Caution and Disclaimer:  This information is NOT to be relied upon for legal advice.  It is offered as educational information.  See an attorney for legal advice.  Each person's situation is unique and legal advice must be tailored to the particular facts and issues.

Chapter 12 Resurrected: But Only Until June 1, 2001

On April 26, 2001, the Senate passed H.R. 256, a bill that once again provides a temporary extension for Chapter 12, the Family Farmer Reorganization chapter of the Bankruptcy Code. H.R. 256 was passed by the House on February 28, 2001. The bill was presented to the President on May 2, and he signed it on May 11, 2001. It has been assigned Public Law No. 107-8.

The legislation technically extends Chapter 12 for 11 months, but because it is effective retroactively back to its last sunset, July 1, the actual time period that Chapter 12 filings can be made will be very brief. The new legislation provides that Chapter 12 will again sunset on June 1, 2001. This will give farmers who are considering filing or wish to convert from another Chapter only about two weeks to decide.

The bankruptcy reform legislation that passed both the House and the Senate contains provisions that will make Chapter 12 a permanent part of the Bankruptcy Code, but that legislation is mired in a debate over the membership of the Conference Committee that will work out differences between the House and Senate versions. (H.R. 333, passed Mar.1, 2001; S. 420, passed Mar. 19, 2001). For updates on this legislation, see the American Bankruptcy Institute’s Internet website, http://www.ABIworld.org.

CHAPTER 12: THE NEW BANKRUPTCY OPTION FOR FAMILY FARMERS

by

Ann Henderson

and

Stephen Matthews

 

Until recently most farmers had only two options under the current Bankruptcy Code. They could either liquidate their assets under Chapter 7 or attempt to work out their debt problems under Chapter 11, a relatively complex and costly business reorganization chapter. Few farmers were eligible for a third bankruptcy option that is commonly, though somewhat erroneously, referred to as the "wage earner's plan." That option previously was available only through Chapter 13. And Chapter 13 relief is restricted to wage earners and sole proprietors with unsecured debts under $100,00 and secured debts under $350,000.

On November 27, 1986, however, Chapter 12, an emergency "family farmer" bankruptcy chapter, went into effect. Chapter 12 is closely modeled after Chapter 13. Both chapters are relatively inexpensive to use and easy to understand. Both offer qualified debtors a chance to propose a plan for repaying, primarily with future earnings rather than the sale of assets, at least as much debt as would be paid in Chapter 7 liquidation. Both require that the plan be feasible, proposed in good faith, and approved by the bankruptcy judge. Neither requires creditor approval of the plan.

Chapter 12, however, alters some Chapter 13 provisions that were considered inappropriate for family farmers--the low debt limits, the exclusion of partnerships and corporations, the requirement that repayment plans be filed within 15 days of the petition, and the requirement that plan payments start within 30 days after plan confirmation. Also, unlike Chapter 13 which contains no comparable deadline, Chapter 12 provides that, under normal circumstances, a plan must be confirmed or rejected within 45 days after it is filed. In addition, Chapter 12 specifically addresses two issues that frequently arise in farm bankruptcy cases: (1) What does it take to satisfy the bankruptcy requirement that a debtor must "adequately protect" secured creditors? and (2) May a debtor sell part of his encumbered farmland and equipment in order to scale down his farming operation?

The following paragraphs discuss (1) the eligibility requirements and key features of Chapter 12 bankruptcies and (2) the primary differences between Chapter 12 and Chapter 11 and 13 bankruptcies. This discussion is designed to provide general information rather than legal advice. Anyone contemplating bankruptcy should obtain personal advice, based on knowledge of his individual situation, from a qualified attorney and a competent tax professional.

I. ELIGIBILTY FOR CHAPTER 12 1 2

Only a "family farmer" with total debts, secured and unsecured combined, not exceeding $1.5 million is eligible to use Chapter 12. The term "family farmers", for purposes of Chapter 12, does not refer exclusively to farmers who operate their farms as sole proprietorships. Partnerships and corporations that qualify as "family farm" businesses are also eligible for Chapter 12 relief.

