                    United States Court of Appeals
                          FOR THE EIGHTH CIRCUIT
                                   ___________

                                   No. 06-2590
                                   ___________

Farmers Bank of Hamburg, Arkansas,     *
                                       *
            Appellant,                 *
                                       * Appeal from the United States
      v.                               * District Court for the
                                       * Eastern District of Arkansas.
United States Department of            *
Agriculture; Mike Johanns,1            *
Secretary of Agriculture,              *
                                       *
            Appellees.                 *
                                   __________

                              Submitted: December 11, 2006
                                 Filed: July 19, 2007
                                  ___________

Before WOLLMAN, BEAM, and RILEY, Circuit Judges.
                          ___________

RILEY, Circuit Judge.

       The Farmers Bank of Hamburg, Arkansas (Bank) appeals the district court’s
order affirming the decision of the Rural Business-Cooperative Service (the Agency)2



      1
       Mike Johanns is automatically substituted for his predecessor, Ann Veneman,
pursuant to Federal Rule of Appellate Procedure 43(c)(2).
      2
      The Rural Business-Cooperative Service is part of the Rural Development
Agency, which is part of the United States Department of Agriculture.
denying the Bank’s loss claim for loans guaranteed by the Agency. We affirm in part
and reverse in part.

I.     BACKGROUND
       In 1998 and 1999, the Hermitage Tomato Co-operative Association (Co-op),
a cooperative of tomato growers, obtained nine loans totaling $9,604,860 from the
Bank. The Agency guaranteed the loans up to 90% of their value. The Bank closed
the loans in three separate phases, each phase consisting of three loans. Phase I and
Phase II loans closed in March of 1998 and 1999, respectively. Phase I loans totaled
$3,000,000 and Phase II loans totaled $1,849,702.

      Sometime after the 1999 summer growing season, but before the Bank obtained
the Co-op’s financial statements for the 1999 fiscal year, the Co-op and the Bank
began discussing the possibility of a third loan, the Phase III loans, for an amount
exceeding $4,000,000. The purpose of these loans was, among other things, to enable
the Co-op to expand its operations to a year-round business by including a supply and
convenience store.

       By December 13, 1999, the Co-op was delinquent in loan payments in the
amount of $447,701.29 on Phase I and Phase II loans. The Bank’s president, Dan
Wingard (Wingard), wrote a letter on December 13, 1999, to the Agency reporting the
Co-op’s delinquencies. In his letter, Wingard also informed the Agency the Co-op
had made arrangements to cure the delinquencies. The Agency, however, would not
issue the Phase III loan guarantees due to the Co-op’s delinquencies.

      Based on the Agency’s position regarding the Co-op’s delinquencies, the
following events took place on or about December 21, 1999: (1) the Co-op deposited
$450,480 into its operating account from bridge loans, which consisted of a $300,000
check from the Co-op’s law firm and three checks totaling $150,480 from an



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individual;3 (2) the Bank submitted a lender’s certification to the Agency, stating there
had been no material adverse change in the Co-op’s financial condition; (3) the
Agency issued a conditional commitment to guarantee the Phase III loans giving the
Co-op one year to meet certain conditions; (4) the Bank closed the Phase III loan
agreement; and (5) the Co-op repaid most of the bridge loans.

       Before issuing the Phase III loans, the Bank had not yet received the Co-op’s
1999 fiscal year audited financial statements. The Agency regulations required the
Bank to submit the financial statements to the Agency within 120 days after the close
of the Co-op’s fiscal year (August 31). When the Bank received the Co-op’s financial
statements in February 2000, the statements showed a loss of $747,000. The
statements also revealed the Co-op failed to meet other conditions under the Agency’s
guarantees, including a minimum asset/liability ratio, minimum accounts receivable
or cash on hand, and a 10% tangible balance sheet equity.

       In November 2000, due to a poor growing season, Wingard requested that the
Agency extend the Co-op’s one-year deadline, set to expire on December 21, 2000,
to meet the conditions previously set forth in the Agency’s conditional commitment
for the guarantee of the Phase III loan.

      On January 3, 2001, the last day of Wingard’s employment with the Bank,
Wingard wrote to the Agency and requested the issuance of the Phase III loan
guarantee. Wingard represented to the Agency that the Co-op had met all the
requirements of the conditional commitment with the exception of the 10% equity
requirement, which Wingard requested the Agency waive. Wingard also requested



      3
       The parties refer to these deposits as bridge loans, and the Co-op used the
proceeds of the bridge loans to pay its delinquencies on Phase I and Phase II loans.
When the Co-op received the bridge loans, the Co-op had an operating account
balance of less than $10,000.

