Farmers' Legal Action Group, Inc. 1301 Minnesota Bldg., 46 East Fourth St., St. Paul, MN 55101, (612) 223-5400 Chapter 12 Bankruptcy-How Will by Susan Schneider On October 2, 1986, Congress passed the Family Farmer Bankruptcy Act. This statute created Chapter 12, a new Chapter in the Bankruptcy Code designed specifically for the reorganization of family farms. It is closely modeled after Chapter 13 of the Bankruptcy Code, although it has a higher debt ceiling, and therefore is applicable to many more farm operations. The effective date of the statute is November 26, 1986. I. Eligibility Chapter 12 is only available to persons and entities which meet the definition of “family farmer," set forth in the statute. According to this definition, the farmer's debt cannot exceed $1,500,000.00. Eighty percent of this debt must arise from the farming operation. For purposes of computing the debt, the debt on a homestead will not be included unless such mortgage was granted in connection with the farm operation.2 In addition to the debt ceiling, the statute also requires that the farmer-debtors must have earned more than one-half of their gross income from farming in the year prior to the filing of the Chapter 12 petition.3 The final requirement for eligibility is regular annual income. This income must be "sufficiently stable and regular to enable such family farmer to make payments" under a Chapter 12 Plan.4 A farm corporation or partnership will be eligible to file a Chapter 12 Bankruptcy if it meets four specific conditions. First, 50% of the stock or equity of the corporation or partnership must be held by one family, with that family conducting Susan Schneider is an attorney with Moratzka, Dillon, Kunkel & Storkamp in Hastings, Minnesota. At the time of the writing of this article, Chapter 12 bankruptcy was new. The article does not include discussions of how courts have actually interpreted the various provisions. Copyright © 1986 Susan Schneider. Reprinted with permission from the farming operation. Second, more than 80% of the value of its assets must be related to the farming operation. Third, the aggregate debts must not exceed $1,500,000.00 with not less than 80% of that debt arising from its farming operation. Finally, if corporate stock exists, that stock must not be publicly traded. 5 5. 11 U.S.C. § 101(17)(B). 1. Farming operation is defined to include "farming, tillage of the 3. Id. 4. 11 U.S.C. § 101(18); 11 U.S.C. § 109(f). Prior to confirmation, the debtor carries on the farm operation in the ordinary course of business. Cash collateral, such as crop or livestock proceeds, cannot be used, however, without either court or creditor approval. To obtain such approval, the debtor must provide the creditor who holds a lien on such property with "adequate protection" for the time period between filing of the petition and confirmation of the plan.10 This protection prevents the creditor from being harmed by the debtor's use of the collateral. Similarly, if the automatic stay prevents a creditor from proceeding against its collateral, and it is shown that this collateral is declining in value during the stay, the creditor may also be entitled to "adequate protection.' For example, the mortgage holder may claim a right to this protection for the continued use of the property. 11 Notice and hearing on such a sale must be provided and the proceeds must be remitted to the secured creditor. 13 C. The Trustee As stated above, the Chapter 12 debtor is given broad authority to operate the farm business, nevertheless, Chapter 12 provides for the appointment of a trustee in every case. 14 Where fraud or gross mismanagement is shown, a creditor or the trustee may move to have the trustee placed in control of the farm. 15 Even while the farmer remains in control of the property, however, the trustee maintains important functions. Under Chapter 12 he is directed to: (1) receive and be accountable for property and pay- (2) object to the allowance of improper claims; (3) make recommendations regarding the discharge of (4) provide information to interested parties; (5) investigate the financial affairs of the debtor for cause; (6) investigate the operation of the farm and analyze (7) participate in valuation and confirmation hearings; Compensation of the trustee is determined by a percentage of the payments made under the plan. For the first $450,000.00 of payments, the trustee's fees are not to exceed 10% of the payments. Beyond that amount, the compensation is limited to 3%." 17 IV. Requirements for Confirmation of the Plan As has been stated, the debtor is responsible for filing a plan for the fair repayment of debts and the reorganization of the farming operation. Only the debtor is authorized to file this plan. Chapter 12 specifically provides that this plan may modify the terms of debt repayment of either secured or unsecured debt. 19 Moreover, it may provide for the curing or waiving of a default over a reasonable period of time.20 In addition, it may provide for the liquidation of farm collateral.21 Beyond these powers, however, there are specific requirements which govern the acceptability of a Chapter 12 plan. Consistent with other chapters in the Bankruptcy Code, unsecured creditors and secured creditors are treated differently. 24 If the plan does not provide for full repayment, the debtors must agree to contribute their entire "disposable income" to the payment of this debt during the term of the plan. However, the statute specifically defines "disposable income" to include only that income which remains after all farm and living expenses have been paid. 25 Again, the term of the plan must run three years or less, unless the court approves an extension. In no event may a plan run longer than five years. Under either alternative, the plan must offer the unsecured creditors at least as much as they would receive through a Chapter 7 liquidation.2 27 B. Secured Creditors 26 With regard to secured creditors, there are also several alternatives. For the debtor's plan to be confirmed, the secured creditors must either approve the plan, retain the lien securing the claim while payments are made, or receive the collateral. 