Bankruptcy – An Overview
Background
Bankruptcy law allows debtors in financial distress to settle their obligations by petitioning a federal court and developing a plan to either reorganize the debt or divide available assets among creditors. Bankruptcy thus allows some debtors to escape cumulative debt, which may not be paid in full, providing them with a “fresh start” upon completion of the bankruptcy process. Bankruptcy also creates an avenue for creditors to share in the debtor’s available assets both fairly and equitably.
Bankruptcy may be the only choice to recover for a farmer who is deeply in debt. Municipal and business bankruptcies may also impact agriculture enterprises. Each type of bankruptcy proceeding has a potential impact on farmers and agriculture as a whole.
The United States Constitution delegates authority to Congress to enact uniform bankruptcy laws, thus barring the states from having individual forms of bankruptcy. Even so, state laws defining and regulating the debtor-creditor relationship affect bankruptcy proceedings because some sections of the Bankruptcy Code incorporate these state laws. For more information about the debtor-creditor relationship under states’ laws, visit the Secured Transaction Reading Room. Title 11 of the United States Code contains the Bankruptcy Code. It contains six different types of proceedings under the two broad categories of liquidation or reorganization. The individual proceedings are divided by code chapters. Chapter 7 involves liquidation, while Chapters 9, 11, 12, and 13 involve reorganization. Chapter 12 applies specifically to eligible farmers, farms, and farm businesses, as well as fisherman.
Types of Proceedings
Chapter 12 – Adjustment of Debts of a Family Farmer or Fisherman with Regular Annual Income
The agriculture crisis of the 1980s led Congress to enact emergency legislation creating a bankruptcy proceeding specifically applicable to farmers. Congress believed that Chapter 11 was too complicated, expensive, and time-consuming for farmers, and Chapter 13 did not address the larger debt loads faced by family farmers. Chapter 7 liquidation was too harsh to be the only option for farmers tied to the land for generations. Therefore, Chapter 12 was created to give farmers a chance to reorganize their debts and keep their land.
Due to the nature of the emergency surrounding the legislation and the uncertainty of its successfulness, Chapter 12 was initially temporary and contained a sunset provision that required periodic action to renew the code section. In 2005, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, (BAPCPA), Pub. L. No. 109-08, 119 Stat. 23 (codified in scattered sections of 11 U.S.C.), which made Chapter 12 a permanent part of the Bankruptcy Code. Other significant changes were made regarding the eligibility requirements for Chapter 12.
For an excellent discussion of the Chapter 12 eligibility requirements, as well as other aspects of Chapter 12, please see the following articles:
Micah Brown, Bankruptcy on the Farm: A Look at the Chapter 12 Option (Sep. 2020) (Center article)
Susan A. Schneider, An Introduction to Chapter 12 Bankruptcy: Restructuring the Family Farm, (Oct. 2005) (Center publication)
Susan A. Schneider, Bankruptcy Reform and Family Farmers, (Sept. 2006) (Center publication)
Generally, Chapter 12 is available to a “family farmer” or “family fisherman” with “regular annual income.” This includes individual debtors and individuals and their spouses, as well as corporate and partnership entities controlled by a single family that pass an eligibility test. In Chapter 12, the maximum debt limit for a family farmer is $11,097,350 and the maximum debt limit for a family fisherman is $2,268,550.
Once the farmer-debtor files for Chapter 12, the proceeding automatically stays (stops) most collection agents. The court appoints an impartial trustee to evaluate the case and aid with disbursement. In Alabama and North Carolina, bankruptcy administrators perform similar functions like the U.S. trustees perform in the remaining states. The debtor, however, is entitled to remain in possession of the farm assets subject to specific duties and can only be removed for cause. Trustees do not generally interfere with farm operations unless the debtor is removed. After the debtor has organized a repayment plan, a meeting of creditors is held. Creditors and the trustee question the debtor regarding their financial affairs and the proposed plan, but creditors do not vote on the plan and may not propose plans of their own. The court evaluates the farmer-debtor’s plan, considering whether it complies with the applicable provisions of the Bankruptcy Code, whether it is proposed in good faith, whether the debtor is likely able to make the payments under the plan, and what each creditor will receive. After the court confirms the repayment, the debtor must meet their obligation to make regular payments to the trustee to ensure creditors receive payment. If the court does not confirm the plan, a remodified plan may be filed. Alternatively, the debtor may also convert the case to liquidation under chapter 7.
