EAG-005 RMC-20 10-13

Risk Management Dealing with Financial Stress on Texas Farms and Ranches— and Non-Bankruptcy Alternatives Danny Klinefelter and Jason E. McMillin*

Over past few years agricultural producers have • Voluntary faced a variety of natural disasters—droughts, • Partial or total voluntary floods, and insect infestations. At the same time, • Bankruptcy crop prices have had dramatic swings, and input prices such as fuel, fertilizer, and seed have risen Do nothing significantly. To make matters worse, it appears that You can always just do nothing when dealing if there is a 2013 farm bill, it will significantly reduce with financial stress. In some cases, this may be federal farm program benefits. These factors will the best alternative. However, don’t take this choice negatively affect agricultural producers across Texas until you consult with your attorney. can and the country. foreclose on the collateral securing your loans. This Traditionally agricultural producers have dealt means they will sell the collateral to apply against with financial stress (being unable to pay creditors their loans. If the collateral doesn’t sell for enough to on time) by tightening their belts, and holding on pay off the loans, creditors can file lawsuits against until things got better. Unfortunately, lean times of- you for the balance due. The creditors can then use ten mean forgoing equipment repairs or replacement the courts to try to collect deficiencies from any other which make it difficult to borrow money against nonexempt assets you may own. these items. At the same time, increased costs have kept many producers from adopting new cropping Changing the operation and conservation practices to preserve soil fertility and maintain long-term profitability. If you are experiencing financial stress, you Many producers simply can’t tighten their belts should examine your operation to see if there are any more or hold on any longer without making changes that would decrease expenses or increase drastic changes. Each situation is unique, and only income. You have probably been trying to do this the producer can decide how to effectively solve for several years, but may have only considered his operation’s financial problems. However, one minor changes. There comes a time when you must element common to resolving any case of financial evaluate every aspect of the operation—each crop stress is to seek professional legal and tax advice. and livestock enterprise must stand on its own. If Alternatives for resolving financial stress include: you need help with this analysis, the Texas A&M • Doing nothing AgriLife Extension Service has resources available • Changing the agricultural operation through the County Extension Agent.

* Professor and Extension Economist - Management Farm Loan Specialist, Texas Farm Service Agency Voluntary able to pay on time. In this case, you should consider a total voluntary liquidation. If you adjust your operation but still cannot make Partial or total voluntary may have payments as they become due, you may be able to tax consequences. When you sell assets whose values extend loan terms or lower interest rates to bring have increased while you owned them, you may debt service into line with your operation’s cash flow. incur capital gains taxes. However, it is unlikely the However, lenders are being asked daily to rene- lender will let you to keep enough of the proceeds to gotiate loans and are unlikely to agree unless you pay these taxes. You must consult with your accoun- can show that the changes will actually solve the tant regarding tax consequences before entering into problem. You should be able to show the lender any any agreement for partial or total voluntary liquida- changes you have made in the operation, and have tion. solid production and economic data to support the Be careful when entering into agreements that restructuring request. will discharge (write off) a portion of your debt. If If you can convince the lender that your operation you agree to sell all of the assets securing a loan is viable under a restructured loan, the lender may from the bank, and the bank agrees to write off be willing. If modifying your loan is only a short- any deficiency after the sale, you may incur what term solution, the lender has no reason to agree to it. is referred to as discharge of indebtedness income, Another factor which may influence the lender’s which can be taxable. USDA Agencies will issue an willingness to restructure your loans is whether IRS-1099 on debts that are written off. Consult your there are defects in the loan or security documents. accountant in advance to ensure you don’t take on For example, if the lender has a in unexpected tax liabilities. crops and the documentation omits or incorrectly describes some of the farms on which the crops are Bankruptcy to be grown, then the may not be properly per- fected. Promissory notes might not identify you as If the alternatives presented above do not solve being personally liable for the debt. In either of these your financial problems, you may have to consider situations, a lender may want to restructure in order bankruptcy. Bankruptcy has number of advantages to avoid liquidation to satisfy loans that are under over nonbankruptcy solutions. First, the bankruptcy collateralized due to paperwork oversight. However, process is supervised by the court to ensure that the you will need an attorney to determine if this situa- and the creditors are treated fairly. Second, tion applies to you. the bankruptcy rules are designed to provide a fresh start for the debtor, whether the creditors agree or Partial or total voluntary not. Third, discharge of indebtedness income is not taxable in bankruptcy. And fourth, capital gains liquidation income from the sale of assets may escape taxation in If you cannot change your operation or restruc- bankruptcy. However, bankruptcy also has disad- ture loans to service the debt, you should consider vantages. partial voluntary liquidation. Initially, analyze Many producers are concerned that filing