Contract Provisions: When Business Dreams Turn to Nightmares
By Austin PeifferAssociate Attorney Recently I read two quotes that really struck me: “Nobody’s business plan includes bankruptcy,” from attorney Ferd Niemann and, from software entrepreneur and essayist Patrick McKenzie, “Contracts exist to be followed on very bad days.” They’re both accurate, of course. Nobody plans to start a business that ends up in bankruptcy, but many ventures end that way. If your farm or business ends up in bankruptcy, that’s a very bad day—but it’s also one of the main reasons contracts exist. Business owners, farmers included, would benefit from time thinking about these two quotes. Your business plan shouldn’t include bankruptcy, but your contingency plans should. It’s good to consider: I’m going to give this business my all, but what happens if, despite everything, it goes badly? Will I lose my house? Will I lose my investments? Will I be forced into bankruptcy myself? What if my contractual counter-party has a very bad day? Then, start looking at the contracts you’re signing for your business. Banks and other sophisticated parties already know the moving parts behind these two quotes well. That’s why their contracts contain pages of legalese. Many or even most borrowers don’t read that language, since they’re sure the business plan will work and none of the contract’s, “In the event of default,” language will be necessary. That language wasn’t inserted on a whim; the drafter (or the person the drafter copied it from) likely paid a lawyer to research and draft that provision—and it wasn’t out of a concern for that poor, starving lawyer’s income stream. It’s said that safety regulations are written in blood; contract provisions are written in red ink. Somewhere, at some time, someone had a bad day, a contract was enforced, and someone lost money. That contract provision exists to allocate the risk in such a situation and make sure that on certain kinds of bad days, one party or another loses money when the contract is enforced. And if someone else drafted the contract that you signed, you can guess how that risk is likely to be assigned. (319) 363-1641 Don’t let optimism interrupt reality Sometimes contractual obligations are overwhelmingly one-way. For a loan, the lender’s main obligation is to lend money, while the borrower will have numerous ongoing obligations: submitting reports, maintaining capital ratios, and, of course, making payments. Other contracts have more mutual ongoing obligations, such as an employment or supply contract. Those obligations on both sides matter. Many contracts are performed by their terms to the parties’ mutual satisfaction, and the default terms are never activated. With others, eventually, someone is going to have a very bad day. Whether it results in bankruptcy or something else, things will not go to plan, and sometimes the parties can’t reach a mutually agreeable resolution. That’s when those oft-neglected default provisions matter. Business owners, particularly farmers, are optimistic: Tomorrow will be better than today. Things will work out. This counter-party would never mistreat me. It makes sense—if you spend all your time worrying about what could go wrong, you’ll never have time to run your business and make money. But never worrying about the consequences, if things go wrong, is dangerous. Take some time to think through what kinds of very bad days might happen—whether to you or your contractual counter-party—and what would happen under the contract on those kinds of very bad days. Can you live with that? If not, think about how to address it. If you need help with the particulars of making a plan, or consulting on the legal provisions of a specific contract, Ag & Business Legal Strategies is here to help. An instructive case study One of our clients had a series of very bad days. They were involved in business ventures that went sour when economic fortunes changed, and their business partner filed bankruptcy. Many contracts were enforced against our client. Fortunately, they thought ahead to seek our legal advice, and planned how to protect themselves. Make no mistake—those days were very bad indeed for the client. They lost investments and business opportunities. But because they planned ahead and didn’t wait to seek legal assistance, the damage was isolated and limited compared to how it could have turned out. Too many people don’t think about very bad days until they’re already happening. When clients come to us early enough, we can do a lot more to prepare and position them for the best possible outcome. We can’t prevent all bad days from happening, and we can’t prevent painful contractual consequences when they do happen. But if we have time to act, we can often help minimize the extent of their consequences. Don’t face very bad days alone—reach out to us sooner than later, for your best outcome. (319) 363-1641 At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our team will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy. Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow, when it may be too late.
