Do not rely upon this for legal advice. Consult your own attorney.

CHAPTERS 11 OR 13: BANKRUPTCY REORGANIZATION

By

Ann Henderson and Stephen F. Matthews*

Many people believe that a farm bankruptcy means that a farmer is forced to sell his assets and go out of business. However, this type of bankruptcy, a Chapter 7 liquidation, is only one alternative under the Bankruptcy Reform Act of 1978. Chapters 11 and 13 of the act provide another option. These chapters allow farmers and others to propose plans for repaying debts over an extended time, primarily with future income rather than the sale of assets. Of the 1,624 Missouri farmers who filed bankruptcy petitions from 1981 through 1985, 67% proceeded under Chapter 7, 29% under Chapter 11 and 4% under Chapter 13.

This factsheet first reviews some basic bankruptcy concepts and then discusses the major features, drawbacks and benefits of Chapters 11 and 13 bankruptcies. There are, however, at least two reasons why this factsheet is not a substitute for consultation with an attorney. First, condensing a topic as complex as bankruptcy into a few pages necessarily involves much omission of detail. In any individual case, this detail could be essential to making a wise decision about bankruptcy. Second, as of the date of this writing (April, 1986), the Bankruptcy Code was last amended in 1984 and bills proposing additional amendments are under consideration in Congress.

SOME BANKRUPTCY CONCEPTS

The following bankruptcy concepts are significant aspects of both Chapter 11 and Chapter 13:

1. THE AUTOMATIC STAY--This means that as soon as someone files a bankruptcy petition, creditors are prohibited from taking any debt collection action against him or his property. All debt collection efforts, including foreclosure and repossession actions, lawsuits, phone calls and letters, must stop. The primary exceptions are actions that are criminal in nature, such as bad check prosecutions and alimony and child support collections. The automatic stay gives the debtor some breathing space and enables him to attempt a repayment plan. It also allows the case and everything connected with it to be handled in an orderly fashion in one court.

This stay generally will remain in effect until the case is either closed or dismissed. A creditor may request that the stay be terminated or modified while the case is pending, but the court will not necessarily grant this request.

2. SECURED AND UNSECURED DEBT--The manner in which a debt may be adjusted in a Chapter 11 and 13 plan depends, to a large extent, upon whether the debt is secured or unsecured. The concept of secured and unsecured debt is also important in determining eligibility for Chapter 13.

In bankruptcy, a debt may be totally secured, totally unsecured or partly secured and partly unsecured. A debt is TOTALLY UNSECURED if the creditor has no lien or security interest in the debtor's property--most phone bills, utility bills, medical bills, credit card bills and bills for fertilizer, fuel and feed fall in this category. A debt is also considered totally unsecured, for bankruptcy purposes, if the creditor has a lien or security interest that isn't enforceable in a bankruptcy proceeding, such as an unfiled financing statement or an unrecorded deed of trust.

A debt is PARTLY UNSECURED AND PARTLY SECURED if the creditor has a lien on property that, although enforceable in bankruptcy, is worth less than his claim. For example, assume the current balance due on a debt is $50,000; that the debt is secured only by machinery now valued at $40,000; and that the machinery hasn't been used as collateral for any other debt. In this example, $40,000 is secured debt and $10,000 is unsecured debt. Now assume that the machinery is also the sole collateral for second loan with an unpaid balance of $5,000. If the first lender properly filed a valid finance statement on the machinery before the second lender, the second loan is totally unsecured.

3. SOLVENCY--For purposes of this discussion, a person is SOLVENT if the current market value of his ASSETS less his EXEMPT ASSETS is greater than his valid debts.

(a) The debtor's ASSETS are also called the bankruptcy "estate." This estate includes all property in which the debtor has an ownership interest at the time he files a bankruptcy petition. It may also include some property (inheritances, death benefit proceeds and property acquired in a divorce proceeding) the debtor becomes entitled to within 180 days after filing as well as property, or the value of property, "unfairly" transferred to others within 90 days (one year if to an "insider") before filing.