bank- whether you could sell enough assets to reduce the ruptcy will damage their credit. Bankruptcy stays on debt load to a point where you could make on-time record for 8 years after filing. Producers are also con- payments. You should consider selling the most cerned about the social stigma of filing bankruptcy. heavily encumbered assets first—selling these will However, the large number of caused reduce debt more than liquidating lesser obligations. by crises in oil and gas, real estate, and banking have However, when deciding whether to sell any given reduced that stigma. As well, no individual may be asset, you must compare the effect on debt service to a debtor under any chapter of the bankruptcy code the effect on net cash flow. It does not help if you sell unless he or she has received credit counseling from an asset that contributes more to net cash flow than an approved agency within 180 days before filing. its sale would lower debt payments. It may be that The type of bankruptcy familiar to most people is partial voluntary liquidation needs to be combined a Chapter 7 liquidation bankruptcy. Under this form with changes in the operation and restructuring the of bankruptcy, the debtor keeps their exempt prop- remaining debt. Unfortunately, you still may not be erty (homestead, household goods, etc.), subject to loans against that property. The trustee collects non-

2 exempt property, converts it to cash, and distributes operation in the tax year preceding the filing date. A the funds to the unsecured creditors who have filed “farming operation” includes “farming, tillage of the proofs of claim. Secured creditors usually use their soil, dairy farming, ranching, production or rais- collateral to satisfy their claims. The debtor gives up ing of crops, poultry, or livestock, and production of all his nonexempt property in return for a discharge poultry or livestock products in an unmanufactured of most, if not all of the remaining debt. This dis- state.” A corporation or partnership may qualify for charge releases the debtor from personal liability for this bankruptcy protection. prebankruptcy debts. is not required for Chapter 12. It is Another type of bankruptcy, Chapter 12, is the only necessary that the be unable to pay family farmer reorganization bankruptcy. In a reor- debts as they come due. This bankruptcy may be ganization bankruptcy, creditors generally look to used to restructure debts, even though selling all the satisfy their claims not through the property of the debtor’s assets would be enough to pay all debts. debtor at the time of initiation of the bankruptcy but If a debtor received a discharge of indebtedness through future earnings. in a case filed less than 6 years earlier than the filing For farming operations that exceed the threshold date of a second bankruptcy, the debtor cannot re- for family sized farms under Chapter 12, there is ceive a discharge in the second bankruptcy. Howev- a third type of bankruptcy that is used mostly by er, there is an exception to this provision if the earlier large farming operations—Chapter 11 bankruptcy. discharge was in Chapter 12 or 13 and the debtor Chapter 11 is different from Chapter 12 in that the paid at least 70 percent of the unsecured claims. discharge comes when the plan is confirmed as A debtor also may not file a new bankruptcy if he opposed to when it is completed. Additionally, all or she filed a case in the previous 180 days that was the secured creditors and the trustee get to vote to dismissed for the debtor’s willful failure to appear approve or disapprove the plan. Chapter 11 bank- or to abide by orders of the court, or was withdrawn ruptcies are fast-paced and complex—legal counsel is to thwart a ’s request for relief from the usually necessary to meet the timeframes. automatic stay in order to foreclose on the collateral. The following is an explanation of Chapter 12 Before the enactment of this prohibition, some debt- farm reorganization, Chapter 7 liquidation bank- ors used repetitive filings and dismissals to frustrate ruptcy and, to a lesser extent, Chapter 11 reorgani- creditors’ efforts to foreclose on their collateral. zation bankruptcy. The purpose is not to promote bankruptcy as the best solution for resolving finan- Commencement of the Case cially distressed loans, but to provide information A Chapter 12 bankruptcy, or any other type of for evaluating alternative strategies. bankruptcy, is commenced by the debtor(s) filing: 1. A voluntary petition with the court Chapter 12 Farm Reorganization 2. A schedule of assets and liabilities Chapter 12 became a permanent part of the 3. A schedule of current income and bankruptcy code in 2005. This bankruptcy may be expenditures particularly relevant when a significant portion of 4. A schedule of executory contracts and the producer’s debts is unsecured or the producer unexpired leases needs to restructure secured debts, but the lender is 5. A statement of financial affairs. unwilling to provide the necessary relief. In an emergency filing, the debtor has 15 days from the filing of the voluntary petition and list of Eligibility creditors to file the property schedules and statement To qualify for Chapter 12, a producer must be a of financial affairs. A joint voluntary petition can be family farmer with regular income. A family farmer filed if the debtor is married. The producer must pay is a producer, and/or producer’s spouse, engaged in a $246 fee at filing. With the court’s permission, the a farming operation whose aggregate debt does not filing fees may be paid in installments provided pay- exceed $ 3,792,650. At least 50 percent of this debt, ment is complete no later than 120 days after filing. excluding the principal residence, must be from The jurisdiction of the bankruptcy court is in- the farming operation, and the producer, and/or voked at the instant the petition is filed. The case producer’s spouse, must have received more than begins the moment the petition is filed, with no 50 percent of their gross income from the farming signature or other action from the judge.

