Overview
The economic circumstances in agriculture presently are disturbing. The financial situation in the agricultural economy has changed considerably over the past 18 months to two years. For instance, in Kansas, 2015 average net farm income was the lowest since 1985. Crop prices are down and the cost of production has gone up. This has had a significant impact on many farmers’ ability to repay debt. Repayment capacity is an important issue, and an erosion of a farmer’s working capital negatively impacts financing. This all means that some farmers (and their lenders) either have already made or will soon be making some very difficult decisions before the spring of 2017.
One possible decision is to restructure debt via the filing of a Chapter 12 bankruptcy petition. That’s the bankruptcy reorganization provision that was enacted during the throes of the last significant debt crisis in agriculture 30 years ago. But, what does it take to be eligible for Chapter 12 bankruptcy? Do you really have to be a farmer? It seems like an obvious question. But, is the answer simple? That’s the subject of today’s topic.
What is a “Family Farmer”?
To be eligible for Chapter 12 bankruptcy, a debtor must be a “family farmer” or a “family fisherman” with “regular annual income.” The term “farming operation” includes farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, or livestock, and production of poultry or livestock products in an unmanufactured state. 11 U.S.C. §101(21). A “family farmer” is defined as an individual or individual and spouse who earned more than 50 percent of their gross income from farming either for the taxable year preceding the year of filing or during the second and third tax years preceding filing (a different rule applies to a “family fisherman) and whose aggregate debts do not exceed $4,153,150 (a lower threshold applies for a “family fisherman”). In addition, more than 80 percent of the debt must be debt from a farming operation that the debtor owns or operates.
To be eligible, more than 50 percent of an individual debtor’s gross income must come from farming in either the year before filing or in both the second and third tax years preceding filing (a different rule applies to a “family fisherman”). This provision seeks to disqualify tax shelter and recreational farms from Chapter 12 protection.
The Need For Farm Income
The farm income test is to be applied at the time of bankruptcy filing. That means that the determination of whether a debtor is a farmer that is engaged in farming is made at the time the bankruptcy petition is filed. Likewise, the determination of whether the debtor has the intent to continue farming is made at the time of filing also. See, e.g., In re Nelson, 291 B.R. 861 (Bankr. D. Idaho. 2003). Indeed, 11 U.S.C. §101(18), says that a “family farmer” is an individual and spouse “engaged in in a farming operation…”. Or, at least that was the thinking…
In a recent case, In re Williams, No. 15-11023(1)(12), 2016 Bankr. LEXIS 1804 (Bankr. W.D. Ky. Apr. 22, 2016), the court reached the conclusion that a debtor that was not currently actively engaged in farming and did not intend to return to farming was eligible to file Chapter 12. Shortly after the petition was filed, the debtors (a married couple) had last farmed two years earlier and notified the creditors that they had no intent of farming again. Instead, their son planted and harvested the crops. Based on those facts, the bankruptcy trustee claimed the debtors were ineligible for Chapter 12. But, the debtors claimed that they had just made a reasonable choice to end a farming business that was no longer profitable.
But, you say, “I thought the purpose of Chapter 12 is to keep farmers on the farm by allowing them to scale their operation down, write off some debt and pay off the balance over time while continuing farming?” You are correct. That is the legislative intent behind Chapter 12. Take a look at 132 Cong. Rec. at S15076 (Oct. 3, 1986). However, the Williams court took note that there was no specific requirement in the Bankruptcy Code that the regular income to fund the Chapter 12 reorganization plan need come specifically from farming. It just had to be stable and regular. The court noted that 11 U.S.C. §101(19) requires a debtor to have regular income sufficient enough to enable the debtor to make plan payments, and that its definition of “family farmer with regular income” meant that the income only be sufficiently stable and regular to enable the debtor to make plan payments. It didn’t require the income to be generated from farming activities. So, the debtors didn’t have to be engaged in farming at the time they filed Chapter 12 and, apparently, they also didn’t have to have any intent to return to farming.
What about funding the reorganization plan? Do the funds required to fund the plan have to derive from farming? Williams would indicate that the answer to that question is “no” and there is some support for that. For example, one court has held that the bankruptcy code does not require that a farmer who meets the pre-petition farm income test must have sufficient farm income to fund the Chapter 12 plan. In In re Sorrell,386 B.R. 798 (Bankr. D. Utah 2002), the debtors, husband and wife, owned two farms which were used for crops and raising livestock. Their Chapter 12 plan provided for modified payment of secured claims and about 10 percent of the unsecured claims. The plan was funded with the wife’s income as a loan officer, the husband’s income from off-farm employment, disability payments, farm subsidies and some cash from asset liquidation. A secured creditor objected to the plan, arguing that the debtors were not eligible for Chapter 12 because the plan was not funded from farm operations. The farm had a profit of only $19 per month. The court held that the definition of family farmer required only that the debtor have regular income, not that the income be necessarily derived from the farm. Another court has held that a Chapter 12 debtor whose reorganization plan proposed the debtor’s discontinuing farming and enrollment of all of the debtor’s farmland in the Conservation Reserve Program was not ineligible for Chapter 12 relief. In re Clark, 288 B.R. 237 (Bankr. D. Kan. 2003).
Conclusion
These seem to be odd results based on the legislative intent behind Chapter 12. However, for farmers that are experiencing severe financial difficulties that are not likely to actually continue in farming, reorganization of debts under Chapter 12 might still be a possibility. That could be a more favorable option than utilizing a different reorganization provision of the bankruptcy code or filing a liquidation bankruptcy.
Just something to think about for those that might have to make a difficult decision come spring.