My practice of bankruptcy law began in 1980 under the brand new Bankruptcy Reform Act of 1978. An economic recession was on the horizon.
Farm real estate values were high and commodity prices were relatively good, but shortly thereafter everything changed. Prices dropped sharply and land values tumbled. Interest rates, however, remained high and credit was hard to find.
Many farmers faced grave financial difficulties. Some were willing to liquidate, but severe tax consequences from liquidation were an even bigger threat. It was a hard lesson to lean that the “absolute priority rule” would prevent them from confirming a Chapter 11 plan. Many who did file Chapter 11 bankruptcy were eventually forced to liquidate anyway — few were able to preserve the family farm.
Because of Chapter 11’s failure to meet the needs of farmers in financial distress, Congress adopted Chapter 12 of the Bankruptcy Code in 1986, which actually brought some helpful and much needed relief to many financially-distressed farmers. Chapter 12 plans offered the ability to:
- reduce debt burdens to the current (and much-lower) asset values,
- reduce interest rates dramatically, and
- stretch amortization schedules out over significant periods of time.
Further, a subsequent rebound in farm product prices and real estate values assured that the confirmed Chapter 12 plans would prove to be feasible, workable and effective for the intended purpose of preserving the family farm.
During the 1980s I represented farmers in more than 40 Chapter 12 cases–almost always in conjunction with a rural attorney who referred the case and worked it with me. Nearly all such cases were successful in obtaining confirmation of a Chapter 12 plan that discharged substantial amounts of debt, and also preserving the family farm.
In the course of my work, I learned many lessons — mostly the hard way:
Lesson 1 – Make careful money decisions.
Prudent financial practices are always essential to avoid future problems. Back in the late 1970s and early 1980s, many farmers, had they known what would happen, would never have purchased that high-price land on credit with little-money-down.
Then, in the mid-to-late 1980s, many farmers, had they known that prices of farm land were bottoming out and beginning a rise to great heights, would have bought-up everything available. So, the only viable course is to always make prudent financial decisions and take prudent financial risks . . . and then hope for the best.
Lesson 2 – Limit tax deferments.
Deferred tax obligations can create serious financial problems. A common 1980s hypothetical is this: Farmer inherits a farm from parents in 1960 at a stepped-up tax basis and expects to pass the farm on to the next generation at another stepped-up tax basis, but values increase dramatically (along with borrowings against the farm). The Farmer buys and depreciates many buildings and items of machinery and equipment–then the Farm Crisis intervenes and results in liquidation of Farmer’s assets, leaving Farmer with a tax liability far beyond anything Farmer could ever afford to pay. Variations on this hypothetical wreaked havoc on many farmers during the 1980s.
Note: In 2005, Congress added a provision to Chapter 12 allowing for discharge, under certain circumstances, of capital gains and income taxes arising from liquidation of farm assets. Such provision is highly technical, has been the subject of much litigation (including a ruling by the United States Supreme Court), and must be applied with great care. Nevertheless, such provision is a substantial benefit to financially stressed farmers that did not exist during the 1980s. For further information, read this CALT article.
Lesson 3 – The farm can only support so many people and/or families.
Some financial problems are the result of nothing more or less than bad timing and bad luck.
A common story in the 1980s: Mom and Pop welcome Son and Daughter-in-law into their farming operation, buy more land and equipment to provide for an extra income from the farming operation, and increase the operation’s debt load accordingly. The recession hits. Everything caves in, and they lose the farm. This is bad timing and tough luck. The result could not have been prevented, except by Son and Daughter-in-law pursuing a vocation elsewhere. Unfortunately, Mom, Pop, Son and Daughter-in-law are all caught in the economic tide and carried away.
Lesson 4 – Nothing lasts forever.
Avoid excessive optimism. Two variations on this lesson:
- Never establish future debt service projections and debt service obligations based upon best-year-ever data. A common problem arising prior to the Farm Crisis is this: Farmer had a great year financially in 1978 or 1979 (perhaps the best-ever) and then set up debt service projections and obligations based upon an expectation that the just-completed best-year-ever would recur each subsequent year for the next twenty or so. History tells us emphatically that such an approach is not wise or prudent and should not be followed.
- Don’t expect high farm product prices and high real estate values to stay high forever–what goes up is likely to come down sooner or later. History shows that the prices of farm assets and products steadily increased over the late 1970s and early 1980s–but such increases did not last.Those prices reached a peak and then dropped quickly to lows that few people thought possible–just ask asset-based lenders from back in those days! The reality is that dramatic declines in prices and values did occur, and did so rapidly and unexpectedly. Perhaps there is a lesson here for farmers and their lenders to consider today?
