Prior to new federal bankruptcy guidelines going into effect on Oct. 17, there was much speculation that Congress, to the detriment of debtors, had handed the legislative reins over to creditor lobbyists. Now, a month later, that hasn’t turned out to be the case – at least not for the farming community and Chapter 12.

“Chapter 12 is actually much friendlier for farming debtors as a result of the new bill,” said Susan Schneider, associate law professor at the University of Arkansas. Schneider, who serves as the director of the university’s graduate program in agricultural law, says the new and expanded Chapter 12 was no accident.

“It definitely was meant to be. There were a number of farmer advocates in the Senate wanting to improve Chapter 12 for farmers. They weren’t necessarily the same ones wanting the overall bankruptcy reform bill. Those wanting the bill to pass basically let the farmer advocates get what they wanted in order to secure the farm-state votes. It was a trade-off.”

The political game

In fact, some of the changes to Chapter 12 would have been passed earlier. However, legislators that desired the big, overall bankruptcy reform bill to pass repeatedly blocked the agriculture-related reforms.

“They said, ‘No, we’re going to hold off on Chapter 12 changes until we get your vote for overall bankruptcy reform.’”

The overall bill contains a number of provisions written by the credit card industry, said Schneider. The industry was very concerned about the ability of consumers to discharge their credit card charges through bankruptcy.

“They wanted to make it more difficult for people to file and more difficult, specifically, for those filing under Chapter 7 – the chapter that allows a discharge of debts in exchange for liquidating. Many creditor groups felt there was bankruptcy abuse going on. So they wanted tougher legislation.”

While much of the new bill was controversial, Chapter 12 has never fit in that category.

“It may not have been a big problem, but Chapter 12 has always been a temporary provision of the bankruptcy code. It kept expiring. Congress was often slow to re-enact it. When they did it was for six months or 12 months. Sometimes Chapter 12 was available, sometimes it was in sunset. It was on-again, off-again.

“The strange thing is almost everyone thought it was a good idea and should be made permanent. But those pushing bankruptcy reform were politically correct in thinking that if they tied farm bankruptcy to overall bankruptcy reform it would garner extra votes. And it did.”

Most of the changes to Chapter 12 start with the fact that it’s now permanent. The actual revisions to Chapter 12 are mostly pro-farmer and were shepherded by Sen. Russ Feingold, D-Wis.

“(Feingold) played the game well. Congress has been working on bankruptcy reform for about eight years. Every time a different bill came up in Congress, Feingold would present his list of amendments to Chapter 12 wanting it to be stronger and broader. No matter what side of the aisle you fall on, farmers can thank him for the Chapter 12 changes. Feingold votes with his conscience, and that’s not always the party line.”

Four major changes

There are four specific changes that expand the eligibility of Chapter 12.

• It increases the maximum level of debt a farmer can have.

“You have to understand this in context. Chapter 12 isn’t meant to help a huge farm corporation. It’s directed at family farmers.

“One of the ways it’s restricted to smaller farm operations is a debt limit. If you have debt over a certain level, you lose eligibility for Chapter 12.”

The old debt ceiling used to be $1.5 million.

“That seems like a lot until you throw in a couple of new combines and farmland and the $1.5 million is quickly exceeded.”

The new debt limit is $3.237 million. The reason the number isn’t round, said Schneider, is “the amount kept getting bumped up because it’s indexed with the cost of living. Because the bill has been talked about so long, the amount is kind of odd.”

• The new law amends the requirement that at least 80 percent of debt comes from farming.

Under the new law, just 50 percent of the debt must come from the farming operation.

• Income requirements are expanded.

In previous years, only the prior tax year would be considered when determining if 50 percent of income came from the farming operation. Now, either the prior year or each of the second and third years preceding bankruptcy filing can be considered.

“One of the reasons this is important is farmers that get into financial trouble typically don’t look to bankruptcy right off the bat. They usually try to figure out a way to get out of the problem by themselves.

“For example, if there’s a bad disaster, farmers don’t usually go file bankruptcy immediately. Instead, they try to work out of it through off-farm jobs, by doing something to bring in non-farm income to make the farm viable again.”

The problem is if a farming family does that for a year and it doesn’t work, they may not be eligible for Chapter 12.

“That’s in spite of the fact that, for all practical purposes, they’re exactly the type of family operation Chapter 12 is made for.”

Another way this becomes an issue is when approaching a lender for a crop loan.

“If they say ‘no,’ the farmer can be stuck and has to cash-rent out his farm that year. There’s no money to buy inputs. That can be a problem because cash-rent, in many circumstances, won’t be treated as farm income.”

If done under a crop-share basis, any income would be from the farm. But in that situation, the farmer still has to come up with money for inputs.

“Often, that means farmers are stuck, even when trying to do what’s right. They want to keep farming so they do everything they can before filing for bankruptcy. But by putting off filing, unfortunately, it may affect their eligibility for Chapter 12.”