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that the Agency restore $580,348 of the Co-op’s working capital from the Phase I and
Phase II loans.

      The Agency denied Wingard’s request for restoration of the working capital,
but agreed to guarantee the Phase III loan if the Co-op could raise $580,000. In
February 2001, the Bank, in conjunction with another bank, agreed to loan the Co-op
$580,000,4 and the Agency issued the Phase III loan guarantee.

       The Co-op eventually defaulted on all the loans. The Bank hired an
independent accounting firm to investigate the Co-op’s finances and activities. In a
report dated September 20, 2002, the accounting firm revealed the Co-op’s working
capital had been mismanaged from 1998 to 2001 in a manner that directly benefitted
Co-op members, but depleted funds available to pay loan debt. The accounting report
also indicated Co-op members made contributions in the form of notes receivable
totaling $1.3 million that were used as collateral for the Co-op loans. A portion of the
notes receivable had been written off and some were past due. The accounting report
further indicated the Co-op made payments to its members on several occasions in
violation of policies and procedures under the Agency’s conditional commitments for
the Co-op’s loan guarantees.

       On December 18, 2002, the Bank submitted to the Agency a loss claim of
$7,442,317.70, specifically, (1) Phase I loan losses of $1,856,294.45; (2) Phase II loan
losses of $1,210,528.60; and (3) Phase III loan losses of $4,375,494.65.

      On December 19, 2002, the Bank filed a lawsuit in state court against Wingard
and the Co-op. The Bank alleged, among other things, Wingard and the Co-op
conspired to commit fraud. The Bank specifically alleged Wingard violated his


      4
       The loan commitment included many restrictions, and the Co-op never actually
received the full $580,000.

                                          -4-
fiduciary duties to the Bank. The Bank asserted, when the Bank closed the Phase III
loans, Wingard and the Co-op used the bridge loans to conceal the fact the Co-op
failed to meet the Agency’s requirements. The Bank claimed Wingard and the Co-op
fabricated assets to serve as collateral for the Co-op’s loans.

       On July 23, 2003, the United States Department of Agriculture’s Office of
Inspector General (OIG) issued an audit report recommending the Agency “take
action to contest the guarantees, or substantially reduce the remaining balance of the
loan [] guarantees totaling $6,993,578.” The audit report, in relevant part, stated:

      Specifically, we found that the lender: Processed guaranteed loans to an
      ineligible borrower, allowed the borrower to use guaranteed funds to pay
      delinquent Federal debt, allowed the borrower to use guaranteed loan
      funds for unauthorized purposes, failed to adequately supervise the
      construction of the borrower’s facilities, and allowed the borrower to
      divert working capital away from the co-operative.

Based on this report, the Agency, on August 29, 2003, denied the Bank’s loss claim,
finding the Bank was negligent in servicing the loans. The Bank unsuccessfully
appealed to the National Appeals Division (NAD). The Bank then appealed, in
accordance with the provisions of the Administrative Procedure Act, 5 U.S.C. §§ 701-
706, to the district court requesting review of the Agency’s final decision. The district
court upheld the Agency’s decision. This appeal followed.

II.   DISCUSSION
      A.      Standard of Review
      “When reviewing the district court’s opinion upholding the administrative
agency’s decision, this court must render an independent decision on the basis of the
same administrative record as that before the district court.” Mages v. Johanns, 431
F.3d 1132, 1139 (8th Cir. 2005) (quotations omitted). “We will set aside an agency’s
decision if it [is] arbitrary, capricious, an abuse of discretion, or otherwise not in


                                          -5-
accordance with law.” Id. “We accord substantial deference to an agency’s
interpretation of its own regulation . . . unless the interpretation is plainly erroneous
or inconsistent with the regulation.” Id. (quotation omitted).

      B.     Regulations and Loan Guarantee
      Under the Agency’s regulations, all lenders obtaining or requesting a loan
guarantee are responsible for servicing guaranteed loans in a prudent manner,
including liquidation, if necessary. The regulations specifically provide:

             The lender is responsible for servicing the entire loan and for
      taking all servicing actions that a prudent lender would perform in
      servicing its own portfolio of loans that are not guaranteed. The Loan
      Note Guarantee is unenforceable by the lender to the extent any loss is
      occasioned by . . . use of loan funds for unauthorized purposes, negligent
      servicing, or failure to obtain the required security interest regardless of
      the time at which the Agency acquires knowledge of the foregoing. This
      responsibility includes but is not limited to the collection of payments,
      obtaining compliance with the covenants and provisions in the Loan
      Agreement, [and] obtaining and analyzing financial statements. . . .

