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 fairly and equitably share in the available assets of the debtor.

Bankruptcy may be the only choice for a farmer who is deeply in debt to recover. 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. However, state laws defining and regulating the debtor-creditor relationship affect bankruptcy proceedings since some sections of the Bankruptcy Code incorporate these state laws. For research and 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 five 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.


Types of Proceedings


Chapter 12 – Adjustment of Debts of a Family Farmer 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, 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 initailly 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, 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:

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, (Aug. 2005) (Center publication)

Once the farmer-debtor files for Chapter 12, the proceeding automatically stays most collection agents.  The court appoints an impartial trustee to evaluate the case and aid with disbursement. The debtor, however, is entitled to remain in possession of the farm assets, subject to specific duties and can only be removed for cause.  After the debtor has organized a repayment plan, a meeting of creditors is held. Creditors and the trustee question the debtor regarding his financial affairs and the proposed plan.  After the court confirms the repayment, the debtor must meet his obligation to make regular payments to the trustee  to ensure creditors receive payment.


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.

In order 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.


Chapter 13 – Adjustment of Debts of an Individual with Regular Income

Procedurally, Chapter 13 is similar to Chapter 12. However, subject to certain limitations, individuals with regular income are eligible for Chapter 13, and it is specifically designed for regular wage earners. Like Chapter 12, it allows the debtor to retain an asset that may have been lost under liquidation.


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. 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 his 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 property and distribute proceeds to unsecured creditors. However, not all assets may be properly sold. Among the schedules attached to the petition is a list of exemptions claimed by the debtor. Property exempt from the bankruptcy estate is protected under either federal or state law from the reach of unsecured creditors, and it remains property of the debtor, subject to valid security interests and mortgages. Bankruptcy also does not affect the rights of secured parties, and 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 into 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.