More specifically, the eligibility requirements for Chapter 12 are as follows:

1. For individuals and married couples engaged in a farming operation:

    1. Aggregate debts cannot exceed $1.5 million.
    2. At least 80% of total debts must be debts that arose from the farming operation. (The farmer's home mortgage debt should be included in calculating total debt only if it arose from the farming operation.)
    3. More than 50% of the farmer's income in the prior tax years must have been from his farming operation.
    4. The debtor(s) must have regular annual income.

2. For corporations or partnerships:

    1. Aggregate corporate or partnership debt cannot exceed $1.5 million.
    2. At least 80% of total corporate or partnership debts must be debts that arose from the farming operations.
    3. More than 50% of the stock or equity must be held by a family that conducts the farming operation.
    4. Corporations must have no publicly traded stock.
    5. The value of assets related to the farming operation must account for more than 80% of total corporate or partnership asset value.
    6. The corporation or partnership must have regular annual income.

Of course, any farmer (and almost any other debtor), whether eligible or ineligible for Chapter 12, may use Chapter 11. And any individual (but not partnerships or corporations) with regular income and unsecured/secured debts under $100,000/$350,000 may use Chapter 13 3 , even those who also are eligible for Chapter 12.

  1. CHAPTER 12: KEY PROVISIONS

FORMS TO FILE, DEADLINES, AND FEES

Forms

The debtor must fill out and sign several forms. These forms, which must be filed in the appropriate bankruptcy court, include:

  1. a petition, which states the petitioner's name, mailing address, social security number, etc. and tells the court that the petitioner wants to proceed under Chapter 12; 4
  2. a list of all creditors, their addresses, amounts owed each, and description of collateral, if any;
  3. a schedule of assets;
  4. a schedule of current income and current expenditures;
  5. a statement of financial affairs, which requires the debtor to:
  1. furnish various types of information, such as details about bank accounts and safe deposit boxes maintained within the prior two years, property sold, traded, given away, lost or destroyed with the prior year; and the location of financial records and all assets and
  2. certify "under penalties of perjury" that the information provided is true; 5
  1. a plan for repaying, over time, at least as much debt as would be paid if the debtor liquidated his assets in a Chapter 7 bankruptcy.

 

Filing Deadlines

All forms, other than the plan, must be filed either with the petition or, if the petition includes the list of creditors and their addresses, within 15 days of filing the petition. 6 The plan usually must be filed within 90 days of the petition--though it can be modified later. 7

By comparison, a Chapter 13 debtor generally must file his plan within 15 days of the petition8, although he, too, may propose modifications in the plan later. On the other hand, a Chapter 11 debtor has no filing deadline, but he loses his "exclusive" right to file a plan 120 days after filing his petition.

 

Filing Fee

A filing fee must be paid when the petition is filed. The filing fee for Chapter 12 is $200.9

By contrast, the filing fees are $90 for Chapter 13 and $500 for Chapter 11.

 

 

 

 

 

THE PLAN

Time Limits10

In the usual case, all payments provided for in a Chapter 12 plan must be made within three years. With court permission, however, payments may be made over a period of up to five years.

Payments on long term debts (debts not maturing within the three to five year period) may either be paid "outside" the plan--directly to the creditor, rather than to the trustee--or scheduled in the plan as payments not to be paid within the normal three-five year period. 11 All overdue amounts on long term debts must be paid within a "reasonable" time--if the debtor wants to prevent foreclosures and repossessions that would otherwise occur.12

The three to five year limit also applies to Chapter 13 plans. By contrast, there are no comparable time limitations for Chapter 11 plans.

 

Valuing the Debtor's Assets

As previously stated, the debtor must file a schedule of his assets with the bankruptcy court. The bankruptcy judge, after hearing from both sides, will decide what the debtor's assets are worth.

An accurate appraisal of the value of the debtor's assets is crucial since, as discussed below, that value determines (1) the minimum percentage of "unsecured" debt that must be repaid and (2) what, if any portion of "secured" debt is actually "unsecured."