New Duties: What Tariffs Could Mean for U.S. Farmers and Other Small-Biz Owners
Author’s Note: This is a developing story; as such, some details may have changed from the time this post was written. Consult trusted, reputable news sources for real-time reporting. Last weekend, the United States imposed tariffs on imported goods from major trading partners, including China, Mexico, and Canada. In response, Canada has already imposed retaliatory tariffs and China and Mexico promised similar responses—though as of this writing, tariffs on Mexico are reportedly delayed a month pending a deal with the U.S. What does this mean for farmers and other small businesses? Let’s explore how these tariffs could potentially affect the agricultural and other business sectors. How tariffs work Tariffs are a “protectionist” tax on imports, meaning they seek to protect domestic production and manufacturing industries. By increasing the cost of foreign goods, they are intended to support the purchase of domestic goods. For example, if Canadian lumber costs $600 per thousand board feet but comparable American lumber costs $700, the Canadian lumber would likely be the more attractive purchase. A 25% tariff on Canadian lumber, however, would increase its cost to $750, making the American product cheaper. While this benefits U.S. lumber producers, it also raises the price on U.S. consumers who would have previously paid $600 instead of $700 or more. For decades the trend in global trade—often led by the U.S.—has been toward free trade, with countries agreeing to more bilateral or multilateral treaties to reduce or eliminate tariffs, with the U.S. generally reserving tariffs to address bad trade behavior such as dumping (selling goods below cost to drive competing producers out of business) or intellectual property violations. The U.S. has generally moved away from protectionist tariffs on the condition that other countries do the same. Now it has drastically changed positions with some of its largest trading partners, and those partners are responding in kind. Retaliatory tariffs As of this writing, Canada had announced retaliatory tariffs on U.S. goods it imports, including: Just as U.S. tariffs tend to reduce sales of exports to the U.S., retaliatory tariffs from those countries will likely reduce our sales to them. Moreover, while Canada’s tariffs are (currently) only on specified goods, U.S. tariffs seemingly apply to all Canadian, Mexican, and Chinese imports. These tariffs were imposed under the International Emergency Economic Powers Act, a law typically used to address national security threats through sanctions rather than trade issues. In fact, this is the first time it has been used to impose tariffs. This novel approach will almost certainly result in legal challenges, and while those may take months or years to work through the courts, it’s possible a judge might impose a more immediate injunction preventing U.S. tariffs from going into effect either on a limited basis or more broadly. Finally, the executive orders imposing these tariffs discussed the possibility of increased tariffs in response to retaliatory tariffs. This could be just the first battle in a longer trade war. The economics for farmers, small biz While the tariffs’ most direct impact will fall on businesses that produce, import, or export listed goods, the entire economy will feel their effects. Here are some basic likely outcomes: The economic theory behind free trade is that everyone, overall, does better when countries compete on price without protectionist trade measures. This is tough on domestic producers when foreign producers can out-compete them on cost, and can inspire calls for protectionist policies. In short, free trade does promote wider economic growth, but its benefits are often widely distributed, while its negative effects—such as job losses in some industries—are concentrated. This makes trade policy a contentious issue. For most farmers and other small business owners, the current tariff situation presents challenges. Perhaps U.S. duties will benefit some operations, but many farmers are likely to see increased costs and potentially reduced sales of goods. This economic situation might also reveal underlying fiscal problems in your business. If you are struggling with managing debt, or financial planning, the attorneys and financial strategist at Ag & Business Legal Strategies can help you figure out a plan. Give us a call sooner than later—let’s find out together how we may best assist. (319) 363-1641 At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our attorneys and financial strategist will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy. Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow. https://www.ablsonline.com/contact/
Right-to-Repair: Equipment is Only Yours Until it Breaks Down
It’s spring planting season, and every farmer is eager to get into the field as soon as conditions allow. No one wants to watch their neighbors planting acre after acre while they’re stuck in the machine shed with broken equipment. With the increased technological sophistication of farm equipment, however, repairs are no longer as simple as a few wrench twists or some baling wire. Can you or your local independent mechanic fix your equipment yourself, or is your only option to go to the dealer’s service center to get it repaired on the service center’s timeline—and at whatever price it may choose? The answer to that question might depend on right-to-repair. The right-to-repair movement in farming seeks to ensure that farmers and independent mechanics have access to the parts, tools, software, and information they need to repair farm equipment. It’s one aspect of the broader right-to-repair movement that spans from cars (where strong right-to-repair laws already exist) to consumer technology such as phones and tablets. Especially given the increased technological complexity of modern farm equipment, without access to the right parts, tools, software, and information, it can be impossible to fix a newer tractor or other piece of farm equipment. This rubs self-sufficient farmers the wrong way. If you’re handy and