that
or equipment and labor or management spect to the income beneficiaries.34 With prohibit contributions of capital, equip-
to their farming operation. It also incor- respect to estates, either the personal ment, or land from being deemed “signifi-
porates the notion that a “real farmer” representative or the heirs must collec- cant contributions” if they were acquired
will make contributions to the farming tively “activate” the estate by contribut- through a loan made, guaranteed, or
operation in proportion to his or her ing the requisite labor and/or manage- secured by someone with an “interest in
share of the operation’s profits and losses ment.35 the farming operation” often present dif-
and that these contributions will be sub- “Active personal labor” and “active ficulties. For example, assume individu-
ject to farming’s economic risks. Accord- personal management” are defined to als A and B farm as a general partner-
ingly, the generally applicable “actively exclude hired services.36 Shareholders in ship. By virtue of the definition of “inter-
engaged in farming” requirement has a corporation or members of a limited est in a farming operation,” they each
three constituent elements: liability company or limited partnership, have an interest in the partnership’s
however, may be paid for their labor and farming operation.46 Also assume that
To be “actively engaged in farming,” a management without disqualifying their the partnership will borrow, in its name,
“person” must directly make to the par- services from being considered as a “sig- all of the capital needed to fund its farm-

6 AGRICULTURAL LAW UPDATE DECEMBER 2000
ing operation, including the funds re- artificially simple hypothetical, consider eration would have received if they had
quired to lease the necessary equipment the case of a husband and wife who farm been “combined” under the general com-
and land. If either A or B guarantee the as a general partnership. They began bination rule for husbands and wives.49
loan to the partnership or secure it with farming together after their marriage, Among other things, this example il-
their personal assets, the partnership’s and they participate in the production lustrates that each partner’s “actively
contributions of capital, equipment, and flexibility contract program. Neither engaged in farming” status is separately
land would not qualify as “significant spouse has an interest in any other farm- determined. The problem this couple
contributions.”47 ing operation that receives farm program encountered with the “commensurate”
Although the so-called “financing rules” payments. contribution requirement would be com-
often present difficulties, there are vari- All of the land farmed by the partner- pounded if only one spouse, instead of the
ous ways to work through these difficul- ship is owned by the partnership. The couple’s partnership, owned or leased
ties. The best solution is to avoid a prob- same is true for the needed equipment, the land or equipment. In that case, the
lem with a financing rule altogether by and all of the necessary capital is bor- other spouse would have to acquire and
making sure that no one with an “inter- rowed by the partnership. The husband contribute an equal amount of land or
est in [the] farming operation” is in- contributes 100 percent of the labor and equipment if they wanted to have sev-
volved in the financing leading to the fifty percent of the management. The enty-five percent/twenty-five percent
acquisition of the input. If this cannot be wife contributes fifty percent of the man- shares based on the contributions of la-
done, an alternative is to satisfy the agement. Finally, for purposes of this bor and management assumed in this
“significant contribution” of capital, example, assume that all of the respec- example.
equipment, or land with the contribution tive contributions of land, equipment, The “actively engaged in farming” re-
of an input whose acquisition is not capital, labor, and management have an quirements are relaxed for landowners,50
“tainted” by a financing rule violation. equal per-unit rental or other value, as family members,51 and sharecroppers.52
For example, if a lender insists on per- applicable to the input or service.48 Under the “landowner rule,” a person
sonal guarantees by the members of a In this example, both spouses have who owns an interest in land and who
general partnership for a loan to the satisfied both “sides” of the “significant receives rent or income for the use of that
partnership, the partnership’s contribu- contribution” requirement. The partner- land based on the land’s production or
tion of this capital will not qualify as a ship satisfied the “left-hand side” for the farming operation’s operating results
“significant contribution.” However, the each of them, and they individually sat- is automatically deemed to be “actively
partnership may still be able to make the isfied the “right-hand side.” engaged in farming.”53 Such an arrange-
requisite “significant contribution” of an Can the husband and wife claim equal ment is usually called a crop share lease.54
input or a combination of inputs by con- shares in the farming operation? No. The use of custom farming services may
tributing equipment or land or a combi- Their respective commensurate shares also qualify a person as a “landowner.”
nation of both whose acquisition was not of the contributed land, capital, and equip- “Landlords,” on the other hand, may
funded by the “tainted” capital borrowed ment are equal because these inputs were never be deemed to be “actively engaged
from the lender. Another option is to contributed at the partnership level and in farming.”55 A “landlord” is a person
persuade the lender to make two loans to thus are deemed to have been made who receives a guaranteed return on the
the farming operation, one of which was equally between them. However, their land’s use, whether payable in cash or in
not guaranteed by the partnership’s indi- respective contributions of labor and a fixed quantity of the crops. Such an
vidual members. So long as the loan that management are not equal. If the wife arrangement is usually called a cash
was not guaranteed results in a contribu- claims more than twenty-five percent of lease.56
tion of at least fifty percent of the capital the farming operation’s profits and losses, On the other hand, cash rent tenants
needed by the partnership for the year’s her contributions will not be “commensu- can receive payments. Cash rent tenants
farming operation, this contribution of rate” with her claimed share of the prof- are persons who rent land for cash or for
capital would qualify as a “significant its of the partnership because she has a crop share guaranteed in amount.57 To
contribution” of capital. only contributed twenty-five percent of be “actively engaged in farming,” a cash
The two components of the “significant the total contributions of labor and man- rent tenant must make a “significant
contribution” requirement are often called agement to the farming operation. Con- contribution” of (1) land, capital, or equip-
the “left-hand side” (the physical inputs sequently, she will be denied all farm ment and active personal labor; or (2)
of land, capital, or equipment) and the program payments, and her husband will equipment and active personal manage-
“right-hand side” (the human services of not be entitled to receive what would ment. If the cash rent tenant seeks to
labor or management). When the farm- have been her share. qualify under option 2 and the equip-
ing operation is conducted through a Assuming that their respective contri- ment is leased from the landlord, the
general partnership, the partnership may butions are “at risk,” both the husband lease must reflect payment of the
make the left-hand side contributions on and wife will be “actively engaged in equipment’s fair market value. If the
behalf of the partnership’s members. farming” if he claims a seventy-five per- equipment is leased from the person who
When it does, the contributions are at- cent interest in the partnership, and she is providing labor to the farming opera-
tributed proportionally to each member claims a twenty-five percent interest. As tion, the equipment lease and the labor
for “commensurate” contribution pur- a result, assuming that their farm will fees must be based on fair market values,
poses. When the farming operation is produce exactly $80,000 in production and the cash rent tenant must exercise
conducted by a corporation or similar flexibility contract payments, they will complete control over a significant amount
entity, the corporation or similar entity be leaving $20,000 “on the table” because of the equipment during the crop year.58
makes the left-hand side contributions, the husband’s partnership distributive In some instances, program participants
and the shareholders or members with at share right to $60,000 of those payments who believed they were qualifying under
least a fifty percent interest in the corpo- will be capped at $40,000 by the produc- option 2 above, and who leased equip-
ration “activate” the corporation by mak- tion flexibility contract payment limit. ment from the same individual who pro-
ing the “active personal labor” or “active As a couple, they will receive $60,000: vided hired labor, have been denied pay-
personal management” contributions. she will receive $20,000, and he will ments because their attorneys drafted
To illustrate how the “actively engaged receive $40,000. This result is still a gain equipment leases that included a provi-
in farming” requirements apply in an of $20,000 over what their farming op- Cont. on p.2

DECEMBER 2000 AGRICULTURAL LAW UPDATE 7