Foster Swift Agricultural Law News
December 1, 2020
Changes in Farm and Agriculture Bankruptcy
In 2019, the Small Business Reorganization Act (SBRA) and the Family Farmer Relief Act (FFRA) were passed to help American farmers who have seen an increase in financial difficulties. Recently, farms have seen a rise in debt due to market disruptions, poor weather, and lower income. The SBRA and the FFRA were passed in order to increase the ease and accessibility of Chapter 11 and Chapter 12 bankruptcies.
Chapter 11 and 12 bankruptcy actions help businesses get a fresh start by reorganizing their finances and creating a debt repayment plan. Chapter 11 allows for the reorganization of businesses with higher incomes and debts and is more accessible to larger farms. For smaller farms, filing under Chapter 12 is more appropriate.
Mid-Size to Large Businesses will Benefit from Changes to Chapter 11 Bankruptcy Procedures
Chapter 11 bankruptcy plans are based on the idea that a business is likely to continue to be profitable and make more money in the future than it can by selling its assets at the time of filing. The goal is for the reorganization of debts to allow the business to remain open. In this situation, the debtor devotes future income earned by the business to paying creditors. Occasionally, the debtor may include partial liquidation of property as part of the overall plan.
A standard Chapter 11 case begins by filing a petition which creates a “bankruptcy estate.” All of the property owned by the business, including equipment, income, and inventory, becomes part of that estate. The plan is then created and voted on by creditors and the plan is approved by the court. This plan then controls the debtor’s relationships with creditors as to all pre-bankruptcy debts. In these cases, a Creditors’ Committee is appointed by the United States Trustee and works with the debtor to understand the case, investigates the debtor’s operation of the business, helps create the debt repayment plan, and acts as a contact for other unsecured creditors.
A trustee is generally not appointed. The committee is allowed to hire its own professionals and the debtor is required to pay their fees. Furthermore, while in bankruptcy, the debtor must have each decision that is not an average day-to-day transaction approved by the court and must comply with monthly reporting requirements. Finally, debtors under Chapter 11 are typically required to pay quarterly fees to the US Trustee system fund. As a result, the administrative costs are often prohibitively high for mid-size farm debtors.
In order to reduce the high administrative costs and increase the number of debtors who can access the bankruptcy system, the SBRA added Subchapter 5 to Chapter 11. The subchapter simplifies the process and significantly reduces costs. Under this subchapter, debtors can retain control of their assets and over their business operation while reorganizing. The debtor is the person who files the plan of reorganization and an external committee is formed only if a court decides there is a persuasive reason.
A debtor is also granted three to five years to repay their debt and any administrative fees incurred. Subchapter 5 removes the quarterly fee requirement. Finally, unlike a standard Chapter 11 claim, a trustee is automatically appointed to each debtor case. The role of the trustee will be to assist the debtor by ensuring the reorganization stays on track. Each of these changes significantly reduces the costs of filing a Chapter 11 reorganization.
Small and Family Farms will see the most Benefit from Chapter 12 Filings
Chapter 12 bankruptcy applies to small farms and was created as an emergency response to the agricultural credit crises of the mid-1980s. It offers relief to “family farmers” with regular annual income. A family farmer is an individual, family owned corporation, or partnership who is engaged in a farming or commercial fishing operation. To file, fifty percent of the farmer’s income for the prior tax year must have been earned from that farming or fishing business.
In a Chapter 12 bankruptcy, the debtor proposes the reorganization plan. Unlike Chapter 11 filings, no creditors vote on the plan. The plan must establish a way to pay debts over a period of three to five years. A trustee is appointed to oversee administration of the case, negotiate a plan between the debtor and creditors, and disburse payments.
Chapter 12 also allows debtors to “cram down” secured debt by reducing the principal balance of a debt to the current value of the secured property. For example, a truck financed for $25,000 in 2010 may only be worth $12,000 at the time of filing. If the debtor still owes $18,000, they can reduce the loan balance to the $12,000 secured portion.
Additionally, Chapter 12 extends bankruptcy protections to co-debtors such as co-signers and guarantors. This protection applies to individual debtors and consumer debts, but is not applicable to business entities. However, these protections may be modified or terminated by the bankruptcy court.
Prior to 2019, only farms with debts not more than 4.4 million dollars qualified to file under Chapter 12. In response to a record high farm debt and a declining net farm income, the FFRA amended that debt ceiling and raised it to 10 million. This allows for larger family farms to file bankruptcy using a less complicated and expensive process than by filing through Chapter 11.
What does this mean for Farmers?
Prior to the FFRA, many mid-size farms had too much debt to file bankruptcy under Chapter 12 but could not afford to file under Chapter 11 because of the high administrative costs. Under the increased debt limit of Chapter 12, farm debtors whose business may have gone under will have a better opportunity to stay afloat and reorganize. It is likely that an additional 5,000 farms nationwide will be eligible to file under Chapter 12.
While most farmers will now qualify under Chapter 12, occasionally a small farming-related business will not. These may be businesses that have too much non-farm income, not enough farming history, or are not directly engaged in farming. Because the changes to Chapter 12 under the FFRA will not apply to them, those businesses may find filing under Subchapter 5 to be more aligned with their goals.
If you are considering filing bankruptcy, be sure to consult with an attorney before taking any actions. Finding the right attorney for you can be invaluable in helping decide whether bankruptcy is the right decision and how to move forward in the process.