(b) Assets that may be claimed EXEMPT from creditor's claims in Missouri include (1) the debtor's equity, up to the stated amounts, in the following: $8,000 in a homestead, $1,000 in a mobile home, used as the debtors principal residence, $1,000 in household goods and wearing apparel, $500 in jewelry, $2,000 in professional books or farm tools, $500 in an automobile, $400 in other property; (2) any equity in professionally prescribed health aides; (3) up to $5,000 cash surrender value of life insurance contracts (unless the policy was purchased within the six months before the debtor filed a bankruptcy petition); and (4) if the debtor is the head of a family, an additional $850, plus $250 for each of his unmarried dependent children under the age of eighteen.

4. CHAPTER 7 LIQUIDATIONS--A Chapter 11 or Chapter 13 plan must pay creditors as much as they would receive in a "Chapter 7 liquidation". In a Chapter 7 liquidation, an insolvent debtor's non-exempt assets would be sold and the proceeds distributed to creditors. Chapter 7 bankruptcies are discussed in AG LAW SERIES #1986-7, "Chapter 7 Bankruptcy: Liquidation."

5. DISCHARGE--When a Chapter 13 plan is completed or a Chapter 11 plan approved by the court, the court may "discharge" the debtor's legal obligation to pay certain debts. The debtor may choose voluntarily to pay a discharged debt, but that would be his unilateral decision.

CHAPTER 13: MINI-REORGANIZATION

Chapter 13 of the Bankruptcy Reform Act of 1978 is entitled "Adjustment of Debts of an Individual with Regular Income". This chapter allows qualified debtors to propose a plan for adjusting debts and scheduling payments over a three to five year period. If the plan is confirmed by the bankruptcy court, it is carried out under the protection of that court. Chapter 13 proceedings are generally considered to be less cumbersome and less expensive than Chapter 11 proceedings. However, only wage earners and sole proprietors with debts under stipulated limits (see below) are eligible for Chapter 13.

A farmer may file a Chapter 13 bankruptcy petition only if:

(1) He operates his farm as a sole proprietorship, rather than as a corporation, partnership or trust asset. A husband and wife could be considered business partners, and thus be ineligible for filing a joint petition, if they have agreed, formally or informally, to operate their business as a partnership.

(2) He owes (or if a farmer and his spouse file a joint petition, he and his spouse owe), on the date he files a Chapter 13 petition, less than $100,000 in noncontingent, liquidated, UNSECURED debts and less than $350,000 in noncontingent, liquidated, SECURED debts. These limits are not doubled if the husband and wife jointly file a Chapter 13. A debt is "noncontingent" if liability for the debt is reasonably certain. For purposes of Chapter 13, nearly all debts, other than untried tort claims and partnership debts, are considered noncontingent. A debt is "liquidated" if the amount of the debt is reasonably certain. Unless a debtor disputes a debt or has an unsettled offsetting claim against a creditor, the debt generally will be "liquidated".

(3) His income is sufficiently regular and stable to enable him to make the payments called for in his Chapter 13 plan.

THE CHAPTER 13 REORGANIZATION PLAN

The Chapter 13 debtor must file a repayment plan either with his petition or within 10 days thereafter. He can, however, propose modifications in the plan later if necessary.

The Plan:

(1) Cannot last longer than three years without court permission. With court permission, it may last up to five years;

(2) Must provide for full payment of bankruptcy court administration expenses and "priority" claims. Priority claims are unpaid taxes that were due within the three years prior to filing, certain unpaid wages and benefits due the debtor's employees and some refunds of customer's security deposits;

(3) Usually will cover all debts that are either overdue or that will mature before the plan is completed;

(4) Must be funded primarily by the debtor's income rather than the sale of assets;

(5) Must provide that money to fund the plan be turned over to the bankruptcy court trustee for distribution to creditors; and

(6) Must be approved (confirmed) by the bankruptcy court.