used to fixing things yourself, or if you have a favorite local mechanic who treats you right, the idea that only the dealer is able to fix your equipment is revolting. It’s your equipment—but if you can’t repair or modify it to suit your needs, then it doesn’t quite feel like it’s your equipment. While manufacturers certainly enjoy the profits they earn from repairs, they tout safety, sustainability, and innovation as justifiable reasons to restrict repair rights. Of course, these same issues could have been raised about farmers’ ability to repair and modify their equipment before manufacturers began restricting repairability, but manufacturers only raised these arguments after proprietary technology gave them the ability to impose these restrictions. Cars have similar safety, sustainability, and innovation concerns as farm equipment, but car right-to-repair laws have not resulted in unsafe, polluting cars harming society while innovation in new vehicles stagnates. In short, manufacturers’ arguments against farm right-to-repair appear to be pretense for maintaining profitable monopolies on repair services. Legislation vs Memorandums Farmers and their allies are pursuing improvements in farm right-to-repair through several avenues. In 2023 more than 30 state legislatures, including Iowa’s, considered right-to-repair legislation (some including and some excluding farm equipment), but right-to-repair legislation was only enacted in Colorado. On the national level, Congress considered the Fair Repair Act in 2021, but it did not pass, highlighting the difficulties in the ongoing struggle against repair monopolies. Outside of legislation, the Farm Bureau has negotiated memorandums of understanding (MOUs) with five of the largest equipment manufacturers to give farmers and independent repair shops access to information, tools, and parts to enable them to repair those manufacturers’ equipment and find equipment breakdown solutions for farmers. Those MOUs came into effect at various dates in 2023, and it is not yet clear what effect, if any, they have had on breaking the manufacturers’ repair monopolies. Finally, several farmers have sued John Deere in federal court, claiming its restrictions on right-to-repair violate federal antitrust laws. Those cases are part of multi-district litigation that has been in progress for nearly two years now, and resolution does not appear imminent. What’s a Farmer to Do? First, get your spring planting done! If you run into breakdowns, have right-to-repair in the back of your mind as you get your equipment back up and running. Would this have been cheaper, easier, or faster if I or my mechanic had better access to proprietary parts, tools, software, and information? When you have a chance, test out the Farm Bureau’s MOUs. Can you actually get the parts, tools, software, and information to allow you to repair your own equipment if you ask these manufacturers? Can your local mechanic? More generally, contact your legislative representatives, both state and federal, and encourage them to support right-to-repair laws and break repair monopolies. Without legislation, progress on right-to-repair depends on the continued goodwill and cooperation of equipment manufacturers. At any time those that have signed MOUs could withdraw from them and stop cooperating, or even stop complying with the MOUs without withdrawing from them. The MOUs also do not bind any manufacturer that has not signed one. Only state or federal legislation can fully protect your right-to-repair. If you have the opportunity to test one or more of the Farm Bureau’s MOU agreements, we would like to know the outcome of your experience! Please call or text our office, or drop us an email through our website link below. (We will keep your identity anonymous, if you wish, should we publish a later update to this blog entry and cite your account in it.) At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our attorneys and financial strategist will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy. Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow.
Personal Guaranties: Know What You’re Signing
Most of us have had to ask a more financially secure family member to co-sign a loan so we could buy a car, farm tractor, or enter into a lease. If you’ve ever been the co-signer, you know that even though you trust your child or family member to pay it off, there’s always that worry you’ll end up on the hook for payments or even the full amount. As a co-signer, you are responsible for the debt alongside the primary borrower or lessee. But what if you’re asked to sign a personal guaranty instead? A guaranty only makes you responsible for the debt if the primary borrower or lessee defaults on the agreement. Sounds better, right? Often yes, but depending on the guaranty’s terms you could end up in dire straits. A co-signer is only obligated on the loan or lease agreement they co-signed, while a guarantor may later learn they are responsible for multiple debts. A recent example from our practice illustrates this. Our client—let’s call him Grandpa—signed a guaranty in 2013 with Bank for debts of a family member’s farm—we’ll call it Farm A. Grandpa assumed whatever later agreements Farm A entered into with other legal entities, such as other companies, would be Farm A’s responsibility, so he did not keep tabs on Farm A’s later indebtedness. In 2020, Farm A wanted to expand and signed a guaranty with Bank for Corporation B, a beef packaging plant that Farm A’s owners saw as a good way to add value to the cattle it raised. Recently Corporation B fell on hard times and defaulted on its loan from Bank. Bank called its guaranty from Farm A. But since Farm A could not honor the guaranty by paying Corporation B’s debts, and because Grandpa signed an unlimited guaranty for Farm A, which secured all of Farm A’s current and future debts to Bank, Bank asserted Grandpa is also responsible for the guaranty that Farm A signed. The total amount of this debt? $28 MILLION. Be Wary of “Unlimited” The lesson here is not to be scared of signing a personal guaranty—they’re expected for many small business loans—but to know what you’re