Chapter 12 bankruptcy poses payment advantages over Chapter 13 because approved plan payments can usually be structured around the farm’s cash flow cycle. Farms with regular monthly income, like a dairy, can provide monthly payments. Farms such as an orchard, vineyard, Christmas tree farm, row crop farm, cattle operation, may provide annual payments or payments that align with the farm’s harvesting and marketing of agricultural commodities. For example, a poultry farmer may provide payments four or five times per year based their grow out. Payment periods typically last no more than three years and may not exceed five years. The flexibility of chapter 12 provides three different options for family farm or fisherman debt relief. The first is traditional reorganization, to preserve the farm’s nature and scale, resulting from specific events that disrupt finances. The second is scaling down the farm’s size or converting to a different or more diverse production base by assessing farm resources and production changes to increase profitability while reducing debt. Finally, in situations where the farmer-debtor no longer wishes to operate the farm, is the sale of the assets excluding the homeplace. In the last situation the debtor maintains control over the marketing and sale, as opposed to chapter 7 where a trustee takes control. Additionally, for family farmers with cross-border operations, such as farming in Canada or Mexico and the United States, see chapter 15.
In 2017, Congress enacted The Family Farmer Bankruptcy Clarification Act 2017 (H.R. 2266), Pub. L. No. 115-72, 131 Stat. 1232, providing family farmers with more reorganization options under Chapter 12. Legislatively, Congress overturned a 2012 Supreme Court opinion (Hall v. United States). The legislation provides that any unsecured claim by a governmental unit resulting from a pre-petition or post-petition sale of farm property in a Chapter 12 bankruptcy is an unsecured claim not entitled to any priority and is dischargeable under the bankruptcy plan. Congress also removed the ability of a governmental unit to veto a Chapter 12 bankruptcy reorganization plan.
Chapter 11 – Reorganization
Reorganization under this chapter is available for any individual but is typically used by businesses that wish to continue operation and pay creditors following a plan approved by the bankruptcy court. It works most efficiently in corporations where ownership and management are divided.
To facilitate the continuation of the business, the Chapter 11 debtor usually remains in possession of the property of the bankruptcy estate and continues to manage the assets, subject to specific duties. As in Chapter 12, however, a trustee is appointed, and a meeting of creditors is also held to question the debtor.
On February 19, 2020, the Small Business Reorganization Act (SBRA) (H.R. 3311), Pub. L. No. 116-54, went into effect, creating a new subchapter under Chapter 11 of the Bankruptcy Code known as “Subchapter 5.” The legislation was designed to offer businesses with modest debts a faster and less expensive option for reorganizing under Chapter 11. Filing for bankruptcy under Subchapter 5 is perhaps most favorable to small businesses since it does not require a meeting of creditors, as opposed to Chapter 11, and other than the initial filing fee and administrative fee, essentially all fees are eliminated. The debtor proposes a plan subject to court approval, just like in Chapter 12, and creditors are not able to submit their own plans. A business qualifies to file a Subchapter 5 case if its debts are in the amount of $3,024,725 or less.
However, the Coronavirus Aid, Relief and Economic Security Act (CARES Act), that went into effect on March 27, 2020, increased the debt limit to $7.5 million. This provision applies to cases filed only after the effective date and is applicable for one year. This time period was extended to two years by the COVID–19 Bankruptcy Relief Extension Act of 2021. On March 27, 2022, the time for renewal of the debt limit for Subchapter 5 cases lapsed. However, on June 21, 2022, President Biden signed the Bankruptcy Threshold Adjustment and Technical Corrections Act (Corrections Act) (S.3823), Pub. L. No. 117-151, 136 Stat. 1298. The Corrections Act extends the $7.5 million debt limit for Subchapter V until June 2024. Notably, the Corrections Act applies retroactively to include all cases pending or filed as of June 21, 2022.
Chapter 13 – Adjustment of Debts of an Individual with Regular Income
Procedurally, Chapter 13 is like Chapter 12. But Chapter 13 is specifically designed for individuals that are regular wage earners. Thus, a corporation or limited liability company may not file for bankruptcy under chapter 13. Like Chapter 12, it allows the debtor to retain an asset that may have been lost under liquidation. Yet, debtors filing under Chapter 13 must have less than $2.5 million in combined secured and unsecured debts according to the Bankruptcy Threshold Adjustment and Technical Corrections Act (Corrections Act) (S.3823), Pub. L. No. 117-151, 136 Stat. 1298. The Corrections Act placed a two year pause on the category specific debt limitations for debtors. Previously, under 11 U.S.C. § 109(e), debtor eligibility was limited to $465,275 in unsecured debt (for example, credit card debt), and less than $1,395,875 in secured debt (for example, mortgages or car loans). Unless the Corrections Act is extended or until the Congress modifies the statute, the Corrections Act will expire in June 2024 and Chapter 13 eligibility will revert to the prior amounts.
