In this case, we consider whether com received under the federal government’s Payment-in-Kind (“PIK”) program — under which farmers receive surplus grain in exchange for an agreement not to plant their intended crop — constitute crop “proceeds” under the Uniform Commercial Code. The Bankruptcy Court for the Northern District of Illinois determined that PIK payments are proceeds and the District Court affirmed. We reverse.
Leland and Mary Schmaling (the “Schmalings” or the “debtors”) are farmers in Jo Daviess and Carroll Counties, Illinois. On May 5, 1982, the Schmalings and the First National Bank of Freeport (the “Bank”) entered into a security agreement. The agreement covered the following collateral:
All of the farm machinery and equipment, livestock and the young and products thereof, corn and all other crops grown or growing, and the feed, seed, fertilizer, and other supplies used in connection with the foregoing which are now owned or existing, and which are now located on the [Schmalings’] real estate ..., together with all property of a similar nature or kind to that therein described which may be hereafter acquired. ...
In 1983, the Schmalings entered into a contract to participate in the United States Government’s PIK program. Under that program, a farmer agrees to remove a specified percentage of his farm’s acreage base and designated crops from production. He also agrees to follow certain soil conservation procedures. If the farmer takes these steps, the government transfers to him a commodity equal in quantity to a percentage of what his diverted or nonpro-ducing acreage would normally yield. 7 C.F.R. § 770 et seq. (1984).
The debtors assigned their PIK rights to three parties: Esther Schmaling, the Carroll Service Company and the State Bank of Pearl City. Esther Schmaling was assigned the right to receive 22,960 bushels of PIK corn. In reliance on this assignment, she loaned the debtors $47,537.92 in 1983. The State Bank of Pearl City loaned the debtors $12,000 in 1983 for operating and rent expenses and received the right to 6,612 bushels of PIK corn as collateral. Later, Pearl City loaned the debtors an additional $3,300, using the PIK corn as collateral. Carroll Service Company sold the debtors supplies for the 1982 farming season worth over $40,000. By September 1983, the debtors still owed $13,972.44 on their 1982 bill and assigned Carroll Service 6,200 bushels of PIK corn toward payment. Later, expenses from the 1983 season came due and the debtors owed Carroll Service $32,196.03.
In October 1983, Esther Schmaling presented the document entitling her to the PIK corn to Johnston’s Feed Service for payment. Payment was denied on the basis of a claim by the Bank of Freeport stating that it was entitled to the PIK payment because of its security agreement with the Schmalings. Thereafter, upon agreement of the parties to the dispute, the total amount of the proceeds that the debtors were entitled to receive under the PIK program — $99,343.44—was deposited in a trust account with the debtors’ attorneys pending resolution of the respective priorities of the parties.
On March 9, 1984, the Schmalings filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. 11 U.S.C. § 1101 et seq. On March 30, 1984, they filed a complaint in the Bankruptcy Court *682 for the Northern District of Illinois under § 544(a) of the Bankruptcy Code 1 to set aside a lien against them in favor of the First National Bank of Freeport. Esther Schmaling, the Carroll Service Company and the State Bank of Pearl City intervened as parties plaintiff.
The Bankruptcy Court found for the Bank. It concluded that, “although the agreement did not contemplate the not-as-yet-commenced Payment-in-Kind program and its proceeds specifically, its coverage was intended to be broad so as [sic] cover all of the debtor’s farm-related assets.”
The United States district court affirmed. It found that because PIK payments are based on debtors’ prior growing history, participants in the program in essence “ ‘exchanged’ their own corn for the PIK corn,” thus making the PIK payments “proceeds.” 2 A contrary result, the court found, would create a potential for fraud, as farmers could avoid a security agreement in crops merely by abandoning their farming activities and participating in a Payment-in-Kind program. We disagree.
I.
Because the Bankruptcy court found the Schmalings’ intent to grant the Bank a security interest in all farm-related assets to be clear, it eschewed engaging in a “hypothetical bout over the meaning of the word ‘crops.’ ”
Schmaling v. First National Bank of Freeport,
Mem.Op. No. 84-A-2037 (Bankr.N.D.Ill. 8/1/84). However, a security interest granted by a debt- or to a creditor is limited strictly to the property or collateral described in the security agreement.
See Allis Chalmers Corp. v. Staggs,
For something to be “proceeds” of crops, therefore, it must be received upon their “sale, exchange, collection or other disposition.” U.C.C. § 9-306(2);
In re Connelly,
As a consequence, most courts have concluded that inkind payments do not constitute proceeds of crops. As the court held in
In re Mattick,
Cases finding PIK and like payments to be proceeds of crops are generally distinguishable. In
In re Kruse,
Some cases have concluded that because the PIK payments substitute for crops that would have been grown but for the participation in the program, PIK receipts are proceeds.
See In re Judkins,
*684
We also cannot accept the district court’s contention that finding for the debtors will create an unintended potential for fraud. The court stated, “If PIK payments were not proceeds, a farmer could abandon all farming activities in favor of program participation, thereby allowing him to dissipate the proceeds of the programs without any regard for his creditors’ interests.” This argument can be made anytime a farmer finds a substitute use of his land, such as using his fields for a rock concert or a fair ground instead of for the growing of crops. Clearly, income derived from such alternative uses could not be considered crop proceeds. Moreover, banks can easily avoid such potential losses of collateral by careful drafting,
see In re J. Catton Farms, Inc.,
The decision below is therefore Reversed.
Notes
. Section 544(a) — the "strong arm clause” of the Bankruptcy Code — states:
(a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the dealer or any obligation incurred by the debtor that is voidable by—
(1) a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained a judicial lien, whether or not such a creditor exists....
Under section 544(a), the trustee takes the position of a hypothetical lien creditor and can avoid any unperfected security interest. In their complaint against the Bank of Freeport, the Schmalings stated that even if PIK revenues were proceeds, the Bank’s interest in them was unperfected, as proceeds paid in tangible property require the filing of a financing statement for perfection under § 9-306(3) of the U.C.C. As the Bank never filed a financing statement specifically mentioning the in-kind payments, the Schmalings contended, the Bank’s interest was subordinate to the interest of the Schmal-ings’ assignees.
. Under the U.C.C., a security interest will continue in proceeds of collateral described in the security agreement unless the agreement or the secured party specifies otherwise. § 9-306(2) states:
Except where this Act otherwise provides, 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, and also continues in any identifiable proceeds, including collections received by the debtor.
. As we find that payments-in-kind do not constitute crop proceeds for purposes of construing the security agreement, it is unnecessary to determine whether proceeds paid in grain require additional measures for perfection under U.C.C. § 9-306(3).