signing. Many guaranty forms have a statement or checkbox specifying whether it is unlimited or for the specific loan/lease/note being referenced. Almost nobody wants to sign an unlimited guaranty for a business they’re not actively involved with, lest they end up like Grandpa. His situation is frightening enough, but what if Corporation B had signed an unlimited guaranty with Corporation C through the same bank, and so forth? The snowball never stops. If you have a question about a guaranty you’ve been asked to sign, have your attorney review the document. Here at Ag & Business Legal Services, we spend a good part of our days reviewing all manner of documents, including loan papers, and we would be happy to answer your questions. You may notice we have referred to leases as well as loans. If you sign a guaranty for a family member to lease a tractor or combine, for instance, be sure you are only signing for that one piece of equipment. If you are not careful, and the primary lessee signs other leases for additional equipment, you could end up guarantying all of them. We have seen claims against lease guarantors for upwards of $3 million, who were unaware of the extent of their liability until the lessor called the guaranty. Other Terms to Note There are a couple other terms to watch out for. One is “cross-default provision.” This means that a default on one loan is a default on all loans. In Grandpa’s example, Corporation B’s default on one loan triggered a default on all its other loans from Bank, making all those loans immediately payable—even the ones in good standing. The other term is “cross-collateralization.” Think of this as the Three Musketeers for loans—collateral for one loan is collateral for all loans. In Grandpa’s case, his home and connected property are now on the line for that $28 million! Ag & Business Legal Strategies can advise you on guaranties before you sign, and also help with spelling out specific provisions in limited guaranties. Say you are signing a guaranty for a corporate borrower, like a farm corporation. You could seek a provision requiring the bank to exhaust all efforts to collect from the primary borrower before seeking to collect on the guaranty. You could also limit the guaranty to certain debts or a total amount (e.g. only debts owed the day the guaranty is signed, or only up to $500,000). We can also assist if you find out you’ve already signed an unlimited guaranty. If you’re not intimately involved in the business, then we can help you get the information you need to assess your risk, and if necessary we can help you terminate your guaranty. Terminating won’t help with debts owed before the termination, and it will likely trigger a default, but it can protect you from incurring further liability. Remember—signing a personal guaranty can be dangerous depending on its terms. You should always be aware of your financial risk before signing. At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our attorneys and financial strategist will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy. Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow. Contact us here!
Choice of Business Entity for Farmers
The choice of business entity for a farm is an important decision that can either protect farm owners and their families from the risks inherent in the farming enterprise or expose them to those risks. Farmers employ various forms of business entity, and the choice varies greatly between types of farms and their sizes. Many are operated as sole proprietorships and general partnerships, but these formations pose great risks to their owners. However, Iowa laws restricting corporate farm ownership makes it harder for corporate entities (corporations, LLCs, limited partnerships, etc.) to own or lease farmland. What’s a farmer to do? Thankfully, many of those restrictions can be avoided with appropriate legal advice, and in almost all cases farmers should be able to take advantage of the benefits of corporate entities in running their farming operations. Sole Proprietorships and General Partnerships Sole proprietorships are the simplest business entity to “create.” They consist of one owner, and it is the default business entity if a farmer does not file to create another kind. In fact, you automatically become a sole proprietor if you own your own farm and are not on another person’s payroll. There may be some licenses and permits required such as a tax certificate or a filing required for a farmer wanting to name their business something different than their own name, but generally, a sole proprietorship has fewer hoops to jump through to start business. Unfortunately, this simplicity comes at a cost, as there are significant risks associated with operating as a sole proprietorship. As sole proprietor, your personal assets are not protected from liabilities deriving from business operations. Because the farmer, as a sole proprietor, is not legally distinct from the business, the assets of the farmer can be used to cover any liabilities and debts. While exemptions will protect some assets, if a farm starts facing financial issues, there is a significant threat that creditors will come after the farmer’s personal assets. These dangers heighten under a general partnership. Under a general partnership, the personal assets of all partners are subject to liability. Moreover, the actions of a partner can create liability for another partner, and every partner can enter into business arrangements that are binding on the whole partnership. Not only is each partner subject to liability as an individual, but each partner can be held fully responsible for the full amount of the partnership’s debt. This creates a situation where one of the partners may be compelled to sue another partner to recover their share of the debt. The partnership can alleviate some of these potential issues by creating a detailed partnership agreement outlining the terms of the relationship, but even with such a written agreement, an alternative business structure would provide more protection. Moreover, a general partnership can be formed unintentionally—all it takes is two people going into