Chapter 7 – Liquidation
Chapter 7 envisions a process under court guidance where a bankruptcy trustee gathers the non-exempt assets of the debtor and distributes the property or proceeds from the property equitably to creditors following the rules in the Bankruptcy Code. This likely means that the farmer or fisherman is seeking to get out of the business. The process begins when a bankruptcy petition is filed with the bankruptcy court. Similar to Chapter 12, the trustee holds a meeting of creditors where the debtor fields questions by creditors and the trustee regarding their financial situation.
The bankruptcy filing creates an entity known as the debtor’s estate that owns all of the debtor’s non-exempt property, including both legal and equitable interests. The trustee administers the estate to dispose of all non-exempt property and distribute proceeds to unsecured creditors. Property exempt from the bankruptcy estate is protected under either federal or state law from the reach of unsecured creditors. It remains property of the debtor, subject to valid security interests and mortgages, and will not be sold as part of the debtor’s estate. Bankruptcy also does not affect the rights of secured parties (for example, banks that hold the debtor’s mortgage), and any proceeds from properly secured collateral must be used to satisfy the obligations owed to the secured creditor before paying unsecured creditors. If estate property is of little value to the estate or the property is a burden for the estate, the trustee may abandon such property by removing it from the estate. Once the permissible estate assets have been liquidated, distribution is made in accordance with the priorities in the Bankruptcy Code.
Chapter 7 entitles the individual debtor to a discharge of certain debts. Entities may not have debt discharged, but they may be dissolved. The discharge is a release of personal liability for the debtor and is the mechanism that provides the “fresh start.” A creditor whose claim has been discharged may no longer continue collection activities on that debt. Public policy demands that certain debts not be eligible for discharge. Such debts include alimony, student loans, taxes, and claims arising from the use of a motor vehicle while impaired. In addition, some debtors are not eligible for discharge due to their actions, such as fraud, refusal to obey court orders, concealment of assets or records, and prior bankruptcy filings within a certain time period. The court may revoke a discharge upon request of the trustee or a creditor if it was obtained by fraud or the debtor acquired estate property and failed to report it.
Chapter 9 – Adjustment of Debts of a Municipality
Under Chapter 9, insolvent municipalities are given the opportunity to reorganize their debt. “Municipality” is broadly defined and may include cities, towns, counties, utilities, school districts, and water districts. The municipality must be authorized by state law to enter bankruptcy proceedings before it is eligible. The reorganization plan usually extends debt maturities, reduces principal or interest, or refinances the debt with a new loan. No provision for liquidation or dissolution exists. While it is unlikely that a Chapter 9 could be filed in an agricultural context, it could arise when governmental entities such as irrigation districts or improvement districts experience financial trouble.
Chapter 15 – Ancillary and Other Cross-Border Cases
Under chapter 15, a debtor, or property, subject to the laws of the United States and the laws of one, or more, foreign countries can find guidance for dealing with cross-border insolvency. With the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Congress sought to promote a uniform and coordinated legal process by codifying the United Nations Commission on International Trade Law Model Law on Cross-Border Insolvency. Canada and Mexico, as well as several other countries, adopted the Model Law with variation in some circumstances. Because of the global nature of food and fiber production, chapter 15 may play a rare but unique role considering the web of debtors, assets, claimants, and other parties of interest among international jurisdictions.
Generally, a chapter 15 case runs ancillary to a primary proceeding brought in the debtor’s home country by a foreign representative. Once recognized by the U.S. courts, the proceeding will be recognized as either (a) a foreign main proceeding or (b) a foreign non-main proceeding. The difference lies in where the debtor’s center of main interests is located. In a foreign main proceeding, the automatic stay and other specific provisions of the Bankruptcy Code take effect within the U.S.
Additionally, foreign creditors have a right to intervene in U.S. bankruptcy proceedings. Subject to certain treaties, foreign creditors are protected against discrimination. Like other chapters, a trustee or other entity, like an examiner, can be authorized to act and represent the U.S. bankruptcy estate in a foreign country. Chapter 15 proceedings are relatively infrequent for agricultural operations.