Introduction to Chapter 12 Bankruptcy

Congress enacted Chapter 12 – “Bankruptcy for Family Farmer with a Regular Annual Income” – of the Bankruptcy Code to mitigate the financial circumstances that exist for many farmers in America. Many “family” farms operate much like an unincorporated business, with high revenue and high debt-loads. Previously, family farmers often had too much debt to qualify as a chapter 13 debtor. However, those farmers also often had too little income to fund a chapter 11 bankruptcy case, making chapter 7 liquidations the only option for debt-ridden farmers.

Chapter 12 operates very much like chapters 11 or 13 of the bankruptcy code, in that it allows the debtor to file a reorganization plan that allows the debtor to retain its assets while repaying creditors all or a portion of their debts over a set period of time. However, chapter 12 of the Bankruptcy Code provides for a middle ground between the short time frame and limited powers of chapter 13 and the longer time frame and broader powers provided in chapter 11.

This article is an introduction into family farmer bankruptcy cases and covers the most basic aspects and common issues of chapter 12 bankruptcy cases. This article will give an overview on how secured and unsecured creditors can best navigate the myriad of rules and regulations pertaining to chapter 12 bankruptcy.

  1. Eligibility
    A debtor cannot be considered a chapter 12 debtor unless the debtor is a “family farmer” with regular annual income. “Regular annual income” is a defined term in the Bankruptcy Code and means annual income sufficiently stable and regular to enable the farmer to make payments under a chapter 12 plan. An individual family farmer must have less than $3,544,525.00 million in total debts, at least 50% of which must arise from a farming operation (excluding debt for a principal residence), and must derive at least 50% of their income from a farming operation to be eligible to file a chapter 12 bankruptcy petition.Corporate entities can also qualify to be chapter 12 debtors. Similarly, more than 80% of the company’s assets must relate to farming activity, its debts must exceed $3,544,525.00, and at least 50% of the outstanding stock must be held by one family and/or their relatives.
  2. Debtor’s Powers
    Similar to a chapter 11 debtor-in-possession, a chapter 12 debtor continues in possession of its assets and continues to operate its business. As in chapter 11, a chapter 12 debtor has a fiduciary duty while in bankruptcy to act for the benefit of its creditors and not in the debtor’s own self-interests.However, in a chapter 12 case a trustee is appointed from the outset of the case to oversee the debtor’s conduct and, most importantly, to collect the debtor’s plan payments and make distributions to creditors.
  3. Most Common Chapter 12 Issue
    The most important issue occurring in chapter 12 are use of “cash collateral” and whether a secured creditor is receiving adequate protection for its claims.With respect to the former, “cash collateral” is defined as any cash proceeds stemming from a secured creditors’ collateral. The most obvious example of cash collateral in a chapter 12 case are proceeds stemming from the sale of milk or crops that act as security for a creditors’ claims. In those instances, when a secured creditor has a lien on milk production or crops “and the proceeds thereof,” the debtor has the right to sell its milk and/or crops to fund its business, but must “adequately protect” the secured creditors’ claims. In chapters 7, 11, or 13, “adequate protection” typically means the “indubitable equivalent” of the value of the property on the date the debtor entered bankruptcy. For example, if the debtor’s crops were worth $100,000 on the petition date and debtor seeks to sell all of the crops, the debtor must ensure that the creditor receives at least $100,000 from the sale.However, chapter 12 has a special provision regarding adequate protection which defines “adequate protection” as, among other things, periodic cash payments, additional/replacement liens, or, with respect to farmland, payment for the use of the land of the “reasonable rent customary in the community in which the property is located.” This provision allows the debtor to sell crops, pay a portion of the secured proceeds to its secured creditor, and retain the remainder of the proceeds to fund new crops. The same can be said of milk production.
  4. Chapter 12 Plan
    Just like in chapters 11 and 13, the goal of the bankruptcy case for the family farmer debtor is to emerge from the case by filing a chapter 12 plan. A plan is simply a document that provides for how the debtor will repay its creditors. The plan term is typically 3 to 5 years and acts as a new contract between the debtor and its creditors regarding how debts are repaid.Like in chapter 11 or chapter 13, generally speaking, secured creditors are paid the lesser of the “present day value” the collateral securing their claims or their total claim. For a plan to be confirmable by the court, the plan must provide unsecured creditors with more than they would have received had the debtor’s assets been liquidated for the benefit of creditors and must include all of the debtor’s “disposable income.” Unfortunately, with the increasing rise in secured debts that would be paid upon liquidation, unsecured creditors often receive less than 50% of their claims over 5 years through a chapter 12 plan.Chapter 12 also allows a debtor to pay its secured claims over a period of time greater than 5 years. This applies to both long-term and short-term secured debt and can even apply to debt that has fully matured prior to the bankruptcy case being filed. In many instances, a family farmer has limited income with which to pay its creditors and is forced to stretch a secured creditor’s debt repayment over many years. This often results in litigation regarding whether a plan is proposed in “good faith” and whether the plan is “feasible.”

    Family farmers are required by chapter 12 of the bankruptcy code to file a plan within 90 days of filing a bankruptcy petition. The Court may extend that period an additional 90 days (180 day total) if adequate justification is shown by the debtor. This differs from chapter 13 – where a plan must be filed with or shortly after the bankruptcy petition – and chapter 11 – where plans often aren’t required for several years.

  5. Conclusion
    Most family farmer cases fall somewhere between a simple individual bankruptcy more suited for chapter 13 and a complex corporate reorganization requiring the rules and procedures of a chapter 11 proceeding. In enacting chapter 12 of the Bankruptcy Code, Congress appears to have attempted to craft a hybrid bankruptcy; not quite as structured and restrictive as chapter 13, not quite as flexible and relaxed as chapter 11. In doing so, Congress created a system in which the debtors are given a reasonable period of time to restructure their financial position for the benefit of all creditors. Now that we have outlined the basics of chapter 12, stay tuned for the coming series of articles on the particular issues and strategies that commonly arise in family farmer bankruptcy cases.

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