Chapter 12 Bankruptcy is a farm business restructuring strategy specifically designed for small and medium-sized family farms. It has provisions that, in the right circumstances, can allow the farm business to remain viable and return to solvency.
The word bankruptcy has extremely unpleasant connotations and among farmers it has an associated stigma that would be difficult to bear. Unfortunately, it is highly likely some Virginia dairy farms will be facing dire financial circumstances in the coming months due to an unprecedented disparity between cost of production and prices paid for milk through most of 2009. Chapter 12 bankruptcy is different; it is specifically for those farm families that are willing to keep fighting to keep their business viable despite financial hardship.
Eligibility for Chapter 12 bankruptcy depends on the business structure of the farm and the level debt. If the farm is a partnership, LLC, or corporation then more than 50% of the stock or equity must be held by a single family or their relatives. Eighty percent of the business entity's value must be related to the farming operation. For individuals and married couples, at least 50% of the debt must be from the farming operation, and more than 50% of the previous year's income must be from the farming operation. For both individuals and business entities, the total farm debt cannot exceed $3,544,525.
Farms that have started other bankruptcy-related proceedings need to consult their attorney to insure their eligibility for Chapter 12 status.
The process of Chapter 12 looks something like this (Moore, 2009, Ohio State University):
There are a number of advantages to Chapter 12 bankruptcy and one of them is the reduction of debt to match the current market value of assets. For example, if a dairy has outstanding debt of $500,000 originally secured by the value of cattle and land and these assets now have a market value of $350,000, then the secured debt obligation may be reduced to this amount. Filing for Chapter 12 bankruptcy also usually halts all collection actions against the farm by creditors. Lawsuits cannot be pursued against the farm while in Chapter 12 and wage (i.e. milk check) garnishments are discontinued. Creditors must make any claims through the bankruptcy proceedings. Furthermore, thanks to changes in Chapter 12 rules enacted by Congress in 2005, federal tax obligations are treated as unsecured debt. In other forms of bankruptcy, federal taxes must be paid but under Chapter 12 bankruptcy the Federal Government has to “get-in-line” with other unsecured creditors such as feed dealers and veterinarians.
Obligations and consequences of Chapter 12 bankruptcy are serious. Within 90 days of filing Chapter 12, the farm must submit a reorganization plan that addresses how secured debt will be paid. The farm must present a detailed financial plan with realistic projected budgets and cash flows that address how the farm will reach solvency in 3 to 5 years. A farm that fails to reach solvency in the specified time frame will very likely to be forced by the court into Chapter 7 (liquidation) bankruptcy. And of course, filing for bankruptcy of any sort has implications for the ability of the farm and individuals associated with the farm to access credit in the future.
This article is a very brief outline of Chapter 12 bankruptcy. Anyone considering this course of action should consult with a qualified attorney and tax professional. In preparing this article, the author interviewed a tax attorney who offered that there are very few attorneys in Virginia qualified to handle Chapter 12 bankruptcy. A farm family should select their attorney very carefully. The attorney needs to have experience working with commercial-scale farms on business entity and tax issues.
Two publications were important sources of information for this article. “Chapter 12 Bankruptcy: Hope for financially stressed family farms” by Robert Moore is available through the Ohio State University website at http://dairy.osu.edu/ under 'timely articles.' “Bankruptcy: Chapter 12 Reorganization” by Kunkel, Peterson, and Mitchell is available from the University of Minnesota at http://www.extension.umn.edu/topics.html?topic=4&subtopic=32.
Virginia Cooperative Extension materials are available for public use, re-print, or citation without further permission, provided the use includes credit to the author and to Virginia Cooperative Extension, Virginia Tech, and Virginia State University.
Issued in furtherance of Cooperative Extension work, Virginia Polytechnic Institute and State University, Virginia State University, and the U.S. Department of Agriculture cooperating. Alan L. Grant, Dean, College of Agriculture and Life Sciences; Edwin J. Jones, Director, Virginia Cooperative Extension, Virginia Tech, Blacksburg; Jewel E. Hairston, Administrator, 1890 Extension Program, Virginia State, Petersburg.
October 7, 2009