3 The automatic stay debtor(s) about the property of the estate and other Filing the petition causes an automatic stay of all matters relating to the bankruptcy. The bankruptcy creditor collection activities. This means creditors judge is not present nor is this meeting held in the can take no further actions to collect until the court courtroom. The debtor(s) must be present and are gives permission. All other litigation or collection is required to testify under oath. There is no court re- stayed, and creditors are prohibited from foreclos- porter—the trustee records the proceedings on tape. ing on collateral, or enforcing judgments or wage Developing the Chapter 12 plan without court permission. Likewise, The reorganization plan is central to the success telephone calls and letters attempting to collect debts of a Chapter 12 bankruptcy. The debtor must file are stayed. The bankruptcy clerk notifies all credi- this plan within 90 days of filing of the case. The tors whose names and addresses are provided by the plan must show the debtor can pay reasonable living debtor. In a Chapter 12 bankruptcy, collection activi- expenses, all operating expenses, required payments ties against a codebtor are also stayed, but only if it to secured creditors, and payments to unsecured concerns consumer debt. A cosigner for an operat- creditors that are at least as much as they would have ing loan or a loan to purchase business assets is not gotten from a total liquidation. The plan must cover protected by the codebtor stay. 3 to 5 years. Creditors may legally object to the plan, The automatic stay remains until the case is but the bankruptcy judge decides whether the plan is dismissed or closed. However, a creditor can re- acceptable. quest relief from the automatic stay if the creditor’s Exempt property: Property the debtor owns at the interest in the security for his loan is not adequately time of filing is classified as exempt or nonexempt. protected, or if the debtor does not have any equity Exempt property is not subject to collection efforts in the encumbered property and that property is not under state or federal law. The debtor is allowed to necessary to an effective reorganization. keep exempt property without further payments Trustee and except payments for a valid lien. Valid against The Standing Chapter 12 Trustee is appointed exempt property include purchase money liens and by the U.S. Trustee to supervise the debtor’s perfor- certain nonpurchase money liens. The debtor may mance of the plan and to disburse payments from choose between federal and state exemptions. Exemp- the debtor to secured and unsecured creditors. The tions under Texas law are generally more favorable trustee plays an important role in Chapter 12 bank- to the debtor, so in most cases the debtor will choose ruptcies because the court often relies on the trust- those. ee’s recommendations whether to confirm a plan A Texas debtor is entitled to a rural or an urban and continue of the case. The trustee is compensated homestead. If the debtor lives in town, the homestead from a fee on all debtor payments that are distrib- is limited to one acre of land, which may be one or uted to the creditors. more lots with improvements. If the debtor does not The debtor retains possession of the property of live in town, they are entitled to a rural homestead, the bankruptcy estate unless the court orders oth- not to exceed 100 acres for a single person or 200 acres erwise due to fraud, dishonesty, incompetence, or for a family, which may be one or more parcels with gross mismanagement of the debtor’s affairs. If the improvements. There is no cap on the value of the court finds that the debtor should be removed as a property under this exemption. debtor in possession, the Chapter 12 bankruptcy will Under the Texas Property Code Sec. 42.001, a Texas likely be dismissed because the trustee is generally debtor is also entitled to an exemption of $30,000 not in position to run a farming operation. worth of property for a single person or $60,000 for a family. This limitation applies only to personal prop- Meeting of the creditors erty. Property claimed under this exemption includes: A meeting of the creditors is scheduled for no • Home furnishings, including family heirlooms sooner than 20, nor later than 35 days after filing. • Provisions for consumption The Chapter 12 trustee convenes this meeting. It • Farming or ranching vehicles and implements is known as a 341 Meeting because it is conducted • Tools, equipment, books, and apparatus, under Section 341 of the bankruptcy code. This is a including boats and motor vehicles used in a time for the trustee and the creditors to question the trade or profession

