Financial conditions during the past few years have been harsh for agricultural producers. Low commodity prices and extreme weather conditions have decreased income for many farmers, making it more difficult for farmers to repay their loan debt. For this reason, there has been a recent surge in farm bankruptcies. Deciding whether to file for bankruptcy is not an easy decision to make, but there are alternatives to bankruptcy. However, these alternatives are not always available. Filing for bankruptcy may be the only opportunity for a farmer who is greatly in debt to recover. Because of the current market slump and ongoing pandemic, understanding which type of bankruptcy proceeding for an agricultural producer is ever more important.
Bankruptcy is governed by federal law. Title 11 of the United States Code contains the Bankruptcy Code which provides the provisions for case administration, creditor claims, debtor’s estate, and bankruptcy relief. The chapters of the Code containing debtor-relief provisions are specifically designed for particular types of debtors or different outcomes for debtors.
In general, bankruptcy provides an opportunity for an individual or business to either liquidate assets or reorganize debts. Chapter 7 of the Code provides the process for liquidation bankruptcy. Under liquidation bankruptcy, also referred to as “straight bankruptcy,” a debtor will turn over all assets to a bankruptcy trustee who distributes cash from the disposition of the assets to creditors, and obtains a discharge from the debts for the debtor. If a debtor prefers rehabilitation or reorganization of their debts, they will file for bankruptcy under Chapters 11, 12, or 13, depending on what type of debtor they are. For this type of bankruptcy, a debtor will retain their assets and develop a plan to repay creditors.
Both types of proceedings seek to provide a debtor with a fresh start, but the outcomes largely differ. Therefore, a farmer-debtor committed to filing for bankruptcy must determine what their goals are for during and after the bankruptcy process. For a more in-depth discussion on the background of bankruptcy and the types of proceedings, visit the Center’s Bankruptcy Overview.
Chapter 12 Background
Bankruptcy law provides a unique type of proceeding directly tailored to agricultural producers. In 1986, Congress responded to the financial crisis challenging farmers throughout the 1980s by enacting a temporary section of the Bankruptcy Code specifically applicable to farmers known as Chapter 12. Since then, many changes have been made to Chapter 12. A significant change to the chapter came in 2005 when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act. This piece of legislation made Chapter 12 a permanent part of the Code, and also extended eligibility to fishermen. Recently, the enactment of the Family Farmer Relief Act of 2019 increased the Chapter 12 operating debt cap from $4,153,150 to $10 million, meaning farmers with debts not exceeding $10 million are eligible to file for Chapter 12 bankruptcy.
In creating Chapter 12, Congress sought to provide a framework that would enable a farmer to successfully reorganize their finances so they could repay all or part of their debts while also keeping the farm operation in business. Chapter 12 may be a desirable course, but the farmer or farm business must meet the eligibility requirements. In general, Chapter 12 is available to a “family farmer” with “regular annual income.” 11 U.S.C. § 101(19). A “family farmer” includes not just an individual debtor, but also an individual and their spouse, corporations, cooperatives, and partnerships. The Code sets forth specific eligibility requirements for the different types of petitioners.
To qualify for Chapter 12 bankruptcy, individual petitioners must satisfy a four-part eligibility test: (1) they are engaged in a farming operation; (2) their debts do not exceed $10 million; (3) no less than fifty percent of their debts arise from farming; (4) and more than fifty percent of their income comes from farming for the taxable year preceding filing or in each of the second and third taxable years preceding filing. 11 U.S.C § 101(18)(A).
Corporations, cooperatives, and partnerships are also subject to an eligibility test, but six requirements must be met: (1) at least fifty percent of stock or equity is held by one family and its relatives; (2) those family members conduct the farming operation; (3) have at least eighty percent of the family’s assets relate to the farming operation; (4) the family’s debts do not exceed $10 million; (5) more than fifty percent of the family’s debts arise from the farming operation; (6) and if the debtor is a corporation issuing stocks, the stocks cannot be publicly traded. 11 U.S.C. § 101(18)(B).