7 C.F.R. § 4287.107 (emphasis added).

      The lender must submit annual financial statements to the Agency within
      120 days of the end of the borrower’s fiscal year. The lender must
      analyze the financial statements and provide the Agency with a written
      summary of the lender’s analysis and conclusions, including trends,
      strengths, weaknesses, extraordinary transactions, and other indications
      of the financial condition of the borrower.

Id. § 4287.107(d).

     As a condition for obtaining loan guarantees, the Bank entered into a Lender’s
Agreement with the Agency. This agreement, in relevant part, provides:


                                          -6-
      The Loan Note Guarantee will be unenforceable by the Lender to the
      extent any loss is occasioned by . . . negligent servicing, or failure to
      obtain the required security regardless of the time at which USDA
      acquires knowledge of the foregoing. Any losses will be unenforceable
      by the Lender to the extent the loan funds are used for the purposes other
      than those specifically approved by USDA in its Conditional
      Commitment for Guarantee. Negligent servicing is defined as the failure
      to perform those services which a reasonably prudent Lender would
      perform in servicing its own portfolio of loans that are not guaranteed.
      The term includes not only the concept of a failure to act but also not
      acting in a timely manner.

      ....

      [The Lender is responsible for o]btaining from the Borrower periodic
      financial statements as required in the loan agreement with the borrower.
      At a minimum, annual financial statements must be forwarded by the
      lender, with a credit analysis, to the USDA servicing office within 120
      days of Borrowers [sic] fiscal year end.

(Emphasis added).

      C.      Phase III Loans
      With these regulatory provisions and agreement duties in mind, we first
consider whether the Agency properly denied the Bank’s loss claim regarding the
Phase III loans on the ground the Bank was negligent in servicing the loan. The NAD
agreed with the Agency, finding that if the Bank had complied with the regulations,
the Bank would have obtained the Co-op’s audited financial statements before closing
the Phase III loans. Before the Bank approved the Phase III loans, the Co-op was in
default on Phase I and Phase II loans, and the Bank was aware the Co-op was
essentially borrowing to pay its delinquencies on the Phase I and Phase II loans. The
regulations provide:



                                         -7-
             Credit evaluation. This is a key function of all lenders during the
      loan processing phase. The lender must analyze all credit factors
      associated with each proposed loan and apply its professional judgment
      to determine that the credit factors . . . ensure loan repayment.

7 C.F.R. § 4279.30(b). The Bank finalized the Phase III loans in December 1999, but
the Bank did not receive the Co-op’s audited financial statements until February 2000.
Considering the Co-op’s known financial difficulties, and suspect credit worthiness,
a reasonably prudent lender would not have loaned the Co-op over $4,000,000 more
without first receiving the Co-op’s audited financial records. The Bank clearly
neglected to keep apprised of the Co-op’s financial condition. Contrary to the Bank’s
assertion, a causal nexus exists between its failure to act as a reasonably prudent
lender and the Phase III loans’ losses.

       The Bank makes several arguments attempting to avoid responsibility for its
failure to act as a prudent lender. First, the Bank tries to disassociate itself from
Wingard’s actions, claiming its Board of Directors was never aware of the Co-op’s
true economic state. However, as the district court notes, the Bank is ultimately
responsible for the negligent acts of its agents and employees made within the scope
of their employment. William Edward Johnson (Johnson), the Bank’s general counsel
and a member of the Bank’s Board of Directors, admits the Bank knew it bore the
responsibility to be aware of the Co-op’s true financial condition. Johnson stated,
once the Bank received the Co-op’s audited financial statements, the Bank’s Board of
Directors was upset and talked “to Dan Wingard about this is [his] baby, not meaning
it was his total responsibility.”

      Second, the Bank attempts to shift responsibility to the Agency, stating the
Agency knew about the Co-op’s losses when the Agency issued its guarantee. The
Agency, however, was unaware of two very important aspects of the Phase III loans,
namely, (1) the Co-op intended to use the proceeds of the Phase III loans to refinance
(by indirectly paying the delinquencies of) the Phase I loans and Phase II loans, and

                                         -8-
(2) the purpose of the $580,000 loan the Bank made to the Co-op for working capital
was merely to induce the Agency to issue its guarantee. The Bank ignored the Co-
op’s poor credit worthiness, as well as the purpose of the bridge loans, to obtain a
guarantee of the Phase III loans.