4 • Wearing apparel purchase money lien against the debtor’s exempt • Jewelry not to exceed 25 percent of the property, the debtor must decide how the property aggregate limitations prescribed by Section and its debt will be treated in the plan: 42.001(a) • The debtor may redeem the property by paying • Two firearms off the creditor in a lump sum. • Athletic and sporting equipment, including • The debtor may reaffirm the debt which is bicycles secured by the property and continue making • One two-, three-, or four-wheeled motor the payments without any changes. vehicle for each member of a family who • The debtor may propose restructuring the holds a driver’s license or for nonlicensed debt’s terms, the interest rate, or both. members who rely on another person to • The debtor may offer to surrender the property operate the vehicle for their benefit to extinguish the debt. • Animals and forage on hand for family If the creditor holds a valid nonpurchase money consumption: lien on exempt property, the debtor may still redeem, –– 2 horses, mules, or donkeys and a saddle reaffirm, or restructure the debt; or surrender the blanket, and bridle for each property. However, there is another way to avoid the –– 12 head of cattle lien. –– 60 head of other types of livestock In many cases, the debtor has actually paid off all –– 120 fowl purchase money liens against farm equipment over • Household pets the years, only to give a lender a nonpurchase money • The present value of any life insurance policy lien against the equipment to secure an operating to the extent that a member of the family or loan. In this situation, the debtor can avoid or elimi- a dependent of a single insured adult is a nate the lien against $11,700 worth of equipment for a beneficiary of the policy. In most cases, the family or $5,850 for a single person. cash value of life insurance can be exempted Nonexempt Property: All other property owned under separate provisions of the Texas by a debtor at the time of filing is nonexempt. If the Insurance Code such that it does not count debtor wants to retain this property, the plan must against the limits of the Texas Property Code. provide for payments to the secured creditors or to the The following personal property is also exempt trustee for the benefit of the unsecured creditors. If the and not subject to the family $60,000 or individual nonexempt property secures a debt, the debtor must $30,000 limits discussed above: decide whether to redeem the property with a lump • Current wages for personal services except sum payment, reaffirm the debt, restructure the debt, for the enforcement of court-ordered child or surrender the property to the creditor. If there is no support payments lien against nonexempt property, the debtor may pay • Professionally prescribed health aids of a the value of the property to the trustee over the period debtor or a dependent of a debtor of the plan, or surrender the property to the trustee. • Unpaid commissions for personal services not The trustee will sell any surrendered property and to exceed $15,000 for a family or $7,500 for a distribute the proceeds to the unsecured creditors. single person • Qualified pension plans and retirement Creditors’ claims accounts The debtor has to list all creditors’ claims on the • Any annuity issued by an insurance company schedules as either secured claims, or priority or non- • Certain life insurance proceeds priority unsecured claims. • College savings plans established under • Secured claims are debts that are secured by Subchapter F, Chapter 54, Education Code liens on the debtor’s property. • Certain savings plans, and contributions to an • Priority unsecured claims are debts such as individual retirement account unpaid taxes that are not secured by a lien on If no creditor holds a valid consensual lien on a the debtor’s property. particular piece of exempt property, the debtor may • Non-priority unsecured claims are debts keep the property. However, if a creditor has a valid that are not secured by a lien on the debtor’s property.

