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:
BANKRUPTCY OPTION FOR FAMILY FARMERS
by
*Stephen Matthews and Elizabeth S. Schilling
(August 2009)
President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “BAPCPA”). These provisions went into effect on October 17, 2005 which in general targeted consumer bankruptcy cases and generally makes it more difficult for some individuals to obtain a discharge from their debts. These provisions and their applications are relatively new, and may affect an individual’s case. Therefore, consultation with a competent bankruptcy attorney is needed. On July 1, 2005, BAPCPA, made Chapter 12 a permanent part of the bankruptcy code.
Income
Tax Issues For Debtors in Chapter 12
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 $303,675 and secured debts under $922,975.
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
Only
a "family farmer" with total debts, secured and unsecured combined,
not exceeding $3,544,525
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:
a.
The
individual or husband and wife must be engaged in a farming operation or a
commercial fishing operation; the total debts (secured and unsecured) of the
operation must not exceed $3,544,525 (if a farming operation)
or
$1,642,500 (if a commercial fishing operation);
b.
if a family farmer, at least 50%, and if family fisherman at least 80%,
of the total debts that are fixed in amount (exclusive of debt for the
debtor’s home) must be related to the farming or commercial fishing operation;
and
c.
more than 50% of the gross income of the individual or the husband and
wife for the preceding tax year (or, for family farmers only, for each of the 2nd
and 3rd
prior
tax years) must have come from the farming or commercial fishing operation.
d.
The
debtor(s) must have regular annual income.
2.
For corporations or partnerships to fall within the second category of debtors eligible to file as
family farmers or family fishermen, the corporation or partnership must meet
each of the following criteria as of the date of the filing of the petition:
a.
More than one-half the outstanding stock or equity in the corporation or
partnership must be owned by one family or by one family and its relatives.
b.
The family or the family and its relatives must conduct the farming or
commercial fishing operation.
c.
More than 80% of the value of the corporate or partnership assets must be
related to the farming or fishing operation.
d.
The total indebtedness of the corporation or partnership must not exceed
$3,544,525 (if a farming operation) or $1,642,500 (if a commercial fishing
operation).
e.
At least 50% for a farming operation or 80% for a fishing operation of
the
corporation
or partnership total debts which are fixed in amount (exclusive of debt for one
home occupied by a shareholder) must be related to the farming or fishing
operation.
f.
If the corporation issues stock, the stock cannot be publicly traded.
g.
The
corporation or partnership must have regular annual income.
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 debts under $303,675 and secured
debts under $922,975 may use Chapter 13, even those who also are eligible for
Chapter 12.
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:
a.
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
b.
Certify "under penalties of perjury" that
the information provided is true;
7. 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. The
plan usually must be filed within 90 days of the petition--though it can be
modified later.
By
comparison, a Chapter 13 debtor generally must file his plan within 15 days of
the petition, 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 plus $39.00 for administrative fees.
By
contrast, the filing fees are $274 (including administrative fees) for Chapter
13 and $1,039 for Chapter 11 (including administrative fees).
THE PLAN
Time
Limits
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. 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.
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:
The
extent to which a debt is secured depends upon the value of its collateral and
the amount owed to prior lien holders, 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".
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 lien holders, 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 the entire 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.
In
Chapter 12 cases, the judge generally will make a decision about the plan within
45 days after the plan is filed.
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
under-secured 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.
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 Trustee
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.
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. 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.
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.
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.
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:
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. In
addition, if there is evidence of fraud, creditors may have a Chapter 12 case
either dismissed or converted to a liquidation case.
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.
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, that
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
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
The
following debts are not dischargeable in Chapter 12 cases:
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, $39 in court administrative
fees, and credit counseling costs of approximately $75; 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.
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, a 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.
This
meant that:
IV. CONCLUSTIONS
Chapter
12 vs. Chapter 13
A
few farmers may qualify for both Chapter 12 and Chapter 13.
The primary advantage of filing for Chapter 12 is the higher debt limits
and it was structured for family farmers by Congress. Additionally, the
debtor/farmer has more time to develop a plan and is not required to begin
making payments within 30 days after the plan is confirmed.
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.
============================================================================
* Matthews is Professor in the Department of Agricultural Economics, University
of Missouri and Attorney; Schilling is an Ag Law Research Assistant.
Prepared August, 2009