Dealing with Financial Stress on Texas Farms and Ranches—Bankruptcy and Non-Bankruptcy Alternatives Danny Klinefelter and Jason E

EAG-005 RMC-20 10-13 Risk Management Dealing with Financial Stress on Texas Farms and Ranches—Bankruptcy and Non-Bankruptcy Alternatives Danny Klinefelter and Jason E. McMillin* Over past few years agricultural producers have • Voluntary debt restructuring faced a variety of natural disasters—droughts, • Partial or total voluntary liquidation 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. Creditors 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 debt restructuring able to pay debts 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 liquidations 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 security interest 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 lien 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- debtor 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 bankruptcies 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. Insolvency is not required for Chapter 12. It is Another type of bankruptcy, Chapter 12, is the only necessary that the debtors 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.

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