5 In a bankruptcy plan, a given debt may be divided • Liabilities for willful and malicious injury, into a secured and an unsecured portion. For exam- including unauthorized sale of collateral ple, if the debtor owes $100,000 to a creditor which • Governmental fines is secured by a lien on a tract of land worth $70,000, • Certain educational debts such as student the creditor has a secured claim for $70,000 and an loans unsecured claim for $30,000. As discussed above, if • Debts for death or personal injury caused by the debtor intends to retain the tract of land, the plan the debtor’s operation of a motor vehicle while must provide for repayment of the $70,000 secured intoxicated claim. However, the $30,000 will be listed with the • Undischarged debts from a previous other unsecured claims. bankruptcy In restructuring secured debts, the debtor must Projected operating income and expenses: Oper- provide for repayment at prevailing market terms ating income and expenses are central to the Chapter and interest. However, the plan can provide that 12 plan because the net cash income from operations the secured claims will be repaid over a period that and any off-farm income must fund the plan. The is longer than the plan period. However, priority debtor must ensure that these projections are real- unsecured claims must be paid in full during the pe- istic and supported by credible documentation. The riod of the plan, unless the creditor agrees to extend bankruptcy judge cannot confirm a plan unless it is repayment beyond the plan. feasible. The debtor must show the ability to generate If a creditor is over secured, the plan must pro- the projected income given projected expenses. The vide for payment of interest from the filing date and plan should include a monthly cash flow projection payment of the over ’s legal fees, up for the duration of the plan, as well as documenta- to the value of the creditor’s collateral. However, if tion that supports projected yields, weaning weights, a creditor is undersecured, postpetition interest be- crop and livestock prices, production expenses, etc. tween the date of filing and the date of confirmation Operating credit: Providing for operating credit is not required. to fund the plan is one of the most difficult parts of a Carefully analyze prepetition liens on crops and successful Chapter 12. Traditional lenders generally livestock. Generally, these liens will give the creditor won’t finance an operation in Chapter 12 bankruptcy. an effective lien on crops that are growing or har- However, some lenders will because the code pro- vested at the time of filing, as well as the offspring of vides effective protection for a postpetition lender. livestock at the time of filing. These types of proper- Finally, some operations can generate operating capi- ty are classified as cash collateral. However, at filing, tal internally—such as a dairy with monthly milk prepetition liens on crops and livestock are cut off checks. Funding a plan internally is the most advan- and are not effective against crops planted or live- tageous alternative. However, if an operation cannot stock born after filing. Consider these liens carefully do that, the debtor must show the bankruptcy judge when scheduling a bankruptcy filing. that he can obtain operating capital from a third- Nondischargeable claims party, or through cash collateral. Projected nonfarm income and expenses: The Not all unsecured debts can be discharged in ability to generate off-farm income is often the most bankruptcy—the debtor must provide for paying important part of a Chapter 12 plan. If one or both these debts in the plan. The dischargeability of debts spouses can generate income that is independent of must be analyzed carefully, however, non-discharge- the farm operation, risk is reduced and net cash flow able debts generally include: to fund the plan increases. • Most taxes Projected family living expenses: The debtor is • Debts for property obtained through fraud entitled to a reasonable allowance for family living (e.g., based on false financial statements) expenses. However, they should be projected real- • Unscheduled debts istically because the trustee will require the debtor • Debts from fraud or defalcation while acting to report living expenses and live within the plan. in a fiduciary capacity, embezzlement, or debt that accumulates in a given year is larceny an important consideration. Mounting credit card • Domestic relations such as child support and debt is typically overlooked and may indicate that alimony family living needs were underestimated. Underes-

