Don’t Hate the Players, Understand the Game - The Lenders

There’s a reason they call it the racing industry. A complex support structure underlies the business that ultimately enables us to watch the Derby on the first Saturday in May. A few weeks ago I wrote about some of the peripheral players in the racing industry, the immigrants who fill the ranks of backstretch workers and horse farm workers (Si, se puede … and as a follow-up, the Paulick Report noted today that B.E.S.T, John Hendrickson, Mary Lou Whitney, and others are teaming up in a tribute to Hispanic workers on the backstretch). From the backstretch workers and farm workers, to the farm owners and veterinarians, the trainers, jockeys, and stewards, the usual suspects put long hours and a lot of labor into the Thoroughbred industry.

But industry also requires capital, and while Thoroughbreds are a big money enterprise, money doesn’t flow as easily as it might seem. And so we find one of the biggest peripheral players in the industry, although one that often doesn’t lumber onto the scene until things have gotten legally complicated - the equine lender, aka the Bank.

The Bank made a notorious appearance during the lead-up to the 2007 Triple Crown, when it turned out that J. Paul Reddam had bought Derby contender Great Hunter from Ilona Whetstone without checking to see if anyone else had a say in the matter. Fifth Third Bank, one of the major equine lenders, had a say in the matter - its loan of more than $3 million to Whetstone was secured by a variety of equine collateral, including “all the Thoroughbred bloodstock” whether classified as “inventory, equipment, farm products, goods or otherwise” (more on that later), as well as “all racing income.” That description of the collateral most certainly included Great Hunter and anything he won; his metaphorical title certificate had a first lien in favor of Fifth Third Bank.

But Whetstone, not Reddam, owed the Bank, right? How could Fifth Third tie up his winnings at Keeneland or attempt to force his sale? This part gets tricky. Horses are governed by Revised Article 9 of the Uniform Commercial Code, which means that they can be used as collateral for loans, just like a car or a crop of wheat or a front-end loader. But everything turns on exactly what kind of collateral a horse is, and that depends on what state they’re in, who owns them, and what they’re used for. In Kentucky, all horses are “farm products” by statute, no matter who owns them or what they’re used for, so in Kentucky, Great Hunter would have been considered a “farm product.” But Kentucky’s uniformity is the exception; in any other state a horse could be a farm product, a good, equipment, inventory, or a few other things (and that’s not counting what happens when you start dividing horses up into breeding seasons or other fractional interests with specific rights).

On to Reddam’s purchase. Had he bought Great Hunter at Keeneland, he would have bought the horse free and clear of Fifth Third’s security interest, due to a specific Kentucky statute (Kentucky is all about facilitating the sale of horses if you haven’t noticed). Alternatively, if Great Hunter had qualified as a farm product, Reddam could have taken free and clear thanks to the Federal Food Securities Act.

But Reddam purchased Great Hunter privately in a state other than Kentucky, where race horses are categorized under the UCC as “equipment.” As a result, Fifth Third’s security interest continued in Great Hunter and his proceeds, i.e. winnings or whatever he sold for, and the bank arguably had a right under the UCC to force his sale. Ultimately, the case settled out of court. Had it been litigated, I think Fifth Third should have won, and this despite the incredulous trade coverage of the matter, which served to vilify the Bank a bit … a disingenuous move, considering the role that equine lending plays in the industry.

Fifth Third made a recent appearance a few days ago in the ongoing mess known as the Classicstar litigation / Chapter 7 proceeding. Fifth Third claims that Classicstar still owes them $3 million and filed a motion with the bankruptcy court for access to certain secured assets. The equine interests here are pretty routine - stallion shares (including Speightstown), stallion income (including Real Quiet), lien proceeds, winnings, and breeders’ incentive awards.

How routine, and how common is equine lending in the industry? More common than you might think. Pinhookers, owners, and breeders all take advantage of the banks that have the knowledge and experience to make these loans. TOBA endorses National City, another of the major equine lenders. Even Tom Gentry tried to get into the equine lending game back in 2000. The banks have experts who can independently value horses and other equine interests, keep track of borrowers as they participate in various areas of the racing industry, and even foreclose on horses when loans go bad. Just like a certain percentage of houses on the market today are foreclosure sales, some of the horses that are prepped for sales and sent through Keeneland and Fasig Tipton were repossessed and sold pursuant to Revised Article 9. And in those cases, it’s rarely just the Banks who have a say in the matter - borrowers who don’t make their loan payments often aren’t paying their bills, either (resulting in stable keeper’s liens or vet liens), their stud fees (stallion service liens), or what they might owe to judgment creditors (as was the case with Whetstone). Often it’s up to a court to decide who gets paid and in what order.

Many of the images we get of Thoroughbred ownership are of limitless affluence (outside the infield, of course), which the industry is willing to perpetuate, to some extent, because that kind of glamor leads to the mystique of the Thoroughbred world. But, while it’s not a poor man’s game, working capital isn’t as easy to come by as it might seem. For the most part, equine lending works seamlessly into breeding, sales, and racing, helping the industry maintain the image we’ve all come to know. Only occasionally do the big banks pop up in trade news, usually to take care of business and return behind the scenes. Unless, of course, you bankrupt your farm with debt and break a few laws trying to figure a way out; just ask J. T. Lundy.