The last fifteen months have seen an increase in Chapter 12 bankruptcy filings among farmers and ranchers in Nebraska.
As production costs continue to exceed commodity prices, more farmers will likely be filing Chapter 12 bankruptcy.
Joe Hawbaker, an agricultural law attorney in Omaha, Nebraska, said there has been a significant increase in filings, with a thirty percent increase between 2016 and 2017 and 2018 being on pace to exceed 2017.
Chapter 12 bankruptcy is “typically the last tool a farmer or rancher reaches for,” Hawbaker said.
Chapter 12 bankruptcy laws were created in 1986 during the farm crisis, with the purpose of giving family farmers a fighting chance to reorganize their debts and keep their land.
A bankruptcy case begins with a filing in U.S. bankruptcy court. The bankruptcy estate is property owned by the debtor as of the date of filing. Claims (or debts) against the debtor are generally classified as one of three basic types: secured claims, unsecured claims, and priority claims. Secured claims are secured by a lien on the debtor’s property, whether real or personal. Unsecured claims are not secured by a lien on the property, that there is no collateral to secure the claim (for example, some medical debts, credit card debts and open account purchases.) A priority claim has special status under bankruptcy laws, such as certain claims for taxes, child support, alimony, and the cost of the bankruptcy. Priority claims usually have to be paid in full.
Exemptions allow the debtor to protect certain property from the claims of creditors. Exemptions differ from state to state.
Chapter 12 bankruptcy is a reorganization bankruptcy, as compared to a liquidation bankruptcy. In a liquidation, the debtor tries to erase debt by giving up non-exempt property. In a reorganization, the idea is that the debtor keeps possession of the property that they want or need to keep, while paying their debt under the terms and conditions of the bankruptcy. In other words, you pay for what you keep and surrender what you don’t want or cannot afford to keep.
The goal of bankruptcy is the discharge, the court order that makes legally binding the conditions of the bankruptcy, namely, the forgiveness or restructuring of debt.
What Chapter 12 bankruptcy does is put up a wall around a farmer’s or rancher’s operation. The wall, called the automatic stay, prevents creditors from collecting debt through repossessing collateral, garnishment, or foreclosure. It gives the debtor a little breathing room in which to comply with the Chapter 12 procedures and to come up with a plan of reorganization.
Chapter 12 also allows debtors to restructure debt and may also allow some debt to be written off, partially or entirely. It helps in dealing with tax debts like capital gains or recaptured depreciation, that come from selling farm assets.
After filing, the immediate pressure a debtor feels is relieved, but the hard work has just begun. Within three months of filing, the debtor, working with his or her lawyer, must put together a Chapter 12 plan, a plan of reorganization, showing how the farm or ranch will keep going.
The core of the plan is how creditors’ claims will be handled. For secured claims, claims that have a lien on the debtor’s property, the debtor may propose to restructure them based on the collateral that secures the claim. A secured claim must be paid at least as much as the value of the collateral that secures it. Valuing the collateral relative to the amount of the claim is an important part of the bankruptcy. A claim secured by land can be reamortized over 20 (sometimes to as many as 30) years and paid in installments that coincide with when funds are available (i.e., when crops or livestock are sold). A claim secured by machinery or equipment can be restructured over three to seven years, depending on its quality. A claim secured by livestock can be restructured for payment over five to ten years, depending on the livestock. One of the goals of Chapter 12 for the debtor may be to get as long a payout as possible, in order to lessen the burden on the cash flow. Another benefit to Chapter 12 bankruptcy is to structure payments so they are due when the debtor is most likely to have funds, for example, in late winter for row crop farmers.
Unsecured claims are handled differently than secured claims. Unsecured claims do not have any collateral securing them, so they are handled under what is called the liquidation analysis. If the debtor had filed under Chapter 7 (liquidation) instead of Chapter 12 (reorganization) bankruptcy, what would the creditors have received? Payment in full? Fifty cents on the dollar? Nothing? Value of the farm debtor’s property is determined, then certain things are subtracted from the value: the amount of the secured claims, the debtor’s exemptions, and the hypothetical cost of sale of the assets. Any amount that remains in the value of the estate property is the amount available to proportionally pay unsecured creditors. The amount they must be paid ranges from nothing to full payment, depending on the value of the debtor’s property and the amount of the unsecured claims.
The Chapter 12 plan is usually set for three years, sometimes five. Unsecured claims typically have to be paid within that period of time, often without interest. If creditors or the trustee of the bankruptcy object to the plan of reorganization, the debtor must put his disposable income towards the unsecured claims. However, there may be very little disposable income.
