Chapter 12 Bankruptcy, [section] 1232 v [section] 553: Setoff as an Effective Veto?

• Author: Pals, Schuyler
• Position: Bankruptcy Code of 1978

1. INTRODUCTION 508 II. BACKGROUND 509 A. Trends in the Agriculture Industry: Early 20th Century 510 to Early 21st Century B. Who is a Small Family Farmer 512 C. Chapter 12 Bankruptcy, What is it Good For? 513 D. The Development of Chapter 12 Bankruptcy 515 E. The Setoff 516 F. In re Devries 518 III. ANALYSIS 518 A. Was the Appellate Court Correct in Overturning In 518 Re DeVries? B. Setoff as an Effective Veto? 520 IV. RECOMMENDATION 523 A. Three Possible Remedies 523 1. Pass Legislation 523 2. Rely on Legal Counsel 524 3. Equitable Considerations to Deny Setoff 525 V. conclusion 526 I. INTRODUCTION

   "You have acres and acres of arable land: fields and orchards, mountains and dells, rivers and springs. But what comes after this? Is not all that awaits you a six-foot plot of earth? " (1) From Thomas Jefferson's yeoman farmer, (2) to our current image of a modestly prosperous family working the land, (3) the independent farmer has long held a significant role in the American psyche (4)--and for good reasons. Studies have shown that small farmers are better on the environment than big agribusiness operations and are a cornerstone to the economic and social well-being of rural communities. (5) However, since the beginning of the twentieth century, the small family farm has been in decline. (6) This is in part because of increased use of technology, a development that decreases the amount of labor input needed to produce food, (7) and the increased number of mid to large sized farming enterprises controlling the industry. (8) In tandem with this long-term transition, the farming industry has gone through periodic crises, usually resulting in the loss of farmers and further consolidation of the industry. In response, Congress created Chapter 12 bankruptcy (9) as a temporary provision in 1986 to mitigate the worst family farm crisis in the twentieth century. (10)

   Since 1986, Chapter 12 bankruptcy has struggled over tax issues. Often a farmer's Chapter 12 plan will require selling farm equipment and land. Naturally this creates capital gain taxes, which until 2017 were not subject to discharge. Farmers were unable to follow their plans and pay the capital gains taxes that arose under the plans. This gave the government an effective veto over otherwise viable plans to help farmers reorganize. (11) In an attempt to clarify how these taxes are to be treated and to get rid of this veto power in a Chapter 12 bankruptcy plan, Congress passed the Family Farmer Clarification Act of 2017. This act makes any claims held by the government falling under section 1232 (12) pre-petition nonpriority unsecured claims subject to discharge.

   A recent district court case in the Eighth Circuit utilized the legislative history of the Family Farmer Clarification Act of 2017 to argue that the IRS's and Iowa Department of Revenue's (IDR) use of their right to setoff (section 553) (13) acted as an effective veto. The court gave an expansive reading to the effects of section 1232, holding that it conflicted with section 553 and that section 1232 controlled. This decision was reversed on appeal, but the appellate court did not address if this use of setoff acted as an effective veto for otherwise viable bankruptcy plans.

   This Note will address whether these sections should be read in conflict with one another and if the right to setoff acts as a veto power in this context. If an effective veto power exists, then small farmers may face a new barrier to successfully filing for Chapter 12 bankruptcy and saving their farms. This Note will start by providing background on the farming industry, Chapter 12 bankruptcy, and the court decision before delving into whether the right to setoff in this context acts as an effective veto.

2. BACKGROUND

   Most urban shoppers would tell you that food is produced on farms. But most of them do not know what farms, or what kinds of farms, or where the farms are, or what knowledge of skills are involved in farming. They apparently have little doubt that farms will continue to produce, but they do not know how or over what obstacles. For them, then, food is pretty much an abstract idea--something they do not know or imagine--until it appears on the grocery shelf or on the table. (14) A. Trends in the Agriculture Industry: Early 20th Century to Early 21st Century.