 

Developing the Plan

The plan must show the amount to be paid regularly (to the bankruptcy trustee for distribution to the creditors), the percentage of unsecured debt that will be paid, and the total amount to be paid. To develop this plan, a debtor should estimate his gross revenue, farm operating expenses and family living expenses, including taxes, for the period the plan is to cover. He then can subtract the estimated expenses from the estimated revenue. The remainder should be sufficient to pay:

  1. All bankruptcy court administration expenses, taxes due within the three year period prior to filing, and other "priority" claims (certain wages to employees and security deposit refunds to customers). 13
  2. To the extent that any debt actually is "secured" by property the debtor will retain, all payments on that debt that are either overdue or will become due within the period of the plan.

    3. The extent to which a debt is secured depends upon the value of its collateral and the amount owed to prior lienholders, if any. For example, assume land currently valued at $240,000 is the sole collateral for a $200,000 first lien, a $70,000 second lien, and a $30,000 third lien. In this example, the full amount of the first lien is secured; $40,000 of the second $70,000 is secured; and none of the third $30,000 lien is secured. Thus, $60,000 of what appeared to "secured" loans is actually "unsecured".

  3. Some portion of "unsecured" debts.

Unsecured debts include: (a) Debts owed to creditors who have no liens or security interests in the debtor's property, such as phone bills, medical bills, credit card bills, and bills for fertilizer, fuel, and feed; (b) Debts owed to creditors who have liens or security interests that aren't enforceable in a bankruptcy proceeding---such as "unperfected" security interests (unrecorded deeds of trust, unfiled financing statements, etc.); (c) (As previously mentioned) any portion of a debt that exceeds the value of its collateral less the amount owed to prior lienholders, if any.

There are two guidelines for determining the amount that must be paid on unsecured debts. First, that amount at least must equal the amount that would be paid on unsecured debt if the debtor liquidated his assets in a Chapter 7 bankruptcy case. 14 In a Chapter 7 case, secured creditors could claim their collateral, the debtor could retain certain assets of limited value as "exemptions", and any remaining cash, along with proceeds from the sale of remaining non-cash assets, would be used first to pay bankruptcy court costs and the tax on any liquidation "income" and then the balance, if any, would be distributed among the unsecured claims.

Second, if an unsecured creditor objects to partial payment, the court will not approve a plan unless all the debtor's disposable income is to be paid into the plan. Disposable income is all income received less reasonable living and farm operating expenses.15 No allowance is made for savings and investments.

 

Confirmation

The debtor's plan must be approved (confirmed) by the bankruptcy judge. The judge will approve a plan only if he believes that, among other things, the debtor (1) will be able to make the payments scheduled in the plan and still pay living expenses and obligations not scheduled in the plan, and (2) has proposed the plan in "good faith."16 Whether or not a plan has been proposed in good faith is determined by several factors, including the debtor's honesty in representing the facts. After the plan is confirmed, the judge may order any source from which the debtor receives income to pay that income directly to the bankruptcy trustee, rather than to the debtor. 17

In Chapter 12 cases, the judge generally will make a decision about the plan within 45 days after the plan is filed.18

 

 

THE AUTOMATIC STAY

Definition and Purpose19

As soon as a bankruptcy petition is filed, an "automatic stay" goes into effect. This stay prohibits creditors form foreclosing, repossessing, or taking any other debt collection action against the debtor or his property. In cases under Chapters 11, 12, and 13, the primary purpose of the stay is to give the debtor a chance to develop a repayment plan.

 

Lifting the Stay: The "Adequate Protection" Test20

Secured creditors who had a right to foreclose or repossess when the case was filed may ask the bankruptcy court to "lift" the automatic stay--so that they can proceed with foreclosure or repossession while the case is pending. The Bankruptcy Code requires the court to grant such a request if the requesting creditor is not "adequately protected." A creditor who is undersecured and whose collateral is depreciating or declining in value is not considered "adequately protected" unless he is given something, such as cash payments or additional collateral, while the case is pending.