To roughly estimate whether one can fund a Chapter 13 plan, the person's farm operating expenses, reasonable living expenses, mortgage payments and taxes should be subtracted from his gross revenue. The remainder must be sufficient to pay (over a three to five year period): (1) bankruptcy administrative expenses, including the trustee's fee, which generally will be about 10% of the payments made under the plan; (2) all "priority" claims, if any; (3) all debts secured by property the debtor wishes to retain and (4) some portion of UNSECURED debts.

There are two guidelines for determining the amount that must be paid on unsecured debts. First, that amount must at least equal the amount that would be paid on unsecured debt if the debtor liquidated under a Chapter 7 bankruptcy. This means that a SOLVENT debtor usually must pay all unsecured debt, including arrearages. Secondly, if an unsecured creditor who isn't to be paid in full objects, the court will not approve a plan unless all the debtor's disposable income during the period of the plan is paid into the plan. Disposable income is all income received less reasonable family living expenses and farm operating expenses.

CREDITORS' MEETING AND CONFIRMATION HEARING

After a Chapter 13 plan is filed, the debtor's creditors may hold a meeting with the debtor and ask him questions about his financial affairs. They may question the feasibility of the plan and the debtor's good faith in proposing it. The debtor must attend the meeting and answer questions under oath. The bankruptcy judge will hold a confirmation hearing very soon after the creditor's meeting, perhaps on the same day. The judge will not confirm the plan unless 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". 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. When necessary, the debtor may propose modifications in the plan after confirmation.

DISCHARGE UNDER CHAPTER 13

Unless the debtor signed a binding waiver of discharge after filing a bankruptcy petition, the court will grant a discharge when a debtor successfully completes a plan. This "completion discharge" terminates the debtor's liability for all debts the court determines are not allowable unpaid portions of most debts listed in the plan.

Debts not allowable in bankruptcy include debts the court determines are not enforceable and, to the extent they exceed stated amounts, unpaid property taxes and debts arising from terminations of leases and employment contracts. All unpaid portions of debts listed in the plan will be discharged except for payments due after the plan is completed, such as mortgage payments, and alimony and child support payments. The court may also grant a "hardship discharge" if the debtor is unable to complete the plan for reasons beyond his control, such as a disabling illness. A hardship discharge will be granted, however, only if creditors have received as much as they would have received under a Chapter 7 liquidation. In addition, a hardship discharge is subject to more exceptions than a completion discharge.

MORE FREQUENTLY USED BY FARMERS

Chapter 11 of the Bankruptcy Reform Act of 1978 is entitled "Reorganization". This chapter also permits debtors to propose a plan for adjusting and repaying debts over an extended period of time. However, unlike a Chapter 13 plan, a Chapter 11 plan may cover a period considerably longer than 3-5 years and may propose that debts be repaid primarily with proceeds from the sale of assets rather than with future earnings.

ELIGIBILITY

With the exception of certain financial institutions and railroads, any business may file a Chapter 11 petition. Chapter 11 is the only bankruptcy repayment plan option for farms that are incorporated or run as partnerships or have debts in excess of the limits specified for Chapter 13.

CREDITORS' AND DEBTOR'S DUTIES AND RESPONSIBILITIES

After a debtor files a Chapter 11 petition, the court will appoint a committee of unsecured creditors to consult with the debtor, investigate any relevant matter and participate in the formulation of a plan. Generally, the debtor will file the plan. However, a creditor may file a plan if the debtor doesn't get one filed or confirmed quickly enough. The debtor normally has, after filing the petition, 120 days to file a plan and 180 days to get a plan confirmed before a creditor may file. A creditor may also file a plan if the court appoints a trustee to run the debtor's business. The appointment of a trustee is fairly unusual and generally occurs only when the business is being grossly mismanaged or the debtor has engaged in fraudulent practices. If a creditor is allowed to file a plan (but not before the debtor has been allowed 120 days to propose his own plan), he may propose a plan calling for liquidation of the debtor's assets.