business together seeking a profit. If one such partner doesn’t realize they’ve entered into a general partnership, they could face unexpected liability for another partner’s conduct on behalf of the partnership. “One advantage of a general partnership is that the business may be able to circumvent payment limitations under certain federal farm programs, since each general partner may qualify to receive payments up to the limit instead of only being eligible for one payment as an entity. However, this doesn’t mean it’s necessary to accept the personal debt risk of a general partnership to obtain this benefit; limited liability entities can serve as general partners, giving the best of both worlds—eligibility for multiple federal farm program payments plus limited liability to protect your assets.” Limited Liability Company The LLC combines the flexibility and favorable tax treatment of a sole proprietorship with the asset protection of a corporation. Understandably, it is a popular choice for a business entity. Farming, like any business, can be unpredictable, and ventures often fail. The LLC provides farmers with greater protection. If the creditors come after the LLC, they can only get LLC assets. This is because when an LLC is created, the LLC becomes its own distinct legal entity. This separation between the owners and the LLC protects a farmer’s personal assets because the farm’s assets are distinct from the farmer’s. Put simply, the risk of the farmer is limited to the amount the farmer invests in the LLC but not more than that. Because the LLC is a separate entity, the farmer must actually separate the assets of the farm from personal assets. In practice, this requires that farmers create separate bank accounts and work to capitalize their farm. LLCs also give farmers more flexibility when operating their business. LLCs offer broad discretion to owners when deciding who has control in making big decisions for the business. For example, if multiple people are farming together, voting rights in the LLC could be based on an farmers’ percentage of ownership, or each farmer could have one vote regardless of share. Additionally, LLCs do not require that farmers divide profits and losses in proportion with the share of the business owned by each farmer. In a general partnership, if there are two equal partners, then profits and losses would be split equally between them. However, with LLCs, this arrangement can be made however the owners choose. Lastly, LLCs lack the formalities of other business entities like corporations. LLCs do not require positions such as President or Treasurer (though an LLC’s members are free to create such positions), and LLCs do not have to establish annual meetings with elected members. Many farms are owned by a single farmer or very few farmers, so the formalities can be more of an inconvenience than useful guidelines for business governance. Despite the advantages of an LLC, there is a risk of automatic dissolution of an LLC if the LLC does not report its filings on time or even if there is some change in the business’s structure as the result of a death of an owner or a merger. This does not mean that
Terminating the Technicality: Venue Reform, Why It’s Important, and What You Can Do About It
Bankruptcy is a legislative creation aimed at giving debtors the opportunity for a fresh start while still recognizing the rights of their creditors to be paid. Chapter 11 Bankruptcy allows an entity experiencing financial distress, typically a corporation or partnership, to seek relief through reorganization, while retaining their business in hopes of generating revenue to pay debts as completely as possible. The debtor first files its bankruptcy petition and proposes a plan for repayment. Creditors are given the opportunity to vote on whether the plan is acceptable, and after considering those votes, the court may or may not confirm the plan. The expectation is that a company will file bankruptcy where it is actually located. Unfortunately, many large companies have found a way to circumvent the statutory requirements and file in a jurisdiction with which they have no meaningful connection in hopes of obtaining a more favorable outcome. The Technicality The current law requires an entity to file its bankruptcy in one of two places: (1) the district where the entity’s place of incorporation, residence, principal place of business, or principal assets in the United States have been located for at least 180 days or (2) the district where an affiliate of the entity has a pending bankruptcy matter. The second option is where companies found an opportunity for creativity. Say Company X wants to file bankruptcy in front of a judge who is historically more likely to accept its arguments. By setting up a subsidiary in that judge’s district, having that subsidiary guarantee the debts of the already-struggling company, and then having the subsidiary file for bankruptcy, Company X suddenly has an affiliate with a pending bankruptcy matter there, albeit a manufactured one. Company X is then legally entitled to file its bankruptcy petition in that judge’s district and potentially have its plan confirmed when other judges would have declined. Purdue Pharma’s Filing In re Purdue Pharma, L.P. is a textbook case of this tactic. Opioid manufacturer Purdue Pharma sought to use bankruptcy as a mechanism to compel acceptance of a global settlement by the plaintiffs in numerous civil actions brought against it and various members of the Sackler family who indirectly owned the corporation, as those were the company’s only major creditors. Among other things, its reorganization plan included what is known as a third-party release, which would shield the Sackler family from liability relating to Purdue’s role in the opioid crisis. Bankruptcy courts are split over whether third-party releases are an appropriate inclusion in reorganization plans, and those that allow them do so on a very limited basis. Appearing in front of the “right” judge in the “right” jurisdiction is paramount. Purdue recognized an opportunity and worked to get its matter into the Southern District of New York in front