The amount of compensation necessary to "adequately protect" creditors is determined by somewhat different criteria in Chapter 12 than in other bankruptcy cases. The Chapter 12 criteria were designed to reduce "unnecessary litigation" in family farm bankruptcy cases. 21 Under Chapter 12, a creditor that requires adequate protection need not be compensated for "lost opportunity costs" (interest the creditor could earn if he could sell the collateral and invest the proceeds). In addition, Chapter 12 specifically provides that the payment of reasonable rent adequately protects a creditor with a security interest in farmland.

 

 

ROLES OF TRUSTEE, DEBTOR, AND CREDITORS

The Bankruptcy Trustee22

A bankruptcy trustee is assigned to every Chapter 12 case. In the usual case, the trustee's duties are limited to performing investigative duties, representing the creditors' interests at certain hearings, and, if a repayment plan is approved, collecting and disbursing payments made under the plan. These are the same functions that a Chapter 13 trustee performs. However, unlike Chapter 13, Chapter 12 provides that, if the trustee or a creditor shows that the debtor is guilty of fraud, dishonesty, incompetence, or gross mismanagement, the debtor must turn over control of the farming operation to the trustee.

In a Chapter 11 case, on the other hand, a trustee is not appointed unless the debtor engages in fraud, dishonesty, etc.--in which case the trustee assumes control of the business operation.

The trustee's fee in a Chapter 12 case may be up to 10% of the first $450,000 disbursed under the plan and up to 3% of the excess.23

The Debtor

Restrictions on the Debtor's Use of "Estate" Property

While a Chapter 11-13 bankruptcy case is pending, the debtor, in effect, holds most of his assets in trust for the benefit of his creditors. These assets are referred to as the "bankruptcy estate." They include (1) all property in which the debtor has an ownership interest at the time he files his petition; (2) some property, such as inheritances, the debtor becomes entitled to within 180 days after filing; (3) property, or the value of property, the debtor is found to have "unfairly" transferred to others in the year prior to filing; and (4) "proceeds, product, offspring, rents and profits of or from" this property. 24 In Chapters 12 and 13, unlike Chapter 11, the estate also includes the debtor's post-petition earnings and all property he wins or acquires, by gift, inheritance, etc., while the case is pending. 25

Generally, the debtor will remain in possession of the "estate's" property and continue to run the farming operation while the case is pending. During this time, he may continue to sell farm products in the ordinary course of farming operations. However, he may not use any encumbered liquid assets, including proceeds from the sale of encumbered grain, livestock, or other farm products, without obtaining prior consent from the court or the secured parties. 26 This restriction, which is applicable to Chapter 11, as well as Chapters 12 and 13, must be strictly followed.

The Chapter 12 debtor, who wants to sell some encumbered farmland and farm equipment, free and clear of liens, may do so if (1) he obtains prior approval from the bankruptcy court and (2) the liens attach to the proceeds. 27 By contrast, a Chapter 11 or 13 debtor may not scale down his farming operation in this manner unless he obtains prior approval from both the bankruptcy court and the secured creditors.

 

Duties

The Chapter 12 debtor also must:

  1. Cooperate with the trustee as necessary to enable the trustee to perform his duties. 28
  2. Give the trustee any recorded information, including books, documents, records, and papers, relating to his property and income. 29
  3. Attend a meeting with the trustee and answer questions relating to the case. 30 (The creditors also may attend this meeting and ask the debtor questions.)
  4. Attend hearings, as required, and testify if called as a witness.31

 

 

The Creditors

No official creditor's committee is appointed in Chapter 12 cases, and creditors have no right to either propose or vote on a plan. They may, however, voice their objections to a plan at the confirmation hearing, and they may participate in other hearings, as well. 32 In addition, if there is evidence of fraud, creditors may have a Chapter 12 case either dismissed or converted to a liquidation case. 33 Creditors also may have a case dismissed, but not converted, for other reasons, such as a debtor's unreasonable delays, gross mismanagement, or failure to carry out an approved plan. 34

The Chapter 12 provisions dealing with the creditors' role essentially were adopted from Chapter13. However, a creditor's right to have a Chapter 13 case converted to a liquidation case, rather than simply dismissed, depends upon who the debtor is. (If a Chapter 13 debtor is someone who received more than 80% of his gross income from a farming operation in the prior tax year, his creditors have no right to convert the case. If the debtor is anyone else, creditors may request conversion on several grounds in addition to fraud.)