28 If the debtor's plan provides for the repayment of a secured debt, the creditor's security interest, of course, remains intact during the repayment period. The amount of the debt, however, is reduced to the present value of the secured property. Thus, in certain situations, it may be possible for the debtor to cash out the secured creditor by obtaining financing in an amount equal to the appraised value of the collateral. In this case, valuation may well be an issue in dispute. As another alternative, the debtor's plan may provide for a repayment schedule which extends beyond the terms of the original secured debt.29 If the last payment on a secured debt was originally due after the date on which the final payment under the plan is due, the three to five year limitation on the term of the plan is waived with regard to that debt.30 Under any such repayment plan, whether the term of the original debt is extended or not, the creditor's claim is again reduced to the value of the collateral. What the creditor must receive, however, under the terms of the repayment plan is the present value of that collateral. Thus, the creditor is entitled to interest based upon the value of the collateral for the duration of the repayment plan. During the entire repayment term, secured creditors, of course, retain their security interest in the collateral. 32 31 22. 11 U.S.C. § 1225(b). 23. 11 U.S.C. § 1222(c). 24. 11 U.S.C. § 1225(b)(1). 25. 11 U.S.C. § 1225(b)(2). 26. 11 U.S.C. § 1222(c). 27. 11 U.S.C. § 1225(a)(4). 28. 11 U.S.C. § 1225(a)(5). V. Conversion and Dismissal Chapter 12 specifically provides that a debtor may voluntarily convert a Chapter 12 bankruptcy case to a Chapter 7 bankruptcy at any time. 33 Creditors, however, may not seek the involuntary conversion of a debtor's Chapter 12 bankruptcy to a Chapter 7 bankruptcy unless fraud is shown.34 Along with the enactment of Chapter 12, Sections 706 and 1112 of the Bankruptcy Code were amended to permit a conversion of a Chapter 7 or a Chapter 11 bankruptcy case to that of Chapter 12. Although the legislative history indicates that Congress intended this conversion privilege to apply to cases pending at the time that Chapter 12 becomes effective, the amendments to Chapter 7 and Chapter 11 do not appear to accomplish this result. Thus, at the present time, it appears that the statute and the legislative history are in conflict on this issue. In addition to the creditor's ability to request that the trustee take control of the farm operation, the creditor also has the right to move for the dismissal of the case. Chapter 12 provides that after notice and a hearing, the court may dismiss a case for cause, including: (1) Unreasonable delay or gross mismanagement; (4) Failure to commence making timely payments un- (5) Denial of confirmation of a plan and denial of a (6) Material default by the debtor with respect to a (7) Revocation of the order of confirmation and denial (8) Termination of a confirmed plan by reason of the 35 After completion of all payments under the plan, a Chapter 12 debtor will receive a discharge of all debt that has been provided for in the plan except for that debt which has been ratified by the debtor and extended beyond the life of the plan. 36 In most cases, this means that the unsecured debt will be discharged at the end of the three or five year plan term. Any secured debt which extends beyond the term of the plan will remain until the repayment has been completed. There is also provision for a hardship discharge which may be granted despite the debtor's inability to complete a plan. Such discharge is granted if the failure to complete the plan is due to circumstances for which the debtor "should not justly be held accountable." It can only be granted, however, if the unsecured creditors have received at least as much as they 29. 11 U.S.C. § 1222(b)(2). 30. 11 U.S.C. § 1222(b)(5). 31. 11 U.S.C. § 1225(a)(5)(B)(ii). 32. Id. 33. 11 U.S.C. § 1208(a). 34. 11 U.S.C. § 1208(d). 35. 11 U.S.C. § 1208(c) and (d). 36. 11 U.S.C. § 1228. 115 Editor's Note: The following article is an edited version of testimony given by Robert Mark at a March 7, 1987, meeting in New Orleans, Louisiana, of the Committee on Provisions for the Delivery of Legal Services of the Board of Directors of the Legal Services Corporation (LSC). The purpose of the meeting was to receive the views of legal services programs and others on whether LSC should request Congress to allow all funding for national and state support and clearinghouse functions to be transferred to field programs, which could then subcontract with support centers subject to LSC approval. Persons testifying at the meeting were asked to assess (1) the likely effect of this on field programs' ability to secure (a) national-level support services and (b) state-level support services; (2) whether consolidation of national support services would increase cost effectiveness; and (3) whether functions and purposes of national and state support are served by preservation of the current system. Twenty-five people spoke at this all-day meeting; none were in favor of transferring national and state support funds to field programs, though several offered suggestions for improvements. The meeting was chaired by Basile Uddo, an LSC board member and professor of law at Loyola University of New Orleans. Mr. Mark spoke at the end of this long hearing. Chairman Uddo: [T]hat leaves [us] with Mr. Mark. You get the last word. Robert Mark is the Director of Legal Services of Northeast Missouri, 801 Broadway, P.O. Box 1276, Hannibal, MO 63401, (314) 248-1111. He has practiced law in rural Missouri since 1978. Mr. Mark: I'd just like to say that when I first started with legal services in a rural area, I became aware that there were certain counties where the judges would, no matter how you got on the docket, call the cases for legal services last. And I used to be very affected by that until I realized that in certain instances the reason the judge called the case for legal services last is because he wanted to rule the way I asked him to, but he didn't want all the private bar there watching him do it. So I became very mellow to the subject of being last because I liked to win. Mr. Valois [Robert A. Valois, an LSC Board member]: So, maybe you'll win today, too. Mr. Mark: I don't know. I'd like to change the focus here today. First of all I'd like to thank you all for having me. I'd like to introduce myself. My name is Robert Mark. I'm primarily a country lawyer. I am also, since 1984, the Executive Director of Legal Services in Northeast Missouri, a $221,000 grantee, serving over 25,000 eligible clients in 14 rural northeastern Missouri counties. At the present, we are providing services to a region of this nation which, like our host state Louisiana, is most crippled by the overseas flight of jobs and capital, as well as the sagging disaster of corn economy. To a family in northeast Missouri, only a few hundred dollars a year separates the eligible client population from the general population. Our clients are served primarily from our principal offices in Hannibal, Missouri, a farm community which is probably most famous to you as the boyhood home of Mark Twain. To make my point this morning, it is important to |