of the Honorable Judge Robert D. Drain, who had previously indicated an openness to entering a third-party release as part of a Chapter 11 reorganization plan. Over multiple creditor objections, Judge Drain approved Purdue’s reorganization plan, including the third-party release that protects the Sacklers from current and future litigation relating to the opioid epidemic. The bankruptcy plan sets aside funds for programs to be established by cities, counties, and other entities, as well as money to be paid to individuals affected by opioids after an adjudication process. However, holding members of the Sackler family liable for their role is no longer an available avenue. In exchange for paying a fraction of their estimated personal profits from the opioid epidemic over nearly a decade, the Sacklers have immunized themselves from further liability, despite objections from those harmed by the opioid epidemic. Exploitation The creative maneuvering employed by these companies, known as “forum shopping”, is an exploitation of flexibility purposefully built into the bankruptcy venue statute by its drafters, and Purdue is not alone in the practice. When the statute was adopted back in 1974, the committee fully expected that allowing companies multiple options for choice of venue would get the cases placed in the most appropriate court. This expectation rested on a belief that judges who found bankruptcy cases filed in their courts without a meaningful connection to the district would kick those cases to the court where it should have been originally filed “in the interest of justice or for the convenience of the parties” as they are authorized to do under 28 U.S. Code § 1412. The unfortunate reality is that judges tend not to exercise that discretion, and even if they do it often doesn’t occur until many of the most important decisions in the case have been made and after significant expenditures of money and effort by objectors. These realities only serve to encourage forum shopping. Termination Current legislation takes aim at closing the loophole and strengthening the integrity of the bankruptcy system while increasing public confidence and fairness. The Bankruptcy Venue Reform Act of 2021 (H.R. 4193), introduced in June of 2021, and the identical Senate bill (S.2827), introduced in September of 2021, acknowledge the practice of forum shopping and the resulting concentration of bankruptcy cases into just a few districts. The bill’s text also notes that not only does forum shopping prevent important stakeholders from fully participating in the bankruptcy process, it removes the possibility of the unchosen district participating meaningfully in the development of the bankruptcy law that will inevitably affect its constituents. In hopes of removing the enticement to forum shop, H.R. 4193 and S.2827 propose to add significantly more detail to the venue statute. Along with formatting changes that would make the statute more readable, the legislation includes important changes, including: specifically defining the term “principal place of business”; significantly limiting the option to file in a district where an affiliate has a case pending; placing the burden of proving correct venue on the entity that files the bankruptcy; and requiring cases filed in an improper venue be either dismissed or moved to the appropriate district rather than leaving it to the judge’s discretion. Leaving limited room for interpretation
A Call for Bankruptcy Venue Reform
In February of 2021, Belk, a North Carolina department-store chain, filed for Chapter 11 bankruptcy in the United States Bankruptcy Court of the Southern District of Texas. After the large retail company with over 90,000 creditors filed on the evening of February 23rd, their plan was confirmed and consummated by the end of the next day. The U.S. Trustee, the Department of Justice’s bankruptcy watchdog, was quick to object to the plan’s confirmation with the understandable concern that about 90,000 creditors would be swindled of their Due Process rights by not being notified prior to plan confirmation. The bankruptcy court appeared to think little of these concerns and granted a toothless 35-day objection period. It was clear to the parties involved that the case was over upon consummation, and Belk’s bankruptcy would sweep through the court before most of their creditors could even blink. Through the rapid administration of this case, the court ignored basic elements of bankruptcy rules and procedure, and the rights of creditors were relegated to an afterthought. Unfortunately, Belk’s bankruptcy is not unlike other Chapter 11 cases. Many courts have been willing to bend the Bankruptcy Code in large Chapter 11s to the whims of the debtors’ executives, debtors’ counsel, and debtor-in-possession lenders who often finance the bankruptcy. These judges have engaged in this Bankruptcy Code puppeteering to compete for large Chapter 11 cases to be filed in their court, and because of flexible bankruptcy venue laws, debtors can easily flock to the courts where the judges will be the most pliable. A Case Study Consider how Belk, a North Carolina company, was able to file in the Southern District of Texas. The current bankruptcy venue statute, 28 U.S.C. § 1408 allows a debtor to file in the district “in which the domicile, residence, principal place of business in the United States, or principle assets in the United States” of the debtor are located. However, the debtor cannot just move from one district to another and file immediately; the statute requires the debtor to be eligible for over 180 days in the district. The issue is that the statute has a built-in exception that allows large companies to file virtually anywhere. Section 1408(2) allows the debtor to file anywhere “in which there is a pending [bankruptcy] case … concerning such [debtor’s] affiliate.” This is how Belk made it to the Southern District of Texas. Belk had subsidiaries file in the Southern District of Texas, and the affiliates’ bankruptcies acted as a venue “hook” to allow Belk to file in the Southern District of Texas. Concerningly, the court did not even appear to accurately apply the