6 timating living expenses to create the illusion of suf- decide whether to object to the plan. In many juris- ficient cash flow for payments is not acceptable. The dictions, the trustee conducts a conference with the debtor may get the plan confirmed, but such a plan is debtor and creditors before the confirmation hearing probably doomed. to resolve objections. If the creditors and the debtor Payments: Plan payments are ones the debtor cannot resolve their disputes, the bankruptcy judge must make to the trustee for distribution to secured will conduct a hearing where the debtor presents his and unsecured creditors. For any plan to meet plan and the creditors present objections. The bank- feasibility requirements, it must show that these ruptcy judge then decides whether the plan is fea- payments will be made on schedule. If the debtor sible and whether it treats the creditors properly. The includes a secured claim without changing the bankruptcy judge will then confirm or deny the plan. amount, terms, or interest rates, the payments can be made directly to the creditor. Otherwise, payments Modification of the Chapter 12 plan to creditors go through the trustee. If the debtor experiences drought, floods, insect Trustee Fees: The plan must provide for trustee infestation, etc., they may try to modify the Chapter fees. The Chapter 12 fee cannot exceed 10 percent 12 plan. In many jurisdictions, however, this oppor- of plan payouts under $450,000, or 3 percent of plan tunity is only available if the debtor has successfully payouts in excess of $450,000. Since trustee fees made the first year’s payments. In addition, if the attach to each plan payment he handles, it helps to need to modify is a failure to make plan payments include unimpaired claims where possible, and pay in the second or third years, the modification will creditors directly. probably need to extend the plan to 4 or 5 years. The Disposable income: This is the income left after approval process for modification is similar to that for paying operating and living expenses, and plan the original confirmation. payments. To meet confirmation requirements, the Discharge of indebtedness plan must provide that all disposable income dur- ing the period of the plan will go to the trustee for After the debtor has made all planned payments, distribution to the unsecured creditors. The essence the remaining unsecured debts will be discharged. of a Chapter 12 bankruptcy is that the debtor agrees This means that the debtor is longer be liable for these to pay the unsecured creditors at least as much as debts. Under Chapter 12, the debtor does not receive a they would have received in a Chapter 7 liquidation, discharge until after all plan payments are complete. plus all of the disposable income for the period of the There are provisions for the bankruptcy judge to plan. Thereafter, unsecured debts will be discharged grant a hardship discharge—it is rare. and unsecured creditors receive no additional pay- Dismissal or conversion ments. Executory contracts and unexpired leases: The debtor maintains an absolute right to dismiss Unexpired leases are just what the name states. An his case, which returns the debtor and his creditors executory contract is a contract that remains partially to the positions they held at the time the Chapter 12 unperformed on both sides at the time of filing (e.g., bankruptcy was filed. This right cannot be waived Direct and Counter Cyclical (DCP) and Conservation by the debtor. The bankruptcy judge can dismiss the Reserve Contracts (CRP)). The debtor must specify case if the debtor fails to file and confirm a plan or which executory contracts and unexpired leases will perform according to the plan and the bankruptcy be assumed and which will be rejected. However, rules. the debtor cannot restructure contracts or leases. The debtor also maintains an absolute right to con- They must be assumed or rejected as is. Likewise, vert the case to a Chapter 7, Chapter 11, or Chapter 13 the plan must provide that any breach in executory bankruptcy, if they qualify. However, the bankruptcy contracts and unexpired leases will be cured before judge cannot convert the case to Chapter 7 liquida- the plan begins. tion, unless it is proven in court that the debtor has committed fraud in their Chapter 12 case. Confirmation of the plan Other considerations When the debtor files his plan, he provides a copy to each creditor and to the trustee. The creditors and Preferences: The debtor must disclose any pay- the trustee have a period to evaluate the plan and ments of $600 or more to creditors in the 90 days

7 before filing the bankruptcy. The trustee may force • Did the transfer occur shortly before or after a creditors to refund payments to the bankruptcy es- substantial debt was incurred? tate if they were payments on an existing debt, if the • Did the debtor transfer the assets to a creditor debtor was insolvent at the time of payment, or the who subsequently transferred the assets to an payment was within 90 days of the filing. The trustee insider? cannot force payment refunds to the bankruptcy if In addition to the provisions that govern fraudu- the creditor received less than they would have in a lent bankruptcy transfers, the trustee can also use Chapter 7 bankruptcy. applicable state and federal laws to avoid fraudulent The preference period is extended to one year transfers. Though the debtor is only required to if the creditor was an insider (e.g., a relative of the report payments made within one year of filing, in debtor). Thus, efforts to pay local trade creditors— Texas the trustee can go back 4 years to seek refund who are usually unsecured—before filing the bank- of fraudulent transfers. ruptcy, may simply result in the trustee compelling Setoffs: If, before the filing date, the debtor owes the creditor to return the payment to the bankruptcy money to a particular creditor, and the creditor estate. However, the preference provision does not also owes money to the debtor, the creditor can set apply if the payments were made for new value, or off the amount he owes