Chapter 12 Bankruptcy: Is it right for me?

Posted on: December 6th, 2021 by Kate Langworthy, ABLS Blog Contributor

The decision to file bankruptcy is not one that is made lightly. By the time the petition is filed, there have likely been many difficult conversations and strategy sessions to make sure that the entity or individual is making the best move for the future. An essential part of that strategy involves considering the goals of the debtor and deciding whether to liquidate assets to pay off debts or to reorganize and repay debt with the hope of continuing to operate their farm or business after the bankruptcy. For farmers* looking to continue operating after a bankruptcy discharge is granted, Chapter 12 bankruptcy is an enticing option, as it offers unique benefits to those who qualify, but it is important to evaluate whether it is really the best choice.

Who Qualifies?

Chapter 12 bankruptcy was created to specifically apply to “family farmers” with regular annual income. By requiring that the debtor have regular income, Chapter 12 lends itself to debtors that are better able to make plan payments while figuring out how to successfully continue farming. To meet the definition of family farmer, individuals and business organizations must show that they meet specific criteria laid out in the Bankruptcy Code. Individuals must: (1) be engaged in a farming operation; (2) be carrying less than $11,097,350 in debt; (3) have at least 50 percent of that debt from a farming operation that they own and operate; and (4) have more than 50 percent of the individual’s (or the individual’s and the individual’s spouse’s) gross income come from farming in the tax year directly before filing or each of the second and third years preceding the tax year in which the bankruptcy case is filed.[i] Bankruptcy courts have indicated some flexibility with what constitutes engagement in a farming operation,[ii] but that is the only factor that allows for much flexibility of interpretation.

Corporations or partnerships may also file “farm bankruptcy,” but they must meet even more criteria to avail themselves to Chapter 12’s protections. In addition to the regular income requirement, on the date of filing, a corporation or partnership must: (1) have more than 50 percent of the outstanding stock or equity held by one family or by one family and its relatives; (2) have the majority owner family conducting the farming; (3) have more than 80 percent of the corporation’s or partnership’s assets be related to the farming operation; (4) have aggregate debts of no more than $11,097,350; (5) at least 50 percent of the debt must be attributable to the farming operation; and (6) the corporation must not issue publicly traded stock.[iii] Once debtors clear the eligibility hurdle, they should assess whether the benefits of Chapter 12 bankruptcy make it the best strategic choice.

Benefits

Family farmers that want to continue their operation while repaying some or all of their debts may find the unique provisions of Chapter 12 bankruptcy extremely helpful in achieving that goal. Because farm income is inherently seasonal, farm debtors may struggle to make consistent monthly payments as required by other forms of bankruptcy. Chapter 12 allows the reorganization plan to provide for payments scheduled around harvest and typical commodity marketing times, and that plan may be confirmed even over the objections of creditors, so long as the court deems it acceptable. Farm debtors may also find value in Chapter 12’s allowance for the sale of farmland or farm equipment free and clear of creditor’s interest where other types of bankruptcy severely limit that sale. Selling that land and equipment inevitably creates tax consequences that must be handled by the bankruptcy estate. Where Chapter 11 requires that the capital gains tax is paid in full as a priority claim, Chapter 12 pushes that capital gains tax liability to the back of the priority line where it may be discharged, either in full or in part, after completion of the plan.[iv] Being able to “right size” the operation without incurring a crippling tax bill increases the likelihood that a debtor will be able to successfully complete the reorganization plan, receive a discharge of the remaining debts, and continue farming after completion of the bankruptcy. Finally, Chapter 12 debtors have the privilege to use “cramdown” on any secured debt. Cramdown makes it so that creditors only receive the present market value of the property used to secure the debt rather than the full amount owed. Debtors who are currently “upside down” on assets can find significant relief in this provision.

Reality Check

Even if a debtor qualifies for Chapter 12 bankruptcy and the benefits would serve them well, it still may not be the best option for relief. The unfortunate reality is that from 2000 to 2015, less than half of Chapter 12 debtors were able to successfully complete all plan payments and receive a discharge of the remaining debts.[v] A debtor whose current cash-flow left them unable to make timely payment of their debts, necessitating a bankruptcy filing, needs to seriously consider whether they can realistically make plan payments while continuing to run their operation as they have been. Though the provisions of Chapter 12 allow for downsizing or changing the type of farming operation, careful consideration should be given to whether attempting to restructure is just postponing the inevitable liquidation of the assets. Having a team of knowledgeable and trustworthy advisors, both personal and professional, is invaluable when making such a pivotal decision. By considering the eligibility requirements, the benefits offered, and the feasibility of a debt reorganization plan, debtors can make an informed decision on whether Chapter 12 bankruptcy is right for them.

*Note: Chapter 12 bankruptcy also applies to family fishermen, but this post only addresses farm bankruptcy.

This article was updated to reflect that as of April 1, 2022, the chapter 12 bankruptcy debt limit was increased from $10,000,000 to $11,097,350.

Sources

Thriving After a Farm Bankruptcy Fact Sheet, https://28xeuf2otxva18q7lx1uemec-wpengine.netdna-ssl.com/wp-content/uploads/assets/articles/bankruptcy/Thriving-after-a-farm-bankruptcy.pdf

https://www.calt.iastate.edu/article/review-farm-bankruptcy

[i] 11 U.S.C. § 101(18)(A)

[ii] In re Mongeau, No. 21-40055, 2021 Bankr. LEXIS 2923 (Bankr. D. Kan. Oct. 22, 2021)

[iii] 11 U.S.C. § 101(18)(B)

[iv] McEowen, Roger, Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities (Update), Agricultural Law and Taxation Blog (Oct. 8, 2021) https://lawprofessors.typepad.com/agriculturallaw/2021/10/farm-bankruptcy-stripping-claw-back-and-the-tax-collecting-authorities-update.html

[v] Resolving Distressed Farm Loans: A Conversation with Michael Fielding, Maryland Risk Management Education Podcast (July 10, 2020) https://music.amazon.com/podcasts/5f22cdc7-794f-4ee5-b328-d723c03c8dbf/episodes/ffda44df-3cce-4c80-a788-b8d56ee8e883/maryland-risk-management-education-podcast-resolving-distressed-farm-loans-a-conversation-with-michael-fielding

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