A Fresh Look at Chapter 12 for Family Farmers

By: Justin C. Valencia

In the 1980s, falling land values and grain prices combined with soaring interest rates and tightening credit led to one of the worst farm crises of the 20th century.  In 1986, Congress responded by giving farmers a reorganization tool, and in 2005 made chapter 12 a permanent part of the Bankruptcy Code.

New Farm Crisis

Weather, disease, boom and bust cycles makes farming an inherently risky business.  Further, between 2012-2016, farm income fell 34 percent, farm-sector debt has reached peak levels last seen in the 1980s, and rising interest coupled with reduced income and increased debt suggests that farmers might not be able to repay debt in future years.  

A Fresh Look at Chapter 12

Chapter 12 has some similarities to a chapter 13 and a chapter 11.  Chapter 12 cases are administered by a standing trustee.  Like a chapter 13, chapter 12 cases proceed under the trustee’s supervision until the plan is completed.  The debtor can receive a discharge, and unlike chapter 11, there is no disclosure statement or voting on the plan by creditors, and there is no absolute priority rule to follow. 

Chapter 12 also offers a great tax incentive under 11 U.S.C. § 1232.  This section is designed to allow a deprioritization of taxes due on the sale of assets as part of a confirmed plan, allowing farmers to essentially avoid large capital gains taxes.  Chapter 12 plans can also modify mortgages on principle residences, adjust interest rates, and re-amortize mortgage loans beyond a 30-year period.  In addition, debtors can restructure loans secured by equipment and livestock based on the value and useful life of the collateral, using the same discounted interest rate (typically prime plus a 1-3 percent risk factor) or Till rate.  Another advantage is that chapter 12 plans are not due until 90 days after the case filing, which allows debtors additional time to assess claims, negotiate terms, and consider courses of action.  Also, generally, plan payments are not due until after confirmation and periodic payments can be structured about the farm’s cash-flow cycles.  Further, under § 1224, a plan confirmation hearing needs to be concluded within a specified time frame.  In other words, chapter 12 needs to be more streamlined and efficient when compared to other chapters of the Bankruptcy Code.

Eligibility

Pursuant to § 109(f). “Only a family farmer or family fisherman with regular annual income may be a debtor under chapter 12 of this title.”  Other sections of the Bankruptcy Code add important definitions including whether a potential debtor is eligible to file for chapter 12 relief.  One very important criterion was recently updated, that of a farmer’s debt load.  As of this writing, H.R. 2336, the Family Farmer Relief Act of 2019, Pub. L. No. 116-51, amended § 101(18) to increase the chapter 12 debt limit to $10 million.  It took effect after it was signed into law. 

Main Uses of Chapter 12

Chapter 12 plans normally fall into one of three categories: traditional reorganization plans, downsizing or conversion plans and sale plans.  These are not mutually exclusive. 

A traditional reorganization plan allows the farm to preserve its essential nature and scale while also allowing it to reduce its debt service, increase efficiency and put the farm back onto a profitable path.  The need for this type of reorganization sometimes stems from a specific event like a bad crop season, significant flooding, livestock death-loss, or illness or disability of the farmers.   If, on the other hand, a farmer’s production costs exceed the market price, then restructuring will not help return the farm to profitability.  In that event, considering other options may be necessary which could include changing the scale or type of farming, selling or surrendering land, livestock, or equipment. 

Normally, the best use for chapter 12 is to assist a farm in changing scale while also converting to a different or diverse production bases.  A careful assessment of the farm’s resources may lead to the sale or surrender of equipment, land, or livestock not otherwise needed which could help return the farm to profitability. 

Sometimes a farmer decides that the work-load, inherent risks, and unreliable income from farming may be no longer what he or she wants.  Perhaps the farmer only wants to save their home but not keep the entire farm operation.  In this situation, chapter 12 can be valuable in that it allows a sale plan that emphasizes selling assets to satisfy debt.  The advantage of doing this through chapter 12 instead of chapter 7 or through other non-bankruptcy solutions is that the farmer, as debtor-in-possession, can retain a higher level of control over marketing the property as opposed to a chapter 7 trustee.  In addition, the special rules for capital gains taxes on the sale of farmland and a chapter 12 plan may allow a farmer to retain his or her home while discharging unsecured debt makes chapter 12 more attractive. 

On the occasion, it may be worthwhile to file for bankruptcy relief – personally and also on behalf of the farming operation – since, often is the case, the family farmer has personally guaranteed debt for his or her operation. 

In any event, if you are a farmer and you find that you and your operation are in dire financial straits, then it may be worth your time and effort to talk with experienced bankruptcy counsel.  Feel free to contact our office to set up an appointment.