existing venue statute, because Belk never showed that any of these affiliates were eligible in the Southern District of Texas either. Regardless, the result was a bankruptcy case that did not belong in the Southern District of Texas being administered expeditiously by a judge who chose to abdicate his duties of enforcing the bankruptcy code in exchange for bolstering the court’s reputation as a Chapter 11 destination. Incentives for Shady Venue Practices Under the current bankruptcy venue statute, two incentives combine for disastrous results. First, debtors and their case managers are incentivized with their broad discretion to maneuver Chapter 11 cases to the judges that will bend to their will. Second, some judges are incentivized to either violate the law or manipulate it to attract glamorous Chapter 11 cases. These incentives have produced a competition over what court or judge can give results most favorable to bankruptcy case placers (most often debtor’s attorneys and financiers for bankruptcy debtors). Currently, five bankruptcy courts that hear more than 90% of the bankruptcy cases in the United States – Houston, Delaware, White Plains, Richmond, and New York. This is enormous control in the hands of very few judges. Even worse, large companies and their attorneys are sometimes able to choose the specific judge that will administer the case by manipulating local bankruptcy court rules. The Argument for Reform The solution is bankruptcy venue reform. On June 28, 2021, H.R. 4193, the Bankruptcy Venue Reform Act of 2021, was introduced in the House as a bipartisan solution, and a substantively identical reform act was introduced in the Senate as S.2827 on September 23, 2021. The Act limits the ability of large companies to forum shop by requiring that the debtor file where its headquarters or principal assets are located. Moreover, it puts the burden on the debtor to show by “clear and convincing” evidence that the venue selected is proper under the act. This would prevent large companies from filing wherever they please and thus would eliminate incentives for bankruptcy judges to cow tow to the demands of large corporations and their financiers. It is easy to see why state attorneys general as well as bankruptcy professionals and scholars are calling for venue reform but make no mistake, this issue has broad ramifications. Look no further than Purdue Pharma’s Chapter 11 bankruptcy. Purdue Pharma, though based in Connecticut, was able to pick the court and even the judge for its bankruptcy. Exploiting the flexibility of the current venue statute, Purdue Pharma was able to file in the Southern District of New York. Even worse, Purdue was able to select their judge by using a local rule that made Judge Robert Drain the only possible bankruptcy judge for the case. This was exactly as Purdue Pharma’s owners had planned. Purdue Pharma and its owners, the Sackler family, had been implicated in the opioid crisis. Judge Drain approved a plan that shielded the Sackler family from liability in future opioid-related cases even though none of the Sacklers had personally filed for bankruptcy. In response to Judge Drain’s questionable decisions, Connecticut’s Attorney General, William Tong, said “[the Sacklers] should not be able to manipulate bankruptcy laws to evade justice and protect their blood money.” Essentially, Judge Drain, through bankruptcy, eliminated the rights of opioid victims to recover potentially billions of dollars in damages. Contact your Elected Officials!
ABLS Saves Debtor Thousands, Receives Judge’s Compliments
Recently shareholder Joe Peiffer and associate Austin Peiffer went toe-to-toe with attorneys representing Farm Credit over that creditor’s exorbitant fee demand. While secured creditors often have the right to make the debtor pay their attorney fees, those fees must be reasonable, and in this case they weren’t. Judge Collins agreed, and by objecting to Farm Credit’s fees ABLS’s client saved over $65,000. Tons of Information Working on a tight deadline, the ABLS team analyzed hundreds of pages of time entries filed by Farm Credit’s attorneys. This analysis revealed numerous duplicate billings and, indeed, billing for things that were, in fact, unnecessary. One unique aspect of this case is that the debtor had five loans with Farm Credit. Farm Credit required that its attorneys bill each loan individually, generating five different sets of invoices for this work. This made the analysis even more tricky. Sometimes the exact same entry would appear on multiple bills. In order to ascertain the actual amount of time spent, the Judge and his team needed to review all five sets of invoices and compare them. In this comparison, they often found duplicates. A High Standard Judge Collins was complementary of ABLS’s approach to billing and fees: “The Court specifically notes that Debtor’s counsel, and his firm’s billing practices are very well known to the Court. The Court has reviewed and approved numerous fee applications from Debtor’s counsel–in both large and small cases. The Court has previously recognized that Debtor’s counsel is incredibly thorough, detail-oriented, and well-prepared. This has earned Debtor’s counsel a stellar reputation in Chapter 12 cases, but that thorough approach pushes up the cost of his services.” Judge Collins also noted that Farm Credit’s counsel and the law firm, “also have an excellent reputation for excellence in this type of work.” This makes evident His Honor’s respect for the members of the bar that practice in front of him. Furthermore, this opinion illustrates the high standard that he requires in this district. You can read the whole opinion here: Kurtenbach (Debtor) Opinion. The opinion also caught the attention of columnist Bill Rochelle. He wrote about the opinion in his daily blog “Rochelle’s Daily Wire” on the ABI website (ABI membership required to bypass paywall). Ag & Business Legal Strategies is a law firm that works strenuously to defend its clients’ interests. Operating often in the debtor-creditor sphere, ABLS has positioned its professionals uniquely to understand their clients’ needs and work to obtain the desired results.