By comparison, creditors in a Chapter 11 case may have a much more active role. Under Chapter 11, a committee of unsecured creditors may be appointed to consult with the debtor, investigate any relevant matter, and participate in formulation of the plan. Chapter 11 creditors vote on the debtor's plan and that vote could determine whether or not a plan is confirmed. In addition, a Chapter 11 creditor may file a plan if (1) due to fraud or mismanagement, a trustee is appointed or (2) the debtor doesn't get a plan filed within 120 days, or confirmed within 180 days, after filing his petition. If a creditor is allowed to file a plan, than plan may call for liquidation of the debtor's assets.

 

THE DISCHARGE

Definition and Purpose

A bankruptcy court may "discharge" the debtor's obligation to pay certain debts. This means that the debtor no longer has a legal obligation to pay those debts. A discharge enables the debtor to get a "fresh start" with his financial affairs after bankruptcy.

 

When Granted 35

In Chapter 12, as in Chapter 13, the court may grant either a "completion" discharge or a "hardship" discharge. A completion discharge is granted after a debtor has successfully completed his plan. A hardship discharge may be granted only if (1) the debtor is unable to complete a plan for reasons beyond his control, such as disabling illness, (2) creditors have been paid as much as they would have received in a Chapter 7 liquidation, and (3) modification of the plan is not practical.

By contrast, a Chapter 11 discharge is granted when a Chapter 11 plan is confirmed. Chapter 11 does not provide for a "hardship" discharge.

 

Dischargeable Debts

Dischargeable debts include debts the court decides are unenforceable (due to statutes of limitations, the creditor's failure to file, record or otherwise perfect a security interest) and, to the extent they exceed stated amounts, unpaid property taxes and debts arising from terminations of leases and employment contracts. In addition, under Chapters 11 and 13, if the debtor's plan provides for only partial payment of certain debts, the debtor's legal liability for the remaining portions of those debts, with some exceptions, may be discharged.

 

 

 

The Exceptions 36

The following debts are not dischargeable in Chapter 12 cases:

  1. debts not scheduled in the plan,
  2. payments scheduled in the plan that are not to be made within the normal period of the plan (three to five years for Chapter 12 plans),
  3. alimony and child support payments,
  4. guaranteed student loan payments due within the five years prior to filing (unless repayment would impose undue hardship),
  5. certain tax claims, fines, penalties, punitive damages, liabilities resulting from the debtor's operation of a motor vehicle while intoxicated, and debts involving fraud, including debts obtained by using false statements, debts for which the debtor listed, as collateral, property he did not own, and debts incurred shortly before filing with the intention of listing them in the bankruptcy petition.

These exceptions also apply to a Chapter 11 discharge and to Chapter 13 "hardship" discharge. However, only the first three apply to a Chapter 13 "completion" discharge.

 

COSTS

In addition to the previously mentioned trustee fee (10% of plan payments up to $450,000; 3% of the excess) and $200 filing fee, the debtor will incur attorney fees. Attorney fees for a Chapter 12 case are expected to be somewhat lower than those for a Chapter 11 case. (In Missouri, attorney fees for Chapter 11 farm bankruptcy cases pending from 1981-1986 tended to cluster between $5,000 and $7,500.)

 

 

III. FEDERAL INCOME TAX CONSIDERATIONS

Under the Internal Revenue Code (IRC) currently in effect, the "bankruptcy estate" created in Chapter 12 and 13 cases is not viewed as a taxable entity separate from the debtor. Thus, unless the IRC is amended, the Chapter 12 or 13 debtor must report, on his own federal tax return, all gains and losses from "estate" assets while the case is pending.