        The Bank claims the bridge loans were proper and, since one of the purposes
of the Phase III loans was to obtain working capital, the Co-op did nothing improper
by paying back the bridge loans with Phase III loan proceeds. The propriety of the
bridge loans, however, is irrelevant to this inquiry. The problem is neither the Bank
nor the Co-op informed the Agency that one purpose of the Phase III loans was to
refinance Phase I and Phase II loans by paying the delinquent bridge loans.
Furthermore, before the Agency’s issuance of the Phase III loans guarantee, a material
change in the Co-op’s financial condition occurred, that is, the Co-op increased its
liabilities by borrowing a half-million dollars. The Bank misled the Agency when it
reported there were no material changes in the Co-op’s financial condition. Quite
simply, the Agency never authorized Phase III loan proceeds to bring Phase I loans
and Phase II loans current.

       Next, the Bank contends the NAD erred in its decision because it failed to
recognize the construction of the Co-op’s convenience store (built approximately
1,000 square feet smaller than expected) did not result in a monetary loss. The NAD,
however, never considered the store’s smaller size a loss. The NAD stated, neither the
fact the store was built smaller than expected nor the possible resulting damages was
the issue. The issue, as the NAD indicated, was whether the Bank complied with its
regulatory duties to supervise the construction of the convenience store. See 7 C.F.R.
§§ 4279.30(a)(1)(v), 4279.156(b). The fact the store was built smaller, and contrary
to the project’s specifications, is simply another illustration of the Bank’s failure to
comply with its duties under the regulations.

       Finally, the Bank claims the OIG’s report is inaccurate because it is based upon
a report of an independent accounting firm hired by the Bank. This claim is meritless,
                                         -9-
first, because the Bank relies upon the same report to support its allegations against
Wingard in the state lawsuit. Second, the record indicates the OIG’s report was the
product of a comprehensive review of records from the Agency, the Bank, and the Co-
op.

       D.    Phase I and Phase II Loans
       We next consider whether the Agency properly denied the Bank’s loss claims
regarding the Phase I and Phase II loans. The Agency states it denied the claims
because the Bank was negligent in servicing these loans. However, the record does
not contain sufficient evidence to prove the Bank’s negligence or the necessary
causation regarding any negligent servicing of these loans in order to demonstrate
what particular losses proximately resulted from any of the Bank’s actions or
inactions. The record contains only two facts the Bank could have known concerning
the Co-op’s financial condition when these loans were issued in March 1998 and
March 1999, namely, (1) the Co-op did not charge members processing fees for the
1998 crop and absorbed a $79,000 loss, and (2) the Co-op sustained losses for the
1998 growing season because of a power failure. The Agency’s decision to deny the
Bank’s loss claims regarding the Phase I and Phase II loans does not explain with any
degree of specificity or factual support how the Bank failed to act as a reasonably
prudent lender in servicing those loans sufficient to warrant a total denial of the loss
claims.

       The Agency contends the Bank’s monitoring was negligent, and the Bank could
have, should have, and would have discovered the Co-op’s mismanagement,
violations of loan provisions, and inadequate funding had the Bank not been negligent.
This contention is mere conjecture. Assuming the Bank’s supervision were negligent,
calculating that discovery would have avoided all the losses, or even some of the
losses, would be sheer speculation on this record. The Bank was not operating the Co-
op and, other than making suggestions, threats, and demands, could only declare a
default and pursue collection. The record contains no evidence regarding how
declaring a default at any particular time would have affected the Co-op’s financial
                                         -10-
condition and ability to repay the loans. The Agency’s principal witness testified the
Co-op’s mismanagement and diversions “may have been prevented” “in part.” The
hearing officer found “[i]t is not to say [the Bank] could have prevented Co-op
financial problems, but proper servicing and oversight could have substantially
reduced financial losses to both [the Bank] and [the Agency].” How? And how
much? The record does not answer either question. The Agency failed to meet its
own regulation and its contractual obligation to show “the extent any loss [was]
occasioned by . . . negligent servicing.” 7 C.F.R. § 4287.107; Lenders Agreement
Business and Industry Guaranteed Loan Program, ¶ IB. With respect to the Phase I
and Phase II loans, the Agency’s decision is not supported by substantial evidence.

III.  CONCLUSION
      Based on the foregoing, we affirm the district court’s order with respect to the
Phase III loans, but reverse with respect to the Phase I and Phase II loans. This case
is remanded to the district court with instructions to remand to the Agency for further
proceedings consistent with this opinion.
                            _________________________




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