Priority claims usually must be paid in full. Child support and alimony are usually paid in accordance with court orders. Taxes are often priority claims. But if taxes were filed and due more than three years before the bankruptcy was filed, they may be considered unsecured claims. Another advantage of Chapter 12 is that if a farmer sells farm assets, the tax claims from those sales can be treated as unsecured claims and they may not have to be paid in full or at all.
Farmers and sometimes ranchers usually borrow money for operating expenses each year. Borrowing that money when a person has filed Chapter 12 can be a problem. If a farmer files bankruptcy before the crop is planted, the new crop can be pledged as collateral to the lender.
With the new crop, the lender may have a first lien on that crop, on crop insurance, and on FSA payments. Chapter 12 financing is often limited in value to the guaranteed crop insurance coverage. Livestock financing may be more difficult to obtain, and a Chapter 12 debtor may have to operate under his own steam, gaining the release of cash proceeds of livestock to meet operating expenses.
Before Hawbaker’s clients file for Chapter 12, he does a thorough analysis with them, working out their options: Can they refinance with a new lender? Will their current lender work with them to restructure debt if certain conditions are met? Are there possibilities for a partial sale of assets that would alleviate debt? Is there assistance available through family, such as sale of assets to family? If time allows, Hawbaker likes to help his clients examine what kind of terms they will expect to receive with Chapter 12. “It’s important to understand ahead of time what a Chapter 12 can do for an operation,” he said, “to estimate what the cash flow will look like under Chapter 12 terms and to look at feasibility.” This means running numbers. The current interest rate in bankruptcy may be 6.25 percent (the Wall Street Journal Average National Prime plus 2 points).
Bankruptcies cost money. The debtor pays the trustee (in Nebraska, the fee can be as high as $6,000 a year) and his own lawyer’s fees (ranging from $7,500 to $15,000). In some circumstances the debtor has to pay his secured lender’s attorney fees, which are typically added to his debt. This is usually true when a lender is oversecured. If the debtor’s collateral is worth more than the debt, the lender is often entitled to collect attorney fees from the debtor, along with interest. Bankruptcy is “not cheap,” Hawbaker said.
There are more than financial costs to consider. “The potential stresses of having to deal with being in a bankruptcy and meeting all the requirements and deadlines, especially in the first few months,” is stressful, Hawbaker said. There’s a significant amount of stress, and people handle it differently. “Some people approach bankruptcy as a management tool. They take a more distanced, objective view of how to use the bankruptcy to solve problems. For others, everything is taken personally. Decision-making in times of great stress can become very difficult. Bankruptcy in many respects is meant to help with that difficulty.”
Debtors also have to “face down the idea of being in bankruptcy,” Hawbaker said. Bankruptcies are public record, and there may be stigma attached to those who have filed for bankruptcy. That stigma, Hawbaker believes, is often based in ignorance, not of the debtor but of those stigmatizing the debtor. “There have been lots of bankruptcies filed in this nation, and some by people who went on to become great success stories.”
A risk that must be considered when filing for Chapter 12 bankruptcy is financing. It’s not likely that a debtor’s lender will loan them new money when they are in bankruptcy. Hawbaker advises those who are considering filing for Chapter 12, if time permits, to explore funding for the bankruptcy with another lender, even to make applications ahead of time.
Farmers who lease ground are “quite vulnerable” in a Chapter 12 filing. In order to keep the lease, the farmer must be current on rental payments and in general be able to make them as they come due. There is no guarantee a landowner will continue to rent to the debtor. Debtors with long term contracts may be able to keep those contracts under bankruptcy rules.
Hawbaker does a lot of preparatory work with clients before and after they file. “It’s very important to establish realistic expectations of what bankruptcy is, what it will do for you, how much work it is, and the risks. This is critically important.”
In his experience, Hawbaker finds that a wide majority of his Chapter 12 clients come through bankruptcy to get their discharge, the goal (and endpoint) of bankruptcy, and most continue to farm. He attributes that to their determination and the preparatory work they do together before filing. He cautions people to be clear about what Chapter 12 is and what it can do for them. “The more clear-eyed and hard-eyed you can be about what’s involved, the better.”
“Succinctly put,” he said, Chapter 12 “bankruptcy gives you a chance to make next year’s payment (under restructured terms). And if you can make that payment, you get to make the next year.”
The Nebraska Farm Hotline (800-464-0258), located in Bancroft, Nebraska, is a great clearinghouse of services for farms and ranches, especially those dealing with financial distress transactions. In Nebraska there are also free one-on-one clinics offered for farm and ranch families through the Nebraska Farm Mediation Service. These clinics are held in four locations every month. Information about them is available through the Hotline.
For producers from South Dakota, Wyoming and Montana, help is available through Departments of Agriculture. Mediation programs can be found by calling each state’s department. For South Dakota, call 605.773.4432; for Wyoming, call 307.777.8788; for Montana, call 406.444.5424.