Bankruptcy requires full and honest disclosure by the debtor of all pertinent financial information–failures to satisfy such requirement can produce dire consequences, including prison time.
I mentioned that “nearly all” of my Chapter 12 cases were successful. The major failure came in a case where the farmer failed, let’s say, to be completely truthful in sworn schedules and testimony. The farmer ended up in Federal prison. That’s all I have to say about that.
Lesson 6 – Excessive debt is a warning sign.
Financial stress requires analysis, evaluation and education on its causes and on alternative courses of action for addressing the stress. Two variations:
Farmer has financial stress, then a crisis happens (e.g., lender shuts off cash and begins collection efforts) requiring immediate action–so the farmer promptly files bankruptcy. Normally, before filing bankruptcy a farmer wants to engage in planning and negotiations with creditors first; unfortunately, in this hypothetical the Farmer waits too long and ends up filing bankruptcy in a “fire, ready, aim” mode, rather than in a pre-bankruptcy planning and negotiations mode.
When financial stress first arises, a farmer needs to take immediate action to fully understand what is causing the stress and what tools (e.g., Chapter 11 and Chapter 12 possibilities) might be used to deal with the stress. Waiting to do so until financial stress reaches crisis proportions is waiting too long.
Excessive debt is a warning sign. Nearly every bankruptcy debtor has excessive debt. Back in the 1980s, many Chapter 11 non-farm cases listed an airplane as an asset. Regardless of how it arises, excessive debt should always be treated as a warning sign requiring immediate evaluation and corrective action.
Lesson 7 – Filing for bankruptcy is not cheap.
Business bankruptcy cases are difficult and expensive.
During the pre-Chapter 12 days of the Farm Crisis, it wasn’t rare for a father and son, in the farm business together, to visit my office. Usually the son had already concluded that they should immediately start the Chapter 11 bankruptcy process to escape a messy financial situation.
I would walk them through the Chapter 11 process — its limitations, difficulties and possible risks, plus the costs of time and additional legal fees should there be complications. The usual reaction was a cloud of doubt and concern coming over the son’s face, and a quick exit to look for someone else to do the legal work.
Lesson 8 – Bankruptcy can lead to lawsuits.
Insiders (e.g., owners or relatives) of a bankruptcy debtor often face preference and transfer avoidance lawsuits initiated long after the bankruptcy is filed. Unintended and unforeseen consequences are always a problem.
Insiders of a bankruptcy debtor are often surprised when, 2 or 3 years after the bankruptcy filing, they are sued by the bankruptcy estate for return of money or property they received from the bankruptcy debtor prior to the bankruptcy filing. Every debt repayment they received from the bankruptcy debtor within 1 year prior to the bankruptcy filing must be returned, the lawsuits claim, as a “preference,” and every transfer of debtor’s assets received within 4 years prior to the bankruptcy filing must be returned, the lawsuits claim, as a “fraudulent transfer.” Upon learning of the lawsuits, the insiders take great umbrage at the “fraud” allegations and react with incredulity to everything about the lawsuits! But the lawsuits are real. They are not a joke. They must be defended. And they must be resolved. Ouch!
Lesson 9 – Don’t count on Chapter 12 saving the farm.
Chapter 12 might not be as effective today in preserving family farms as in the 1980s–for two reasons.
First, Congress set the initial aggregate-debt-limit eligibility requirement for seeking Chapter 12 relief at $1,500,000. Back in the 1980s, (a) the aggregate debt for most farmers did not exceed $1,500,000, and (b) many farmers whose aggregate debts did exceed such limit could sell some assets, use the proceeds to pay down debt and, thereby, create eligibility for Chapter 12 relief.
Today, the aggregate-debt-limit for Chapter 12 eligibility is set by Congress at $4,031,575. Today’s farming operations tend to be dramatically larger than in the 1980s. It’s likely that many farmers who might need Chapter 12 relief in the future will not qualify because of the aggregate-debt-limit eligibility requirement.
Second, Chapter 12 arrived in 1986 at an opportune time for providing successful relief to farmers because of recent farm asset value reductions, high debt loads based on previously-high asset values, and recent interest rate declines. Accordingly, late-1980s farmers in Chapter 12 could confirm plans that discharged large amounts of debt and repaid the diminished value of retained assets at dramatically reduced interest rates.
Today, farm land values are still high and interest rates have been low for quite some time. A confirmable Chapter 12 plan in today’s reality would probably not discharge much (if any) debt or achieve any significant interest rate reduction. That’s a huge difference!
The author, Donald L. Swanson, is a shareholder in the Koley Jessen P.C., L.L.O., law firm of Omaha, Nebraska. His online bio is here.