Farms come in all shapes and sizes. They are operated by publicly traded companies, closely held organizations and individuals. They share many of the same successes and problems, including the booms and busts directly related to external circumstances. Weather, tariffs, trade and politics are just a few of the factors outside the day to day control of a farming operation which impact the bottom line.
As a result of the uncertain nature of farming, farmers are typically self sufficient by nature and reluctant to seek financial or legal help at the early signs of financial distress. Fortunately, even at the 11th hour of an emergency, there is one step that can be taken to turn around a farm and give it a fresh start.
Chapter 12 of the U.S. Bankruptcy Code is a unique chapter designed specifically for family farms and farmers. Other chapters of the bankruptcy code just did not fit the special circumstances facing family farms. For instance, Chapter 13 bankruptcy limits how much debt that can be reorganized through this process. The debt limits are far too low for the typical family farm. On the other hand, Chapter 11 bankruptcy doesn’t have a debt limit for reorganization. It does however have a rule known as the “absolute priority rule”. The absolute priority rule prohibits, with some exceptions, the continued current ownership of the farm over the objection of creditors that are not going to be paid in full. Since most family farms are owned and operated as a lifestyle business and are generational in nature, this rule is completely contrary to an effective family farm re-organization.
The good news is that the Bankruptcy Code provides a straight forward approach and roadmap to follow regarding eligibility for family farming operations to file bankruptcy and achieve a court approved plan of reorganization. For instance, section 101(21) of the bankruptcy code generally states that the term “farming operation” includes farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, livestock.
Section 101(18)(A) of the bankruptcy code generally outlines eligibility for an individual or married couple engaged in a farming operation as:
- Total debt cannot be greater than $4,031,575 on the day the case is filed;
- 50% or more of the debt must come from the farming operation; and
- More than 50% of the gross income in the taxable year before filing or 50% of the gross income in the second and third year before filing must come from the farming operation.
Many family farms however are run through corporations, partnerships and limited liability companies. Section 101(18)(B) of the bankruptcy code generally outlines eligibility for a farming operation owned in this matter as:
- More than 50% of the outstanding ownership must be held and operated by one family, or one family and their relatives;
- More than 80% of the value of the assets must relate to the farming operation;
- The total debt cannot be greater than $4,031,575 (excluding the family residence) on the date the case is filed; and
- If the farming operation issues stock, such stock is not publicly traded.
Once we determine that a family farm is eligible to reorganize its operation under Chapter 12 of the bankruptcy code, a petition and schedules must be filed with the appropriate bankruptcy court. The petition and schedules will include the farm’s assets and liabilities as well as its income and expenses. This information will constitute the initial “property of the estate”. Unlike bankruptcy estates under other chapters of the Bankruptcy Code, however, Chapter 12 bankruptcy requires that all property acquired and income earned after filing until the case is closed, dismissed or converted be included as property of the estate. Ultimately, most collection actions are stopped by virtue of the “automatic stay”, i.e., an automatic injunction imposed against creditors, upon filing the petition. The property of the estate is then protected, the farmer can take a breath and operate the farm before setting forth the plan of reorganization.
During the window of time between the filing of the petition and a confirmed plan of reorganization, the farm will continue to operate as a ‘debtor–in-possession” with a court appointed trustee, versed in farming operations, assigned to oversee the proposed reorganization. Unless extended with court approval, the debtor in possession will file its plan of reorganization within 90 days of filing bankruptcy. While creditors don’t get to vote for or against the plan, they and others can object to the plan. As long as the plan meets the requirements of Section 1225 of the bankruptcy code, the court must confirm the plan.
Sections 1222 and 1225 of the bankruptcy code outline the requirements to have a plan of reorganization confirmed. Generally, the plan of reorganization must:
- Be proposed in good faith and not forbidden by law;
- Unsecured creditors, over 3 to 5 years, must receive at least as much for their claim as they would if the farm assets were all sold;
- Secured creditors must:
- Accept the proposed treatment under the plan; or
- Receive money, with interest, equal to the collateral securing its claim; or
- Receive the collateral.
The largest creditors in family farming operations are typically Farm Credit, a network of private lending institutions dedicated to serving rural and agricultural communities or the USDA Farm Service Agency, a government backed lending institution whose mission is to assist and promote farming. Both lenders understand the difficulties farmers can face operating a farm. Both lenders want farming operations to succeed and both lenders are typically cooperative with reorganization efforts.
Once the plan is confirmed by the court, payments are made to the Chapter 12 Trustee who will distribute funds as indicated in the plan. In the event circumstances change the debtor’s ability to make the payments proposed in the plan, the plan can be modified with court approval. After all payments are made pursuant to the plan, the debtor finally receives its discharge.