The Family Farmer Relief Act of 2019: Will the Increased Debt Limit Lead to an Uptick in Chapter 12 Filings?

The United States Senate passed the “Family Farmer Relief Act of 2019” (H.R. 2336), which substantially increases the debt limit for agricultural producers seeking to file for relief under Chapter 12 of the United States Bankruptcy Code. The bipartisan legislation, which passed the U.S. House of Representatives in June and is expected to be signed into law by President Trump, raises the debt limit for Chapter 12 bankruptcy filings from approximately $4.3 million to $10 million.

The debt limit increase will dramatically expand Chapter 12 bankruptcy eligibility at a time of turmoil for the U.S. agriculture industry, precipitated by years of depressed farm income, crop overproduction, increased debt loads, natural disasters, extreme weather events, and, more recently, retaliatory tariffs on many U.S. agricultural products as part of a renewed trade war. As noted by the American Farm Bureau Federation, even before passage of the Family Farmer Relief Act, Chapter 12 bankruptcy filings were up 13% over the past year, and farm loan delinquency rates were at a six-year high. Farm bankruptcies under Chapter 12 can only be expected to rise sharply now that farmers with debts as high as $10 million dollars are eligible to file for Chapter 12 relief.

A farm seeking to reorganize its operations, restructure its debt, and continue as an ongoing business may consider relief under several chapters of the Bankruptcy Code:

Chapter 13

In a Chapter 13 proceeding, the debtor commits all of his or her future disposable income to pay all or part of the debtor’s outstanding debts under the terms of a confirmed Chapter 13 plan. Certain debts, including residential mortgages, must be paid in accordance with the terms of the mortgage, either through or outside the plan (any pre-petition arrearage on the mortgage can be provided for and paid through the plan). Chapter 13 eligibility is limited to individuals (i.e., not corporations, LLCs or partnerships) with unsecured debts of less than $419,275 and secured debts of less than $1,257,850.

Chapter 11

Chapter 11 bankruptcy is most commonly used to reorganize large corporations. Chapter 11 has some provisions aimed at small business debtors, and individuals whose debts exceed the limits for Chapter 13 may be eligible to file for Chapter 11. As a practical matter, however, Chapter 11 cases are costly and complex, which frequently limits its availability to larger debtors with the means to fund a case. In Chapter 11, the debtor will typically reorganize its debts in accordance with a confirmed Chapter 11 plan, which must classify the types of claims against the estate and provide for treatment of each class. The plan must be accompanied by a detailed disclosure statement containing sufficient information for creditors to make a determination as to whether to vote to accept the plan. Creditors whose claims are “impaired” under the plan may vote on the plan.

Chapter 12

Chapter 12, which was initially enacted during the farm debt crisis of the 1980s, provides many benefits for small to medium-sized family farming operations as compared to Chapter 11 or Chapter 13. Chapter 12 is reserved for “family farmers” or “family fisherman” with “regular annual income.” A “family farmer” may be an individual (or an individual and spouse), or a corporation or partnership (with certain restrictions), so unlike the case with Chapter 13 bankruptcies, which is limited to individuals, a family farm that is structured as a corporation or partnership may be eligible for relief under Chapter 12.

Chapter 12 has numerous other benefits over both Chapter 11 and Chapter 13 for parties who are eligible. Like Chapter 13, Chapter 12 contemplates that the debtor will use future disposable income to fund a plan; however, a Chapter 12 reorganization plan can provide for payments to be made seasonally, when the farm earns most of its income. Moreover, a Chapter 12 debtor has 90 days from the petition date to file a proposed plan and need not begin making plan payments prior to plan confirmation, in contrast to Chapter 13 debtors who must propose a plan and begin making plan payments much more quickly. Therefore, Chapter 12 debtors have a longer breathing spell before they must start funding the plan.

Chapter 12 is considerably less expensive than Chapter 11 — the Chapter 11 filing fee alone is $1,717, versus $275 for a Chapter 12 case. Moreover, if the debtor does not qualify as a “small business debtor,” as defined in the Bankruptcy Code, an official committee of unsecured creditors will be appointed in a Chapter 11 case, with the costs of the committee’s professionals (in addition to its own professionals) to be borne by the debtor. The unsecured creditors’ committee has broad authority to investigate the assets, liabilities, financial condition and transactions of the debtor, which can substantially increase the costs of the case, even if the scope of such investigation is limited.

A typical business reorganization will often include the sale of underperforming or unneeded assets. Asset sales in Chapter 12 have many advantages for the debtor over those in over Chapter 11. In order to sell assets “free and clear” of liens, claims, and encumbrances in Chapter 11, the debtor must satisfy the stringent requirements of section 363(f), which can be hotly contested by stakeholders. The Chapter 12 debtor, on the other hand, may sell any property free and clear of liens under section 1206 so long as the property is “farmland or farming equipment.” With narrower statutory grounds for objecting to an asset sale in Chapter 12, the process is typically less contentious and less expensive. Also, asset sales in Chapter 12 have significant tax advantages over those in Chapter 11. Any tax liability for capital gains generated by a sale in Chapter 11 is treated as a priority claim that must be paid in full at plan confirmation. By contrast, in Chapter 12, any tax arising from the sale of property used in the debtor’s farming operation is treated as an unsecured claim of the debtor that may be discharged in bankruptcy. This allows the debtor to retain the upside from the sale of farming assets.

Finally, one of the biggest advantages of Chapter 12 over Chapters 11 or 13 is that Chapter 12 debtors may modify any secured loan — including residential mortgages, nonresidential mortgages, equipment loans and vehicle loans — through a so-called “cram down.” In a cram down, the debtor pays secured creditors based on the current value of collateral rather than the amount owing on the loan. In Chapter 11 and Chapter 13 cases, a debtor cannot cram down the mortgage on the debtor’s principal residence.  Chapter 12 does not contain this restriction, so a Chapter 12 debtor may cram down his residential mortgage along with any other secured debts. This can be a powerful tool for family farmers who frequently live and farm on the same land.

Given the clear advantages of Chapter 12 over Chapters 13 and 11 for family farmers seeking to reorganize under the Bankruptcy Code, the newly expanded eligibility for Chapter 12 bankruptcy – combined with the troubled economic climate for U.S. farmers – may well lead to a proliferation of Chapter 12 filings. If the current problems facing the U.S. agricultural industry are transitory in nature, Chapter 12 may well provide small to mid-sized farmers with the relief they need to weather the temporary downturn. If, on the other hand, the downturn is symptomatic of a more fundamental reordering of the industry and its place in the global economy, then expande