Tough Financial Times in Agriculture and Lending Clauses – Peril for the Unwary
Overview The farm economy continues to struggle. Of course, certain parts of the country are experiencing more financial trauma than are other parts of the country, but recent years have been particularly difficult in the Corn Belt and Great Plains. Aggregate U.S. net farm income has dropped by approximately 50 percent from its peak in 2011. It is estimated to increase slightly in 2017, but it has a long way to go to get back to the 2011 level. In addition, the value of farmland relative to the value of the crops produced on it has fallen to its lowest point ever. A dollar of farm real estate has never produced less value in farm production, and real net farm income relative to farm real estate values have not been as low as presently since 1980 to 1983. A deeper dive on farm financial data indicates that after multiple years of declining debt-to-asset ratios, there was an uptick in 2015 and 2016. Relatedly, default risk remains low, but it also increased in 2015 and 2016. Also, there has been a decline in the ratio of working capital to assets, and a drop in the repayment capacity of ag loans. As a financial fitness indicator, repayment capacity is a key. At the beginning of the farm debt crisis in the early 1980s, it dropped precipitously due to a substantial increase in interest payments and a decline in farm production. That meant that land values could no longer be supported, and they dropped substantially. Consequently, many farmers found themselves with collateral value that was lower than the amount borrowed. Repayment capacity is currently a serious issue that could lead to additional borrowing. While financial conditions may improve a bit in 2017 and on into 2018, working capital may continue to erode in 2017 which could lead to increased debt levels. That’s because average net farm income will remain at low levels. This could lead to some agricultural producers and lenders having to make difficult decisions before next spring. It also places a premium on understanding clause language in lending document and the associated rights and obligations of the parties. Two clauses deserve close attention. One clause contains “cross-collateralization” language. “Cross-collateralization” is a term that describes a situation when the collateral for one loan is also used as collateral for another loan. For example, if a farmer takes out multiple loans with the same lender, the security for one loan can be used as cross-collateral for all the loans. A second clause contains a “co-lessee” provision. That’s a transaction involving joint and several obligations of multiple parties. Today’s post takes a deeper look at the implications of cross-collateral and co-lessee language in lending documents. My co-author for today’s post is Roger McEowen of Washburn University’s School of Law. Roger and I have worked together on many presentations through the years on law and taxation. Cross-Collateralization Language As noted above, clause language in lending and leasing documents should be carefully reviewed and understood for their implications. This is particularly true with respect to cross-collateralization language. For example, the following is an example of such a clause that appears to be common in John Deere security agreements. Here is how the language of one particular clause reads: “Security Interest; Missing Information. You grant us and our affiliates a security interest in the Equipment (and all proceeds thereof) to secure all of your obligations under this Contract and any other obligations which you may have to us or any of our affiliates or assignees at any time and you agree that any security interest you have granted or hereafter grant to us or any of our affiliates shall also secure your obligations under this Contract. You agree that we may act as agent for our affiliates and our affiliates may as agent for us, in order to perfect and realize on any security interest described above. Upon receipt of all amounts due and to become due under this Contract, we will release our security interest in the Equipment (but not the security interest for amounts due an affiliate), provided no event of default has occurred and is continuing. You agree to keep the Equipment free and clear of all liens and encumbrances, except those in favor of us and our affiliates as described above, and to promptly notify us if a lien or encumbrance is placed or threated against the Equipment. You irrevocably authorize us, at any time, to (a) insert or correct information on this Contract, including your correct legal name, serial numbers and Equipment descriptions; (b) submit notices and proofs of loss for any required insurance; (c) endorse your name on remittances for insurance and Equipment sale or lease proceeds; and (d) file a financing statement(s) which describes either the Equipment or all equipment currently or in the future financed by us. Notwithstanding any other election you may make, you agree that (1) we can access any information regarding the location, maintenance, operation and condition of the Equipment; (2) you irrevocably authorize anyone in possession of that information to provide all of that information to us upon our request; (3) you will not disable or otherwise interfere with any information gathering or transmission device within or attached to the Equipment; and (4) we may reactivate such device.” So, what does that clause language mean? Several points can be made: The clause grants Deere Financial and its affiliates a security interest in the equipment pledged as collateral to secure the obligations owed to it as well as its affiliates. When all obligations (including debt on the equipment purchased under the contract and all other debts for the purchase of equipment that Deere Financial finances) to Deere under the contract are paid, Deere Financial will release its security interest in the equipment. That appears to be straightforward and unsurprising. However, the release does not release the security interest of the Deere’s affiliates. This is the cross-collateral provision. The clause also makes Deere Financial the agent of its affiliates,