The 411 On Chapter 12 Bankruptcy

April 25, 2019 02:55 PM
 
An increasing number of farms might soon be unable to service their debt with existing assets. This means they face extremely difficult decisions and might be considering filing bankruptcy—which provides both opportunities and challenges.

For farmers facing consecutive years of low profits or a devasting event that left them upside down on large loans, the options can seem dismal. What is the best strategy moving forward? What steps are needed to turn the business around? Should you just hang it up?

Financial pain is real in farm country. The numbers of Chapter 12 bankruptcy filings in 2018 were essentially even with 2017, at around 500. That compares to 4,824 filings in 1987, says Roger McEowen, Kansas Farm Bureau professor of agricultural law and taxation at Washburn University School of Law in Topeka, Kan.

“What we're going through right now, in terms of the number of Chapter 12 filings, is a drop in the bucket compared to the 1980s,” he says. “But economic matters remain tough in Midwest crop agriculture and dairy operations all over the country, and the projection is for the third-lowest net farm income in the past 10 years.”

Bankruptcy Data


“Chapter 12 is about fixing the balance sheet and rightsizing the debt for the operation.”


Debt-to-asset ratios are on the rise and the debt-service ratio (the share of ag production that is used for ag payments) is projected to reach an all-time high, according to USDA. Additionally, the "current ratio," which is current assets divided by current debt, is forecast to hit 1.31 in 2019—the lowest number since USDA started collecting data in 2009.

What’s the bottom line? An increasing number of farms might soon be unable to service their debt with existing assets. This means they face extremely difficult decisions and might be considering filing bankruptcy—which provides both opportunities and challenges. Bankruptcy carries numerous misconceptions, fears, emotions and stigmas. 

Many think filing for bankruptcy is the finish line for a business, but that’s not always the case. Chapter 12 bankruptcy enables financially distressed family farmers to propose and carry out a plan to repay all or part of their debts—with the goal of keeping a farm in business. 

“Chapter 12 is about fixing the balance sheet and rightsizing the debt for the operation,” says David Warfield, an attorney with Thompson Coburn in St. Louis.

To file a Chapter 12, a farmer fills out forms and pays a $275 filing fee. Once you file, an “automatic stay” immediately goes into place, which means creditors cannot take many forms of any action against you.

“As part of the filing, you disclose all assets and liabilities,” Warfield says. “This is a very extensive process and the penalties for trying to hide something are significant and can even result in jail time. If you’re going to file bankruptcy and take advantage of automatic stay, you live in a financial fish bowl—you cannot hide anything.” 

Claims against a Chapter 12 farmer are treated differently, depending on the type of the claim. Secured claims, that is claims secured by collateral, can be restructured in a Chapter 12, but the lender will retain its collateral. Unsecured priority claims, which include most types of taxes, are generally paid in full over time, although there is an exception to the payment in full requirement for certain capital gains taxes.  General unsecured claims are at the bottom of the pile and frequently are not paid in full in Chapter 12.  

After the initial filing, you have 90 days to file a plan, which essentially shows how and in what order you will pay your claims. For instance, you can decide which leases and contracts you want to assume or reject, Warfield says. If you are locked into a long-term cash rental lease that’s on economically unfavorable terms, you can reject that contract. 

Or, if you’re in an environment where asset values are falling, such as land, you can write down that secured creditor’s debt to the value of the collateral. For example, if you owe a $1 million loan on a piece of ground that’s now worth $700,000, you can write down the secured claim to $700,000 and you can adjust the terms and interest rate. The $300,000 doesn’t go away, Warfield says, it goes into the unsecured section. 

Once a farmer decides on this plan, he or she presents it at a confirmation hearing, where a judge will ultimately decide to confirm the plan. A Chapter 12 plan usually lasts three to five years.

“If judge confirms the plan, that becomes the new contract between you and all your creditors,” Warfield says. “As long as you devote all of your disposal income over the life the of plan you can discharge any unpaid general unsecured claims at the end of the plan. For example, if at the end of five years, you’ve only paid 18% of the general unsecured claims, the other 82% is discharged.”

While Chapter 12 can help farmers stay in business, McEowen says, it is a public process, which might intimidate farmers. He suggests working with an attorney who understands Chapter 12 bankruptcy law, as well as your banker and accountant to come to the best decision. 

Don’t delay in working through financial problems. “Any time you find yourself in a position where making your secured debt payment is difficult, you need to start thinking about restructuring of some sort,” Warfield says. “In working with your lender, you may find a better option than Chapter 12.”


Many think filing for bankruptcy is the finish line for a business, but that’s not always the case.


Potential Change to Chapter 12

The current Chapter 12 laws require a farmer’s total debts (secured and unsecured) must not exceed $4.4 million. A bipartisan group of lawmakers aim to increase that limit to $10 million with the Family Farmer Relief Act, which is set to be introduced to the House next week.

“That’s where it needs to be,” McEowen says. “Now there are farmers who have too much debt that they can’t even file.”

For farmers in this position, they must look at a different bankruptcy chapter. There are two different bankruptcy strategies: liquidation and reorganization. Chapter 7 is used to liquidate a business. Chapters 11 and 13 are reorganization bankruptcies that allow for debtors to come up with repayment plans to pay back some or all of their debt over a period of time and may allow for restructuring debt. These are not as geared toward farmers and are more expensive to file.

 

Read More

The Backstory on Bankruptcies

Trends Show Chapter 12 Bankruptcies Not Rising At An Alarming Rate

2018 Farm Bankruptcies Down from 2017, Still Close to 500 Farms
 

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Comments

 
Spell Check

ck
bad axe, MI
4/26/2019 11:26 AM
 

  Having been involved with a family member in chapter 12 in the late 80's. First all you assets are controlled by a trustee for the length of your duration in chapter 12. Second most, if not all the time its almost imposable to obtain credit while in chapter 12. That's why most farmers who file down size and have to find other off farm income .

 
 
Just Shocked
The Panhandle, TX
4/30/2019 10:06 AM
 

  I think a lot of banks are just working with their customers a little more this year to keep them from bankruptcy. What's been keeping farmers afloat has been the low interest rates and value of land. A tenant farmer with no land may be in a totally different situation. Having gone through the 80's crisis, land values are the only thing keeping several people going along with phenomenal corn yields! There are a few farmers that keep kicking no matter what--I think they print money in their basement!! LOL!!

 
 
Tom Martin
Mt. Pulaski , IL
4/29/2019 07:02 PM
 

  The past few years we always see the reference to the 80’s downturn. While I agree the 80’s was to this point in time more devastating, what percentage of farms filed in 1987 as compared to 2017, our total farm numbers are quite different today than now. Also what were the years leading up to 19987 looking like. Maybe you need to compare 2017 to the years of 1984, 85, 86 for a true comparison. Unfortunately, no one knows!

 
 

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