Guest Article: The 1980s Farm Crisis: Some Lessons Learned

 

Law school graduation occurred in May of 1980, and the law firm job interview concluded with this question: “Don, would you like to do bankruptcy?!”  Figuring I needed a job, “Yes,” came the response.  And so began my career as a bankruptcy attorney in Omaha, Nebraska.

My practice of bankruptcy law began in 1980 under a brand-new Bankruptcy Code (officially, the “Bankruptcy Reform Act of 1978”), with an economic recession in the offing.  Farm real estate values were high, farm products brought relatively good prices, interest rates were high, and farms tended to be highly leveraged with debt.  Shortly thereafter, the bubble burst on the farm economy, with farm product prices dropping sharply and real estate values tumbling but with interest rates remaining high and credit becoming increasingly hard to obtain.  Many farmers faced grave financial difficulty.  Some were willing to liquidate and move on to other endeavors, but many found they would face severe tax consequences from liquidation that would leave them in even worse financial shape.  Many farmers decided to address their financial problems by filing Chapter 11 bankruptcy, only to learn the hard way that the “absolute priority rule” would prevent them from confirming a Chapter 11 plan.  Many farmers who filed Chapter 11 were, ultimately, forced to liquidate anyway—few were able to preserve the family farm. 

Because of the failure of Chapter 11 to meet the needs of farmers in financial distress, Congress adopted Chapter 12 of the Bankruptcy Code in 1986.  Chapter 12 actually brought some helpful and much-needed relief to many financially-distressed farmers: they were able to confirm Chapter 12 plans that (a) reduced debt burdens to the current (and much-lower) asset values, (b) reduced interest rates dramatically, and (c) stretched 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 forty 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 both (i) obtaining confirmation of a Chapter 12 plan that discharged substantial amounts of debt, and (ii) preserving the family farm.  In the course of such representations, I learned many lessons—mostly the hard way.  The following are some of those lessons.

Lesson One

Because the future is hard to predict, 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 Two

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), and 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 Three

Some financial problems are the result of nothing more or less than bad timing and bad luck.  A common 1980s hypothetical demonstrating this is as follows: in 1980 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.  Then the recession hits.  Everything caves in, and they lose the farm.   This is bad timing.  It is 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 Four

Avoid excessive optimism.  Two variations on this lesson are the following:

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?

Lesson Five

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 above 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 for such offense.  That’s all I have to say about that

Lesson Six

Financial stress requires analysis, evaluation and education on its causes and on alternative courses of action for addressing the stress.  Two variations on this lesson are the following:

A common 1980s hypothetical is this: 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.Accordingly, 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.Some excessive debt is incurred by unwarranted spending: back in the 1980s, for example, when many Chapter 11 non-farm cases began to be filed, it seemed that ownership of an airplane had to be a requirement for filing Chapter 11 because every set of Chapter 11 bankruptcy schedules, it seemed, 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 Seven

Business bankruptcy cases are difficult and expensive.  During the pre-Chapter 12 days of the Farm Crisis, father and son farmers are sitting in my office.  Son declares, “We want one of them-there Chapter 11s,” in response to my “How can I help you” inquiry.  He says it in a this-would-be-a-really-smart-and-clever-thing-to-do sort of way.  The following hour of discussion consists of my efforts to explain the Chapter 11 process, what can be accomplished, what can’t be accomplished, what some of the risks and difficulties might be, what my fees and retainer request might be, how a creditors’ committee might be appointed and hire an attorney who would be paid by them, how over-secured creditors can recover attorney fees from them, how creditors in a bankruptcy tend to fight hard to protect their interests and require them to incur a corresponding amount in legal fees for their defense.  As discussions ensue, I see a cloud of doubt and concern coming over the son’s face; whereupon, he finally decides they need to look elsewhere for an attorney who can provide one of the “them-there Chapter 11s” he is looking for.       

Lesson Eight

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, two or three 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 one year prior to the bankruptcy filing must be returned, the lawsuits claim, as a “preference,” and every transfer of debtor’s assets received within four 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 Nine

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 eligiblity 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; consequently, it seems likely that many farmers who might need Chapter 12 relief in the future will not qualify for such relief 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; accordingly, 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!

Hopefully, the foregoing learned-the-hard-way lessons can be helpful to someone who might face similar circumstances in the future.


*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.

 

 

CALT does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. CALT's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.

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