By contrast, the "bankruptcy estate" created when an individual (but not a corporation) files under Chapter 11 is viewed as a taxable entity separate from the debtor. 37

This meant that:

  1. An individual farmer who proceeds under Chapter 11 must file two federal tax returns--one for the bankruptcy estate and one for himself.
  2. He must report post-petition income from estate assets on the estate's return. And, unless he files a "short year" return (see #4 below), he also must use any operating loss, charitable contribution, and credit carryovers from prior years on the estate's return.
  3. If the estate has a net gain, any tax due on that gain is payable solely out of estate assets. On the other hand, if the estate has a net loss, that loss cannot be used to offset income on the debtor's return.
  4. He must report, on his own return, his (a) pre-petition income (income earned between the beginning of the tax year and the date of filing) and (b) post-petition income, other than income from estate assets. (He may, however, divide his own tax year into two "short tax years" and report his pre-petition income on one "short year" return and his post-petition on a separate "short year" return. By so doing, the debtor can (1) convert the tax due on pre-petition income to a "tax due…prior to filing", which is a priority claim against the estate and (2) use the carryovers that could otherwise be used only on the estate's return to off-set his pre-petition, but not post-petition, income.)

IV. CONCLUSTIONS

Chapter 12 vs. Chapter 13

A few farmers may qualify for both Chapter 12 and Chapter 13. The primary advantages of Chapter 13 are the lower filing fee and more comprehensive discharge. The primary advantages of Chapter 12 are that the debtor has more time to develop a plan and is not required to begin making payments within 30 days after the plan is confirmed.

 

Chapter 12 vs. Chapter 11

Although Chapter 12 is likely to be less expensive and less complex than Chapter 11, it will not necessarily be the better bankruptcy alternative for every family farmer. For example, some farmers who qualify for Chapter 12 may (1) need more time to develop a plan or to make the requisite payments to unsecured creditors or (2) find that Chapter 12's requirement that the debtor contribute all "disposable income" to the plan is a more severe standard than would be imposed under Chapter 11. In addition, unless the federal income tax code is amended, some farmers may find that their tax liability will be sufficiently lower under Chapter 11 to offset the higher cost and attorney fees.

 

 

 

 

 

FOOTNOTES

 

1Except as otherwise indicated, all footnotes refer to 11 USC.

 

2Secs. 109(f) & 101(17).

 

3Sec. 109 (3).

 

4Official Form 1; See also Secs. 301 & 302.

 

5Sec. 521(1); Rules 4002 and 1007; Official Form No. 8.

 

6Rule 1007(b).

 

7Sec. 1221, 1223, 1229.

 

8Rule 3015.

 

928 USC Sec. 1930.

 

10Sec. 1222(c).

 

11Sec. 1222(b) (9).

 

12Sec. 1222(b) (5).

 

13Secs. 1222(a) (2); 507.

 

14Sec. 1225(a) (4).

 

15Sec. 1225(b).

 

16Sec. 1225(a) (3) & (6).

 

17Sec. 1225(c).

 

18Sec. 1224.

 

19Sec. 362.

 

20Sec. 1205.

21Joint Explanatory Statement of the Conference Committee (See The Congressional Record, 10/2/86).

22Sec. 1202.

23Sec. 1202(d) (1).

24Sec. 541.

25Secs. 1207(a) & 1306.

26Sec. 363 (a) & (c) (2).

27Sec. 1206.

28Sec. 521(3).

29Sec. 521(4).

30Sec. 521(5) and Rule 4002.

31Rule 4002.

32Sec. 1224.

33Sec. 1208(d).

34Sec 1208(c).

35Sec. 1228(a) & (b).

36Secs. 1228(a) & (c); 523(a).

37IRC1398.

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*Henderson is an Ag Law Research Assistant and Attorney, and Matthews is Professor of Agricultural Law, Extension Ag Law Specialist, and Attorney; both are of the Department of Agricultural Economics, University of Missouri-Columbia.   Prepared February 23, l987