Advantages of Chapter 12
A debtor who meets the Chapter 12 eligibility requirements is not immediately required to file under that chapter. Most likely a debtor that is eligible to file under Chapter 12 will also be eligible to file under Chapters 7, 11, and 13. Depending on the debtor’s situation, one of those chapters may better serve their bankruptcy goals. However, unlike other bankruptcy chapters, Chapter 12 was created to protect farmer interests.
One situation in which a family farmer may prefer a Chapter 12 proceeding over another type of bankruptcy is when the goal is to continue the farming operation. Although chapters 11 and 13 allow the debtor to continue their business operations, Chapter 7 does not. A Chapter 7 filing will cause an immediate stop to all farming activity and each of the farmer’s assets will be liquidated. This type of bankruptcy is the quickest and least expensive, and for a farmer interested in discontinuing their farming operation, Chapter 7 will satisfy that objective. However, for a debtor intending to continue the farming operation, Chapter 12 is the more appropriate type of bankruptcy.
When it comes to repaying creditors, Chapter 12 may better serve a farmer’s goals because it provides a farmer with far more flexibility and control over reorganization of their debts than other types of bankruptcy. When a debtor files for reorganization bankruptcy, they are required to propose a plan for how their creditors will be repaid. A Chapter 12 filing grants a farmer the ability to consider past production expenses, income, and future plans to make their repayment plan is practical. Debtors in Chapter 13 are individuals “whose income is sufficiently stable and regular,” and the payment plans usually require monthly payments. 11 U.S.C. § 101(30). Because of the nature of the farming industry, many farmers would have difficulty making regular monthly payments to creditors. Thus, Chapter 12 will likely be more useful because it allows farmers to propose a repayment plan with seasonal payments that coincides with harvesting and marketing of the farmer’s commodities, unlike the other chapters of bankruptcy.
Another reason a farmer may prefer to initiate a Chapter 12 proceeding over another type of bankruptcy is to sell assets. Debtors in bankruptcy often seek to sell assets for the purpose of funding their business operations. However, the Bankruptcy Code requires Chapter 11 and 13 debtors to meet strict standards in order to properly sell assets. The Code requires these debtors sell property “free and clear” of liens. 11 U.S.C. § 363(f). Meanwhile, a farmer in Chapter 12 is not restricted to these requirements if the farmer is selling “farmland or farm equipment.” Being able to sell these assets free and clear of liens enables farmers to pay down their debts and end the bankruptcy process successfully.
Additionally, Chapter 12 provides tax advantages for farmers selling assets. A Chapter 11 debtor is required to pay any capital gains produced by a sale of assets. This tax will be treated as a priority claim, which means the debtor must pay the full amount of the claim. However, for farmers in Chapter 12, tax claims arising from “the sale . . . of any property used in the debtor’s farming operation” are treated as unsecured claims instead of priority claims. 11 U.S.C. § 1232(a). Unsecured claims in bankruptcy are claims that may not have to be paid in full or at all. This is a great advantage for a farmer under Chapter 12 because the income from the sale will not be restricted to repay a tax claim.
One last advantage of Chapter 12 over Chapters 11 or 13 is that Chapter 12 debtors may modify any secured loan through a legal principle called “cramdown.” Cramdown is where the debtor pays the present market value of the property rather than the amount owed on the loan. For example, if a debtor owes $40,000 on a loan and the underlying asset for the loan is worth $25,000, the debtor can reduce the loan debt to the present market value of $25,000. Though cramdown is available in Chapters 11 and 13, the Bankruptcy Code has limited a debtor’s ability to use cramdown on the mortgage of their principal residence. However, this restriction does not exist in Chapter 12. Thus, a Chapter 12 farmer-debtor can use cramdown to have the principal balance of the mortgage reduced to the current value of the property. Using cramdown on a mortgage can be significant for a farmer that lives on the same land they farm.
To read about the entire Chapter 12 bankruptcy process, click here.
To read Chapter 12 of the Bankruptcy Code, click here.
For more National Agricultural Law Center information on Bankruptcy, click here.