the debtor. For example, if if the payments were made in the ordinary course of the debtor has a loan with a bank and has money business. If a local trade creditor is normally paid by in a checking account at the same bank on the date a producer at the end of the crop year, this payment of filing, the bank can set off the loan against the would probably fall within the ordinary course of checking account by withdrawing the balance. The business and not be classified as a preference. debtor should evaluate his exposure to setoff before Fraudulent transfers: The debtor must disclose all filing bankruptcy. If the debtor has money at a bank payments made within one year of filing. The trustee to which he owes money, he should withdraw the may compel the refund of payments made within money and deposit it elsewhere before filing, or one year of the filing if: simply hold it and disclose it as cash on hand. The • The debtor intended to hinder, delay, or debtor may have significant exposure to setoff if he defraud a creditor has a loan with the Farm Service Agency, and they • The debtor received less than reasonably are owed Direct and Counter Cyclical Program or equivalent value Conservation Reserve payments etc., from participa- • The debtor was insolvent at or immediately tion in Farm Service Agency programs. after the transfer Postpetition property: The property of the estate • The debtor’s operation was undercapitalized in a Chapter 7 bankruptcy consists of the nonexempt after the transaction property owned by the debtor at the time of filing • The debtor knew that they would incur debts Chapter 7. It also includes any property the debtor they could not repay receives within 180 after filing, through inheritance, The debtor may not know that a particular trans- a divorce settlement, or from a life insurance policy fer is deemed fraudulent, and it can be difficult to or death benefit program, if it would have been part know in advance if the trustee will try to avoid a of the bankruptcy estate had the debtor owned it transfer. at the time of filing. A critical difference between a Some of the factors the trustee will examine are: Chapter 7 and Chapter 12 is that the property of the • Did the debtor receive market value for the estate in Chapter 12 includes anything that would transfer? have been property of the estate in Chapter 7 wheth- • Was the transfer to an insider? er owned at the time of filing, or received before the • Did the debtor retain possession or control of case is closed, dismissed, or converted to Chapter 7. the property after the transfer? This includes earnings from services performed after • Was the transfer concealed? the filing and before the case is closed, dismissed, • Was the debtor sued or threatened with suit or converted to Chapter 7. Thus, if the Chapter 12 before the transfer? debtor receives a windfall (e.g., he wins the lottery) • Did the transfer include all or substantially all or a large inheritance in the last month of his Chap- of the debtor’s assets? ter 12 plan, he could find that his windfall or inheri- tance goes to his creditors.

8 Legal Fees: Chapter 12 bankruptcy is complex— charge/Reaffirmation hearing, which concludes most the debtor will usually incur significant legal fees. Chapter 7 cases. These fees must be disclosed to the court and are In general, Chapter 7 is less expensive, faster, and reviewed by the trustee and the bankruptcy judge. less stressful than Chapter 12. The producer should The debtor must ensure that he will have funds to evaluate their objectives in deciding between Chap- employ competent counsel. The debtor should retain ter 7 and Chapter 12. If the producer wants to retain counsel as early as possible. Though waiting until a significant portion of their nonexempt assets or re- the last minute can hurt chances for a successful structure debts associated with the exempt or nonex- bankruptcy, it is unlikely to reduce the associated empt assets, the producer will probably find Chapter legal fees. 12 is appropriate. However, no producer should file a Chapter 12 case without seriously comparing of the Chapter 7 liquidation benefits and costs of Chapter 7. Liquidation does not mean that everything a producer owns will be sold to pay his debts. In a Tax considerations Chapter 7 bankruptcy, the debtor is allowed to keep Filing Chapter 12, Chapter 7, or any other bank- exempt property subject to its liens. Producers who ruptcy can have significant tax consequences. It is file Chapter 7 bankruptcy are often able to continue essential that the producer consult a knowledgeable farming by reaffirming debts on equipment and accountant before filing the bankruptcy. This will livestock that they need to keep operating, while help the producer and his attorney optimize the tax discharging significant levels of unsecured debt. consequences of filing and administering a bank- The Chapter 7 bankruptcy, like Chapter 12, starts ruptcy case. with filing a voluntary petition, a list of creditors, Other legal considerations schedules of assets and liabilities, and a statement of financial affairs. The producer should not fear the legal processes A trustee is appointed in a Chapter 7 case from of bankruptcy. The design and operation of the a rotating roster of attorneys or nonattorneys that system treats the debtor courteously and recognizes have been