Unless the court appoints a trustee, the debtor will continue to run his farm while he develops the plan. During this time, however, he cannot use "cash collateral" unless each creditor with a security interest in the collateral consents or the court authorizes such use. This restriction needs to be clearly understood and adhered to by the farm debtor. Cash collateral includes proceeds from the sale of crops, livestock or other property used as collateral. The debtor may obtain unsecured credit necessary for farming operations without court approval but will need court approval to obtain secured credit or credit not relating to farm operations. To help insure extension of credit during this period, the Bankruptcy Code provides for a "priority" lien for those who extend unsecured credit after the petition is filed and before the plan is confirmed. These provisions also apply in a Chapter 13 case, between the time the petition is filed and the plan completed.

A Chapter 11 plan must:

(1) Specify means for reducing the debt load, securing operating capital or otherwise solving the farm operation's financial problems. Alternatives include restructuring debt (for example, repaying some debt over a longer period of time than that originally agreed to), bringing in additional income, finding buyers and selling off unproductive assets, obtaining new financing, etc. A Chapter 11 plan may also call for voiding certain liens, pre-petition property transfers and unprofitable leases or contracts not substantially completed by either party;

(2) Separate claims into classes, such as bankruptcy administrative claims, priority unsecured debts, other unsecured debts and debts secured by different types of collateral;

(3) Specify the treatment (repayment terms, debt forgiveness required) of each class of claims;

(4) Be accepted by at least one class of claims that, under the plan, will receive less than the full value of their claims. A class "accepts" if, after receiving court approved information about the plan, a certain portion of creditors in the class vote to accept the plan;

(5) Meet certain requirements with respect to treatment of creditors that have not accepted the plan. For example, total payments to a non-accepting creditor cannot be less than the amount that creditor would receive in a Chapter 7 liquidation, and total payments to a non-accepting secured creditor cannot be less than the value of his interest in the property securing his claim; and

(6) Be confirmed by the Bankruptcy Court.

CONFIRMATION OF THE CHAPTER 11 PLAN

A Chapter 11 plan, like a Chapter 13 plan, will not be confirmed unless the court believes that the debtor has proposed the plan in good faith and will be able to make the payments called for. If a Chapter 11 plan is confirmed, the debtor and creditors will be bound by the plan rather than by previous agreements. As long as the debtor abides by the terms of the plan, he will be able to retain his property and continue his farming operation.

DISCHARGE OF DEBTS UNDER A CHAPTER 11 PLAN

The court generally will grant a discharge when it confirms a Chapter 11 plan. However, there are more exceptions to a Chapter 11 discharge than to a Chapter 13 completion discharge. In addition to excluding alimony and child support, a Chapter 11 discharge does not cover guaranteed student loans, debts incurred by fraud, fines, penalties or punitive damages. Also, a Chapter 11 discharge will not be granted if the plan is essentially a liquidation plan for a corporation, a partnership or a debtor who commits some wrongdoing in connection with the case, such as withholding, destroying or falsifying records or fraudulently transferring or concealing assets.

COSTS AND OTHER DRAWBACKS UNDER EITHER CHAPTER

Anyone contemplating bankruptcy should be aware of the disadvantages of proceeding under Chapter 11 or 13. These disadvantages include the costs of bankruptcy (both monetary and psychological), the need to publicly disclose financial information, the potential effect on future credit availability, and the possibility that a Chapter 11 or 13 case might not be completed

successfully.

Costs

The monetary costs generally are less under Chapter 13 than Chapter 11. Chapter 13 expenses include a $60 filing fee, bankruptcy administrative expenses and attorney fees. The Chapter 11 filing fee is $200. Since a Chapter 11 case usually is more complex and time consuming than a Chapter 13 case, attorney fees and bankruptcy administrative expenses generally will be higher.