   While there has been much recent coverage about the family farm crisis in the United States, the problem has been occurring for decades. There has long been a trend in people leaving the family farm, seeking a new life in the city throughout U.S. history, but the most rapid migration came after World War II. (15) Between 1940 and 1980, the population on farms decreased tenfold. According to agricultural historian Paul Conkin, the total value of farm output increased forty percent between 1950 and 1970. (16) This led to over-production and chronically low prices. (17) Prices began to rebound in the 1970s when stockpiles of grain were drawn down (18) under a secret "Russian grain deal" made by the United States to sell wheat to the U.S.S.R. (19) when poor weather resulted in diminished crops overseas. (20) This led the Secretary of Agriculture, Earl Butz, to conclude that exports could solve America's farm production surplus problem. (21) In response to higher prices, the U.S. Government instituted production loans and new forms of income compensation that heavily favored larger producers and encouraged farmers to lease land, buy out smaller farmers, and remove conservation methods to increase farmable land. (22)

   Robust agriculture production figures led to optimistic lending secured on increasing land prices. (23) Of course, good times cannot last forever, and crop prices began to turn in the late 1970s. (24) This occurred in part because President Carter stopped supplying agriculture products to the U.S.S.R. in response to their 1979 invasion of Afghanistan. (25) To make matters worse, in October 1979, the federal reserve increased interest rates to fight inflation. (26) Interest rates soared into double digits, hitting a record high twenty-one percent in 1981. (27) Still lenders remained over-secured because of land prices, so they continued to extend credit to farmers when they lacked positive cash flows. (28) Eventually, this land price boom busted, and farmers saw their net worth plummet by more than half. (29) The farm crisis was so severe that the farmer insolvency rate was higher than during the Great Depression. (30) Amid the response to this crisis, Congress created Chapter 12 in 1986. The aim was to help the family farmers who could successfully reorganize get relief from heavy debt burdens while paying creditors what was reasonable under the difficult economic circumstances of the day. (31)

   Chapter 12 bankruptcy was an important stop-gap for ailing family farmers amid the farm crisis. However, it did not stop the general consolidation of the farming industry in the United States. (32) In 1935, the number of farms in the United States reached an all-time high, at 6.8 million. (33) By 1990, that number had dwindled to 2.1 million. (34)

   To help farmers, Congress passed the Agriculture Improvement and Reform Act, or the "Freedom to Farm Bill," in 1996, which sought to deregulate the industry. (35) Congress hoped that a deregulated market would find opportunities in exports, and thus help farmers. (36) This export boom, however, failed to materialize. (37) Instead, Congress had to triple the amount they were paying in subsidies to farmers when prices fell below production costs. (38)

   Good times did eventually come in the 2000s. In 2006, a commodity boom began. Land prices and commodity prices went up once again, encouraging some farmers to borrow heavily. (39) However, by 2013 prices for staple farm products like corn, soybeans, milk, and meat started to fall. (40) Bankruptcies were again surging as this fall in prices corresponded with a host of other negative indicators: net farm income fell 50% since 2013; (41) farm debt jumped by a third since 2007; (42) bad weather prevented farmers from planting twenty million acres in 2019; (43) and soybean exports to China fell 75% in 20172018 because of the ongoing trade war. (44) "[D]elinquency rates for commercial agricultural loans in both the real estate and non-real estate lending sectors are at a six-year high." (45) There has been a surge in Chapter 12 bankruptcy filings, but it is not near the levels of the 1980's family farm crisis. (46) This is in part because land prices are still high. (47)

   2. Who is a Small Family Farmer

      As the preceding paragraphs indicated, the decline of the small family farm and the rise of agribusiness in the agriculture sector has been the trend over the twentieth century. This trend radically changed how farming is conducted while simultaneously warping the landscape of the United States, and its rural communities. The transition of the agriculture sector from small enterprises to large businesses can be seen in the sharp decline of "the number of farms and in farm population, the increased acreage of farms and real estate capitalization, and the replacement of the family with hired labor." (48) This transition is due in part to limited liability entities in agribusiness have less risk exposure, tax advantages, and easier access to investment. (49) This squeezes out the small family farms and increasingly makes the agricultural sector a layered cake arrangement of management and control (50) that has been compared to feudalism. (51)

      Differentiating between our idealized small family farm and corporate agribusiness is not as easy as it seems. Some small family farms are partnerships or corporations run by one family. What differentiates a small farm operation compared to a large agribusiness operation largely comes down to gross annual sales. To further complicate this, what qualifies as small varies amongst the geographic locations and production sectors. (52)...