approved by the U.S. trustee. Since there is that a primary objective of bankruptcy is to give no operating plan in Chapter 7, the trustee does not the debtor a fresh start. However, no discussion of play the supervisory role of the Chapter 12 trustee. bankruptcy is complete without a caution that fed- Instead, the Chapter 7 trustee: eral law penalizes bankruptcy crimes. These crimes • Identifies the debtor’s exempt property include knowingly concealing assets, making false • Abandons collateral property for secured statements, and transferring or receiving property loans, in which the debtor has no equity in order to subvert the bankruptcy code. However, a • Liquidates the remainder of the property debtor who makes full disclosures and ensures that • Disburses the proceeds from these sales to the their oral and written statements are true and correct unsecured creditors in a prorate fashion based should be within the law. on their proof of claim. Debtors must understand that if they have exist- Chapter 7 cases cost the debtor less than Chapter ing DCP or CRP executory type contracts when they 12. Though the filing fee is $306, compared to $246 file for bankruptcy, they must assume/reaffirm these for Chapter 12, the Chapter 7 debtor does not incur contracts before the case is discharged. Failure to do trustee fees because these are paid from the assets this will terminate the contracts and may, in the case which the trustee liquidates. Chapter 7 legal fees of the CRP contract, have long term financial conse- are usually only a fraction of those in Chapter 12 quences for the debtor. because there is no 3- to 5-year plan to develop and Chapter 11 reorganization administer. The normal Chapter 7 case concludes within Chapter 11 is the least common of the three bank- about 4 months provided there are no assets for the ruptcies for farming operations. However, anyone trustee to administer. The Chapter 7 case convenes eligible to file under Chapter 7 may file under Chap- 341 creditors’ hearing, but there is no confirmation ter 11. The purpose of Chapter 11 reorganizations is hearing because there is no plan. Normally, the 341 not to liquidate the debtor’s estate, but to stop credi- meeting in a Chapter 7 case is followed by the Dis- tor actions so that a business or personal financial

9 estate can be reorganized and become profitable with a proposed agreed order that includes replace- again. Chapter 11 is better suited to corporations, ment postpetition liens on milk. Timing is essential sole proprietorships, or partnerships. Like the Chap- because disrupting the labor, feed, or upkeep can ter 12 bankruptcy, the debtor proposes a plan. How- devastate the operation moving forward. ever, unlike the chapter 12 the creditors get to vote This discussion of Chapter 11 bankruptcy is whether to accept the plan. A major difference is that intended simply as an overview of a third option. the discharge occurs when the plan is confirmed—in Using this bankruptcy chapter requires experienced Chapter 12, the discharge typically comes after suc- legal representation. cessfully completing year 3 or 5 depending on the plan. Summary Filing a voluntary petition for relief, invokes an Alternatives for dealing with financial stress order whereby the debtor automatically becomes include doing nothing, changing in the operation, the debtor in possession. This means the debtor will voluntary debt restructuring, partial or total liquida- keep possession and control of their assets during tion, and bankruptcy under chapters 7, 11, or 12. As a the reorganization. The debtor will remain a debtor producer evaluates how to solve financial stress, they in possession until the reorganization plan is con- must consider each of these alternatives. Which the firmed, dismissed, converted to a chapter 7, or a producer finally chooses often depends on factors trustee is appointed. Few trustees are appointed in that are beyond his control. The same forces that cre- Chapter 11 cases as the debtor in possession typically ate financial stress (e.g., weather, prices, government performs many of the trustee functions under other programs, etc.) will also influence the effectiveness chapters. The debtor usually does not have to pay of each of these alternatives. As well, nonbankruptcy a trustee and on larger operations this represents solutions usually depend on the creditor’s willing- considerable savings. ness to work with the producer. In Texas, large dairies or cattle ranches that Producers should start evaluating alternatives as operate as corporations have used Chapter 11 bank- soon as they see that tightening their belts or holding ruptcy. These cases take preparation and timing. on will no longer work. Producers need legal and tax Typically they need cash weekly to buy necessary advice early in the decision process, in order to make feed and meet payroll after the filing. In the case of a an informed choice and develop a sound plan. Delay dairy, legal counsel will typically file an emergency in seeking counsel, making a decision, and imple- motion to use cash collateral—the milk checks— menting a strategy will greatly reduce the probabil- simultaneously with the voluntary petition. The ity of achieving the desired outcome. creditors will often be contacted just before the filing

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