Financial-Disclosures

The Chapter 11 and Chapter 13 debtor must be prepared to disclose detailed financial information. He must file, with his plan, a schedule of assets and liabilities, a schedule of current income and expenditures and a statement of his financial affairs. The statement of financial affairs must include a significant amount of information, such as information on bank accounts or safe deposit boxes the debtor has maintained within the past two years, the existence and location of his financial records, a list of any lawsuits he has been a party to within the past year, an explanation of the disposition (by sale, trade, gift, etc.) of any property within the past year, an explanation of any fire, theft or gambling losses within the past year. He must certify "under penalties of perjury" that this information is true. Spaces are provided for this information on the official bankruptcy forms.

As previously stated, under Chapter 13, the debtor's creditors may hold a meeting with the debtor and question him about his financial affairs. The debtor is required to attend this meeting and answer questions under oath. If the plan is confirmed, the debtor will be required to furnish periodic reports and statements of receipts and disbursements to the bankruptcy court at designated intervals while the plan is in effect.

In Chapter 11, a committee of unsecured creditors appointed by the court may investigate the farming operation, the debtor's financial condition and any matter relevant to the case or plan. In exceptional cases, a trustee or examiner may be appointed to operate the farm or to investigate and report on the management of the farming operation and the debtor's assets, liabilities and financial condition. If a trustee or examiner is appointed, the debtor must cooperate sufficiently to enable this person to perform his duties. In addition, the debtor must file periodic (generally monthly) statements of sales and expenses with the court.

Effect On Future Credit Availability

Some debtors who have gone through a bankruptcy proceeding may have difficulty obtaining credit. A creditor's willingness to extend credit after bankruptcy generally will depend upon the factors that led to the bankruptcy, the portion of debts paid in the bankruptcy proceeding and the debtor's financial management in the period following bankruptcy. For example, creditors may be more willing to extend credit to a farmer whose financial difficulties can be attributed to agricultural problems and unanticipated medical bills than to those whose financial problems stemmed from land speculation. In addition, many creditors are less reluctant to extend credit to a farmer who paid nearly all his debts in a bankruptcy proceeding than to one who had a large portion of debts discharged.

Unapproved or Uncompleted Plans

A Chapter 13 and Chapter 11 bankruptcy will not always be successful. Not all plans will be approved, and not all approved plans will be completed successfully.

BENEFITS TO THE DEBTOR

The primary benefits of bankruptcy, for many debtors, are the AUTOMATIC STAY and the DISCHARGE. Other bankruptcy provisions, such as the power to terminate disadvantageous leases under Chapter 11, may be equally advantageous to the debtor.

The Automatic Stay

This prohibition of debt collection actions not only gives the debtor a chance to attempt a repayment plan but also helps insure that aggressive creditors will not benefit at the expense of other creditors. Under Chapter 13, the automatic stay extends to civil actions against some co-debtors on consumer debts (debts incurred primarily for personal, family or household purposes). The stay does not, however, extend to co-debtors on business debts, including farm debts, or debts secured by real property.

The Discharge

The debtor's legal liability for debts the Bankruptcy Court determines are not allowable will end if the debtor successfully completes a Chapter 13 plan or has a Chapter 11 plan confirmed. In addition, if a plan calls for only partial payment of certain debts, the debtor's legal liability for the remaining portion of some of these debts will be discharged in all successfully completed Chapter 13 cases and in many Chapter 11 cases, as well. The availability of a discharge enables the debtor to get a "fresh start" with his financial affairs after bankruptcy.

Other Potentially Advantageous Provisions

The debtor may benefit from several other bankruptcy provisions. For example, if the debtor is insolvent, interest on his unsecured debts will stop accumulating when he files a bankruptcy petition. Under Chapter 11 or 13, a debtor may prevent foreclosures and repossessions that would otherwise occur by scheduling in his plan prompt payment of all related overdue amounts.

====================================================================================================
* Henderson is an attorney and ag law research associate, and Matthews is an attorney and professor of agricultural law; both are with the Department of Agricultural Economics, University of Missouri-Columbia.  This informational fact sheet was prepared in l986.