John Phipps: Possible Fallout From Raising Chapter 12 Bankruptcy Cap

May 14, 2019 07:12 AM

Last week I responded to a question about what farm bankruptcies tell about the farm economy. This week I would like to comment about a new wrinkle in these situations.

Basically, filing bankruptcy is a way an individual who cannot pay their debts can get out of the downspiral. In general, it uses a legal framework to either sell most assets and distribute the money to those who are owed (liquidation), or refinance over a longer term often with debt reduction, called reorganization. In both cases, once completed, all financial claims terminate, regardless if all creditors have been repaid in full. Hence the term, “fresh start” is often used.

The key point however, is creditors – those owed – will likely not get paid back all or possibly even any of their money. The philosophical idea behind bankruptcy is two-fold.

First, sometimes the major cause is just bad luck, which is true, especially in the case of medical bankruptcies. Second, bringing an end to fruitless collection efforts is good for both sides. And I think blame should also be shared with creditors who made bad financing decisions.

Chapter 12 – farm bankruptcy – is more like reorganization than liquidation. It is essentially a special kind of Chapter 13. The qualification limit mentioned last week, about $4M dollars refers to the values of the assets. When advocates mention making Chapter 12 easier for farmers, they generally refer to raising this limit. Unfortunately, there is little evidence to show doing so makes outcomes any better.

This is a legitimate debate, but the bigger problem I see is ag supplier and bank consolidation impact how farm bankruptcies are eventually paid for, because those forgiven debts come out of somebody’s pocket. When ag suppliers were smaller and more numerous, a farm failure could trigger a supplier failure spreading the loss to not only that retailer but his creditors. And raising prices to other customers to cover those losses meant losing them to competitors. This was a powerful motivator for careful financing decisions. Large suppliers who control the market today can be hit with the same loss, but not only are those debts less likely to threaten their viability, but their considerable pricing power means they can spread their loss over remaining customers more easily. We all have fewer input supplier choices. This means the financial fallout from farm bankruptcies are largely, if not entirely paid by surviving farmers.

Perversely, this ability to pass losses to other customers also can encourage aggressive financing. All of us have sensed this instinctively when the list of creditors is published for a bankruptcy. When it’s your fertilizer dealer, you have pretty good idea where that loss will be made up, and it’s rarely their stockholders. Bankruptcy draws the line between how much debt will be paid by individuals and how much by others. I think we need different splits for different types of failures, but I am wary of making it easier just farmers, due to scant evidence the fresh start theory is effective and the cost passed on to neighbors.

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Spell Check

David F. Mills
Smithfield, NC
5/18/2019 08:28 AM

  As a clarification, your statement that "the qualification limit mentioned last week, about $4M dollars refers to the values of the assets" is an error. The qualification to which you refer, and which Congress is now considering raising, is a debt limit, not an asset limit. Currently, farmers with more than $4.2 million in debt do not qualify for Chapter 12. That doesn't mean they don't end up in bankruptcy; it just means that they will be forced into either liquidation or a very expensive and difficult Chapter 11 reorganization, which is not designed for the peculiar risks and revenue cycles of farming.

Fort Wayne, IN
5/23/2019 09:58 AM

  John should stay out of trying to verse people on the law. First, and as pointed out above, he is incorrect that the 4M is an asset cap, when it is a DEBT cap. Second, nothing in the Family Farmer Relief Act makes it EASIER as he says. All it does is give farms with higher debt the same access to Chapter 12 that farms below 4m in debt are able to utilize. Third, he says bankruptcy is for those who can't pay their bills. People often have to use bankruptcy due to reasons they have no control over, not just being unable to pay bills.

Jim Weeber
Goshen, IN
5/14/2019 04:40 PM

  Well there you have it. The bigger, bigger, bigger promoted at our unnamed land grant universities during the 70’s when I attended has come home to roost. Use to be you could hunker down in lean times and make it through as my family did a couple times. Pretty tough to do now. Big dependence on others to finance heavily and make up troubles on volume has resulted in too much of everything and the valleys are deeper and wider than the peeks are tall. Take a big whiff ag industry and cheerleader promoters. You created this mess. The “we are going to feed the world” bs has always been short circuited by infrastructure, logistics and politics. Hence a downward spiral over time. Yes those in unique niches feel pretty good most of the time but I don’t see them gloating as much as they used to. Extreme global debt and devaluation of our currency is catching everyone to some degree. We were far better off when smaller farms covered the countryside, supported more families, and produced more farm children who went on to do great things wherever they went. Rural values, strong community fabric, and work ethic! There will be a reset eventually where big operations may fall into smaller hands. Till then get lean and find outside income. Maybe someone else should farm your ground awhile if you can get a job without input cost out of the check. My fertilizer/chemical supplier will spread some hical on my sand tomorrow while heavy ground waits. He mentioned some things are not penciling out now. Pray our leadership keeps the music playing (as they are trying hard to do) because if it stops there are certainly not enough chairs for everyone. The consequences this time around are too dire for most to contemplate as we have never had an expansion of overall debt so all encompassing. I’m surprised what I’ve seen in 60 years and how short people’s memories are concerning farm realities. Get ready. Stay ready. Gee that was.....cathartic. I love you all.


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