10th Circuit Finds Debt "Arises out of Farming Operation" Only if "Direct Use" Test Satisfied

February 19, 2014 | Roger A. McEowen

In re Woods, No. 12-1111, 2014 U.S. App. LEXIS 2960 (10th Cir. Feb. 19, 2014), rev'g. bankruptcy court opinion and B.A.P. opinion reported at 65 B.R. 196 (B.A.P. 10th Cir. 2012)

(Chapter 12 case; debtors (married couple) farmed hay and raised horses since 1999; debtors purchased land securing bank’s claim in 2007 and decided to build home on tract in 2008; home construction loan executed in 2008 and bank approved debtors for 30-year adjustable rate permanent loan; home completed in 2009 and parties engaged in dispute over bank’s commitment to permanent financing ultimately resulting in foreclosure of construction mortgage and pending sale of home which precipitated debtors’ Chapter 12 filing; debtors’ office and farm headquarters located in newly constructed home; issue was whether debtors qualified for Chapter 12; if bank’s principal and interest claim included in debtors’ farm debts, 50 percent test satisfied; court determined that construction portion of bank loan included in debtor’s “farm” debt because house was integral part of farm operation due to farm’s books and records maintained in office in home and home’s proximity to farming operation which allowed debtors to care for livestock and maintain irrigation system; debtors’ treatment of bank’s claim also satisfies 11 U.S.C. §1225(a)(5) – U.S. Supreme Court decision in Till v. SCS Credit Corp., 541 U.S. 465 (2004), overrules In re Hardzog, 901 F.2d 858 (10th Cir. 1990) and formula approach to determining cramdown interest rate applicable to Chapter 12 reorganization plan to be utilized rather than market rate for similar loan approach of Hardzog; interest rate is prime rate plus 2 percent; amended Chapter 12 plan feasible and confirmable; on further review by 10th Circuit, court reversed on issue of whether principal residence debt arises out of a farming operation; 10th Circuit held that debt "arises out of farming operation" under 11 U.S.C. Sec. 101(18)(A) if it is directly and substantially connected to any of the activities constituting a farming operation as defined by 11 U.S.C. Sec. 101(21); when loan debt is involved, objective "direct use" test to be used in determining when "direct-and-substantial-connection standard is satisfied" - loan proceeds must be used directly for or in farming operation for debt to "arise out of" farming operation; bankruptcy court used incorrect standard and is reversed).