Rough Economic Times Elevate Bankruptcy Legal Issues

April 3, 2015 | Roger A. McEowen

As the general economy continues to struggle, the farm economy will have another tough year.  Crop prices have declined significantly from where they were a couple of years ago, and financial stress among producers is increasing.  In the general economy, the March 2015 jobs report tells an awful tale – a record 93.175 million Americans 16 years old and older are not working, the January and February jobs numbers were dramatically revised downward, and the Federal Reserve has cut its growth forecast to zero.  The labor force participation rate is at its lowest since 1978. 

In agriculture, the scene is reminiscent of the 1980s. But, there are some differences. In the 1980s, many farmers expanded too rapidly by virtue of purchasing farmland with little down. That has changed.  Many lenders now require significantly greater down payments. That should, at least, lead to safer loans.  Also, interest rates are much lower than in the 1980s.   But, barring a significant weather problem this year, Midwest and Great Plains producers are staring at another year of low crop prices and lower farm incomes. The downturn in the ag economy is broad-based and many segments are already feeling the pinch (cash rents, seed sales, machinery dealers, etc.). In certain respects, the agricultural economy is enduring a rebalancing of the ag portfolio. Crops dominated the last few years. Livestock is now catching back up as crop returns retreat. The transition can be painful as some crop farmers are pushed out of the industry.

We are seeing an increase in questions revolving around financial distress – landlord liens, bankruptcy tax issues and filing requirements, secured transaction default rules, and priority issues.  One big problem seems to be tenant farmers that expanded by utilizing, among other things, long-term leases at high rental rates.    
In many of the situations that we have become aware of, the farmer would be too big to file a Chapter 12 bankruptcy. Currently, the maximum debt limit for Chapter 12 filers is $4,031,575. The “family farmer” of 1986, when the debt limit was $1,500,000, does not resemble the family farmer of 2015. Chapter 12 is becoming less of an option due to the size of family farms. That means that large creditors with under-secured claims are again able to control the direction of a family farmer’s Chapter 11 bankruptcy much like they did before Chapter 12 was enacted. While an option for a family farmer is to downsize in the tax year before filing the Chapter 12 to a size where the debt owed does not exceed $4,031,575. That allows a Chapter 12 petition to be filed. In addition, because the liquidation (downsizing) occurred in the tax year before filing, 11 U.S.C. §1222(a)(2)(A) can be utilized to deprioritize the taxes making the tax on the gain on the sale of agricultural assets used in the debtor’s farming operation an unsecured, dischargeable debt.  

In all of this, we have resources that can help.  We recently posted a technical article to TaxPlace on the “qualified farm indebtedness” rule, a tax provision that can help farmers that are in financial trouble but aren’t in bankruptcy and aren’t insolvent.  Next week, I will make a presentation to bankruptcy practitioners in KS on behalf of the Kansas Bar Association.  We are sure to address more financial distress-related issues at the tax schools this fall.

A long time ago, a sage made a profound statement when he said he had learned to be content in all things.  That’s good advice that also goes a long way to helping people stay out of financial trouble, no matter what type of business is involved.