Reaping Wild Oats – Creative Strategies Employing the Concepts of Chapter 12 of the Bankruptcy Code for Handling Distressed Agricultural Loans

Ervin Cohen & Jessup LLP
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Handling distressed agricultural loans can be very tricky.  Loan balances for agricultural loans are typically smaller than nonagricultural commercial real property secured loans, requiring that they be handled extremely cost effectively.  The collateral may not only be perishable but its value is often quite volatile depending on such external issues as the weather, domestic and foreign markets, and the nature and degree of political interference.  Further, satisfactory monitoring of agricultural loans can require additional time and costs to make sure that the information provided is thorough and up to date to cover seasonal issues that may be specific to the crops, livestock and other collateral that secure the loan.

Unfortunately, default rates for agricultural loans are continuing to rise and will likely continue to rise throughout this year.  According to a Wall Street Journal Article published just last month, the U.S. Department of Agriculture projects that farmers’ incomes will decline for a fourth straight year in 2017, to just half what they were in 2013.  Drought conditions and rising interest rates may further erode the incomes of agricultural borrowers.  Thus, in a survey recently conducted of agricultural lenders by the American Bankers Association and Farmer Mac, it was anticipated that only 54% of total agricultural borrowers will remain profitable in 2017.

Lately, there has been much discussion as to whether the present economic conditions for farmers are as severe as in the 1980s.  Nevertheless, even if the present economic conditions are not as dire as in the 1980s, it is anticipated that farm related bankruptcy cases will rise in 2017.  This may be largely due to Chapter 12 of the Bankruptcy Code, which was enacted in 1986 largely in response to the farming crisis of the 1980s.  In fact, although bankruptcy filings in general have fallen in the last few years, Bloomberg has reported that in the twelve month period ending in March 2017, Chapter 12 bankruptcy filings have increased.

Chapter 12 has guidelines and procedures similar to both Chapter 11 and Chapter 13 of the Bankruptcy Code.  Although significantly cheaper than Chapter 11 bankruptcy cases, Chapter 12 of the Bankruptcy Code allows a family farmer with a regular annual income to discharge his or her debts through a confirmed reorganization plan while remaining in control of his or her business.   Similar to Chapter 13 of the Bankruptcy Code, the Bankruptcy Code has limitations as to the amount of liabilities for a Chapter 12 debtor.   However, the debt ceilings for Chapter 12 are far greater than those found for Chapter 13 and, unlike Chapter 13 of the Bankruptcy Code, a corporation or partnership can file for Chapter 12 bankruptcy relief, provided it complies with the requirements found in the Bankruptcy Code.

Chapter 12 can be a nightmare for a creditor.  As with bankruptcy cases generally, filing a bankruptcy petition under Chapter 12 creates an automatic stay against debt collection and lien enforcement actions against the debtor, the debtor’s property and property of the debtor’s bankruptcy estate.  Similar to a Chapter 11 bankruptcy case, Chapter 12 permits a debtor to “strip” the unsecured portion of a secured debt to the present value of its collateral and treat the unsecured portion far less favorably in his or her plan than the secured portion of the same debt.

Chapter 12 cases also move very quickly.  A Chapter 12 plan must be filed within 90 days of the bankruptcy filing and, except for cause, the confirmation hearing for the Chapter 12 plan must be concluded no later than 45 days after the filing of the plan.  Further, the penalties for a creditor that fails to timely act can be severe.  Unlike Chapter 11 reorganization plans, no creditor acceptance or consent is required for confirmation of a Chapter 12 plan, even if the creditor’s claims are impaired.  Therefore, it is imperative that the creditor keep abreast of all events and deadlines in the Chapter 12 bankruptcy case and file objections when appropriate, to preserve all of its rights and remedies,

The burdens placed on a debtor under Chapter 12 can also be onerous.  A Chapter 12 plan must provide for the submission of all of the debtor’s future earnings and income to the supervision of a Chapter 12 trustee for distribution under the plan.   Further, if the Chapter 12 trustee or the holder of an allowed unsecured claim objects to confirmation of the debtor’s Chapter 12 claim, the bankruptcy court may the not approve unless the Chapter 12 plan pays the full amount of the unsecured claim or the Chapter 11 debtor demonstrates either one of the following:

  • The plan provides that all of the debtor’s disposable income during the duration of the plan be applied to pay the unsecured creditors; or
  • The value of the property to be distributed during the duration of the Chapter 12 plan is not less than the debtor’s projected disposable income for such period.

Under the Bankruptcy Code, the term “disposable income” is narrowly defined to generally mean income received by the debtor that is not reasonably necessary for either (i) the payment of expenses necessary for the continuation, preservation or operation of a debtor’s business, or (ii) the maintenance or support of the debtor and the debtor’s dependents.

In short, Chapter 12 cases are no picnic for the debtor either.

Because of the difficulties and costs of filing for bankruptcy relief for both creditors and debtors, I have been successful in creatively employing concepts found in the Bankruptcy Code to reach out of court settlements favorable to both creditors and borrowers, without requiring the debtor to file for bankruptcy relief.  .  For example, a creditor holding an under-secured claim may be willing to agree to a settlement mirroring the likely outcome of a Chapter 12 plan but agreeing to broaden the concept of the borrower’s “disposable income” to allow the borrower to pay for certain expenses that may not be necessary for “the maintenance or support of the debtor and the debtor’s dependents”,  such as allowing the borrower to continue to send his or her children to private school, in exchange for the  borrower’s agreement to valuations of the creditor’s collateral favorable to the creditor.  Or, employing the framework of a Chapter 12 plan, a borrower may be willing to waive certain claims or defenses against a lender in the context of an out-of-court workout, in exchange for the creditor’s agreement to extend the payout period beyond the deadlines found in Chapter 12 for a plan of reorganization.  Further, the concepts of Chapter 12 can be employed for out of court settlements of agricultural loans well exceeding the debt limitations found in the Bankruptcy Code.

The only limitation to such mutually favorable settlements is the creativity of the parties.   In fact, I have also been able to apply my experiences in Bankruptcy Court to allow creditor clients to obtain, in the context of a settlement modeled on the likely result of a successful bankruptcy filing, additional collateral that they would not have otherwise received, in exchange for concessions that ultimately provided all parties huge savings in terms of time, as well as attorney and expert fees.  Thus, even without filing for bankruptcy relief, Chapter 12 of the Bankruptcy Code can be a tool to further settlements involving distressed agricultural debt.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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