• “Family fisherman” defined and afforded Chapter 12 eligibility.

Under the new legislation, “family fisherman” can refer to anything from aquaculture to a family shrimp boat.

“The only part that’s tricky probably plays right to some of Farm Press’ readers. This may have been an oversight, but the new rules say a family fisherman will still be bound to the old eligibility rules.”

That means a family fisherman’s debt level will be held at $1.5 million. Eighty percent of their debt must come from the fishing operation. And only the income for the year prior to filing will be considered.

“The way ‘family fisherman’ is defined includes small-scale shrimpers or lobstermen but also those raising catfish in the Delta. The reason that sounds a bit odd to those of us in the Delta and Southeast is most of us already assumed a catfish producer is a true family farmer.

“If you’ve got some catfish ponds on your property, you could be labeled a ‘family fisherman’ rather than a ‘family farmer.’ If that’s the case, you’ll be subject to lower debt limits and all the rest. Of course, in this region, many of the catfish producers also have row crops.”

Does Schneider suspect the “fisherman” definition will be addressed in a later legislative session?

“I’ve already heard some have approached (Iowa Republican) Sen. Charles Grassley, about some technical amendments to this statute. Grassley was one of the main proponents of the overall bankruptcy reform bill.

“They believe family fishermen should be under the exact same rules as family farmers, that there should be just one test for eligibility. So they’re trying.”

The problem is the bankruptcy reform bill is over 500 pages long. Once one change is made, everyone else will jump in.

“In making up the bill, groups representing consumers had a say, credit card companies had a say, car finance companies had a say, on and on.”

Now, bankruptcy professionals – representing both debtors and creditors – claim there are a lot of problems with the bill. Many say no one who really understood all the intricacies of bankruptcy sat down and considered the bill as a whole.

“That has resulted in many wanting to finagle and tweak the finished product. But the second the notion of ‘technical amendments’ is broached, everyone will want a say. Congress is reticent to open that door.”

Tax obligations

Dealing primarily with capital gains, some tax obligations under Chapter 12 have also been modified.

“Sometimes your equipment is depreciated out or the farm has a low basis. When going to sell it in bankruptcy – or maybe having sold it prior to the bankruptcy – a farmer can have a huge capital gains obligation.”

Under the old rules, those would usually be entitled to priority and must be paid first. The new change provides that some of those obligations will be treated as unsecured debt.

“I really encourage anyone who thinks that provision might apply to them to visit a tax advisor and bankruptcy attorney. No one needs to make a decision on that provision without professional advice.”

Retroactive assessments

Schneider said this is a “sleeper” provision that could be the biggest Chapter 12 change of all.

“Here’s how a Chapter 12 works. There are specific provisions that apply to secured creditors like a mortgage holder. In order to get your plan confirmed, you must treat debt a certain way. The same is true of unsecured creditors – there are specific rules for what you can do in a Chapter 12 plan.”

One of the things unsecured creditors are entitled is “projected disposable income.” The language for this comes right out of Chapter 13, the consumer bankruptcy reorganization apparatus.

“The way it was interpreted under Chapter 13 is, as part of the confirmation process, you figure out the debtor’s cash flow and whether his plan is feasible. They then look at how much extra the farmer will have if everything goes according to plan – their projected profit. The amount left over is what the debtor is obligated to pay an unsecured creditor. At the end of a plan term (usually three years) unsecured debt will be discharged while the debtor continues to pay on secured debt.”

At the discharge hearing, a farmer may have done everything as he was told and paid everything he was told to.

“However, a while back, creditors figured out they could claim the debtor had more income than was projected originally. So they would go back and begin pulling certain things out the three-year budget and say, ‘Well, you shouldn’t have spent money for a new barn roof. It wasn’t needed.’ Or, ‘You got some disaster payments that we didn’t think you’d get.’ They wanted that money.

“The Eighth Circuit bought this argument and said, ‘Yeah, it’s not really projected disposable income. It’s going to be actual disposable income. At the discharge hearing, after the fact, creditors can go back and account for every penny the farm brought in and the farmer will be liable for any extra.’”

The practice got “really messy. In some cases, they began counting livestock on hand even though it wasn’t ready for slaughter. They began counting grain in storage and other things.”

Some farmers showed up at discharge hearings believing they’d paid everyone. Then, they’d be hit with an additional $50,000 or $75,000. There’s at least one case, said Schneider, where a farmer owed over $100,000.

“At that point, the farmers are over a barrel. In order to get the bankruptcy discharge, they’ve got to come up with this money.

“Feingold heard about this and got this new provision put in. It’s kind of complicated, but the new language encourages the courts to set projected income and stick with it unless there’s a seriously unforeseen change in circumstance. Under the new rules, if a certain amount of income is projected and something bad happens so the family can’t pay off, the plan can be revisited and modified. The same thing can happen if a farmer wins the lottery and has all kinds of extra money.”

e-mail: dbennett@primediabusiness.com