Chapter 12 Bankruptcy Alternative for Family Farmers

• Publication year: 2015
• Author: Jason "Jake" Rios and Jennifer E. Niemann

Chapter 12 Bankruptcy Alternative for Family Farmers

Jason "Jake" Rios and Jennifer E. Niemann

Jake Rios is a partner at Felderstein Fitzgerald Willoughby & Pascuzzi LLP in Sacramento. Mr. Rios is a former member of the Insolvency Law Committee of the Business Law Section of the California State Bar. Mr. Rios's practice focuses on all aspects of business bankruptcy and commercial law.

Jennifer Niemann is counsel at Felderstein Fitzgerald Willoughby & Pascuzzi, LLP in Sacramento. Ms. Niemann previously served as a long-term judicial law clerk at the U.S. Bankruptcy Court for the Northern District of California. Ms. Niemann's practice focuses on all aspects of business bankruptcy and insolvency-related matters.

Introduction

California is in its fourth year of extended drought, with Governor Brown having declared a drought State of Emergency in January 2014.¹ Financial pressures from California's drought, which can arise from multiple sources, including water shortages, production changes, or increased expenses, may cause farmers to consider restructuring their debts under the Bankruptcy Code. Unique provisions of bankruptcy law allow family farmers—which can include a corporation or partnership engaged in farming—the opportunity to solve their financial problems by reorganizing under chapter 12 of the Bankruptcy Code. Less well known than chapter 11, chapter 12 may provide the financial relief farmers need to avoid foreclosure or otherwise restructure their debts, because it is "intended to be more generous to debtors than the other options under the Bankruptcy Code[.]"² In general, chapter 12 is a hybrid of chapter 11 and chapter 13 of the Bankruptcy Code, and provides a less expensive and more streamlined procedure for reorganization than under chapter 11. And, of particular significance to farmers, chapter 12 omits certain stringent chapter 11 provisions, which can make it possible for the farmer to use chapter 12 to avoid losing the farm.

This article first provides an overview of chapter 12 and then discusses the differences between chapter 12 plans of reorganization and typical plans in chapter 11 cases. Finally, the article discusses limitations on who can qualify as a "family farmer," since eligibility for chapter 12 relief is limited to "family farmers."

Overview of Chapter 12

Chapter 12 was originally enacted in 1986 "as emergency legislation in response to the agricultural debt crisis of the mid-1980s."³ The emergency legislation was enacted because farmers, especially small family farmers, found it difficult to reorganize under chapter 11 of the Bankruptcy Code.⁴ In particular, family farmers found it difficult to confirm a chapter 11 plan and meet the "absolute priority" rule, which precludes a chapter 11 debtor from retaining property under a chapter 11 plan unless the debtor's unsecured creditors accept the plan or are paid in full.⁵ Many debtors, whether because of an industry shift, a loss of key customers, rising supply prices, or other reasons, simply cannot generate enough income to pay all unsecured creditors in full and, therefore, cannot successfully emerge from bankruptcy. Fortunately for farmers, chapter 12 does not have an absolute priority rule, which means family farmers facing financial distress can reorganize their debts to obtain the relief that they need and confirm a plan of reorganization that allows them to retain their property without providing for payment in full to unsecured creditors.⁶

Chapter 12 is modeled after chapter 13 of the Bankruptcy Code, which provides a framework for qualified debtors to retain their homes while paying their disposable income to creditors over a period of time, and incorporates many facets of chapter 13 cases. Primarily, as discussed in more detail below, the chapter 12 plan process follows the chapter 13 process for court approval, which is more streamlined than the chapter 11 plan process. Importantly, creditors do not vote on the plan under chapter 12.⁷ This means chapter 12 plans are typically confirmed more quickly than chapter 11 plans, on which creditors do vote, and at less expense because there is no need for a disclosure statement and solicitation of votes from creditors. Moreover, because the creditors do not vote on chapter 12 plans, the confirmation process tends to focus on demonstrating the fairness of the plan to the bankruptcy court instead of trying to obtain the votes and support of recalcitrant creditors, who may be disgruntled by the lack of or delay in payment.

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Under both chapter 13 and chapter 12, a trustee is appointed to oversee the distribution of payments to most creditors, for which the trustee is paid a percentage of those distributions.⁸ In a typical chapter 11 case, the debtor oversees the distribution of payments under the plan.

Chapters 13 and 12 both provide an enhanced automatic stay to protect individuals who are co-debtors on consumer debts.⁹ Because the chapter 12 co-debtor stay is limited to liability on consumer debts, the chapter 12 co-debtor stay does not apply if the chapter 12 debtor is a corporation.¹⁰

Chapter 12 provides farmers with financial restructuring tools that are not found in either chapter 13 or chapter 11. For example, unlike chapter 13, chapter 12 does not require monthly plan payments, but rather permits a farmer to make annual plan payments to coincide with the timing of farming income.¹¹ Chapter 12 also allows farm-related assets that are not needed for the chapter 12 reorganization to be sold free and clear of liens without the consent of the secured creditor.¹² Such assets can be sold prior to confirmation of the chapter 12 plan without the secured creditor's consent so long as the interest of the secured creditor attaches to the sale proceeds.¹³ The circumstances under which a chapter 11 debtor can sell property without the consent of the secured creditor are much more limited.¹⁴

Thus, for farmers experiencing financial difficulties, chapter 12 provides distinct advantages that are not available to debtors in other industries.

Differences Between Chapter 11 and Chapter 12 Plans

Because a chapter 12 case generally tracks the procedures in a chapter 13 case, there are a number of differences between a chapter 12 plan of reorganization and a chapter 11 plan, some of which make the chapter 12 plan confirmation process more attractive to farmers because it can be faster and less expensive.

To start with, only the debtor can file a plan under chapter 12.¹⁵ By contrast, in a chapter 11 case, the debtor typically has the exclusive ability to file a plan for only the first 120 days.¹⁶ When that exclusivity period expires, a creditor or trustee can file a plan, which could lead to a contested confirmation hearing, further delay and expense or, even worse, confirmation of a plan that the debtor does not support.¹⁷

A chapter 12 plan usually is confirmed sooner than a chapter 11 plan for two reasons. First, a chapter 12 plan must be filed within 90 days of the bankruptcy case being filed, although that period can be extended for cause.¹⁸ Second, the confirmation hearing on a chapter 12 plan is to be held within 45 days after the chapter 12 plan is filed.¹⁹ These two requirements mean that a chapter 12 plan is typically confirmed within four and one-half months after inception of the case, much faster than the time required to confirm a plan in a typical chapter 11 case.

Creditors do not vote on a chapter 12 plan. This means there is no disclosure statement, so there is no expense or delay associated with the preparation and approval of a disclosure statement, as there would be in a chapter 11 case.²⁰

Also, there is no absolute priority rule in chapter 12.²¹ Thus, under chapter 12, a debtor can retain property under a confirmed plan without paying unsecured creditors in full.²²

Certain claims may be treated differently under chapter 12 as compared to chapter 11. For example, a chapter 12 plan can modify the rights of a secured creditor whose claim is secured only by the debtor's principal residence.²³ Such rights cannot be modified under either a chapter 11 plan or a chapter 13 plan.²⁴ Also, a secured creditor cannot elect to accept its security in full satisfaction of its claim under chapter 12, as can be done in a chapter 11 case.²⁵ Otherwise, a chapter 12 plan treats secured claims similarly to a chapter 11 plan by allowing bifurcation of undersecured claims. Bifurcation of an undersecured claim means that a claim is...