Bankruptcy: Chapter 12 Reorganization
Phillip L. Kunkel, Attorney
Scott T. Larison, Attorney
Hall & Byers, P.A.
St. Cloud, MN
Copyright © 1998 Regents of the University of Minnesota. All rights reserved.
Chapter 12 was added to the Bankruptcy Code in 1986. It is designed specifically for the reorganization of family farms. It is closely modeled after Chapter 13, that chapter of the Bankruptcy Code designed for wage earners, although it has a higher debt ceiling, and therefore applies to many more farm operations.
A farm corporation or partnership will be eligible to file a Chapter 12 case if it meets four specific conditions. First, at least 50 percent of the stock or equity of the corporation or partnership must be held by one family, with that family conducting the farming operation. Second, more than 80 percent of the value the corporation or partnership's assets must be related to the farming operation. Third, the aggregate debts must not exceed $1,500,000 with not less than 80 percent of that arising from its farming operation. Finally, if corporate stock exists, that stock must not be publicly traded.
Since its enactment, there has been a substantial amount of litigation concerning whether a person is eligible for Chapter 12. Generally, the debtor must be actively involved in farming operations in order to be eligible. If merely renting out the farmland for cash rent, the debtor will not likely be found to be engaged in farming.
Initiating a Chapter 12 Bankruptcy
Within 90 days after filing the bankruptcy petition, the debtor must present a plan for repayment of debts to the Bankruptcy Court. A confirmation hearing to consider the plan will be scheduled soon after the filing of the plan. Chapter 12 specifically provides that, except for cause, confirmation hearings must conclude within 45 days after the filing of the plan.
Chapter 12 lists ways in which the debtor can satisfy this adequate protection requirement. Making cash payments or granting a secured creditor a replacement lien are two such ways. For real estate, the statute specifically provides that "reasonable rent customary in the community" is sufficient. The issue of whether a crop share arrangement would be acceptable in lieu of cash rent is not addressed. However, if this type of lease is customary, such an arrangement should be satisfactory.
Down-Scaling the Farm Operation
Appointment of Trustee
Although the farmer remains in control of the property, the trustee maintains important functions. Under Chapter 12 he or she is directed to:
The Chapter 12 trustee is paid by the debtor. In addition to the plan payments, the debtor must pay 10 percent of all such payments to the trustee. This payment must be made at the time of the plan payment. After payments under the plan have totaled $450,000, the trustee payment is reduced to three percent of the plan payment.
Requirements for the Chapter 12 Plan
Beyond these powers, however, there are specific requirements which govern the acceptability of a Chapter 12 plan. Consistent with other chapters in the Bankruptcy Code, unsecured debts and secured debts are treated differently.
With regard to unsecured debts, two alternatives are available. Either the plan must provide for total repayment of the unsecured debt, or the debtor must agree to contribute all of his disposable income to the payment of these debts. Such repayment can be extended over a three year period; however, if cause for a longer repayment period is shown, the court may extend the term of the plan for up to five years.
If the plan does not provide for full repayment of unsecured claims, the debtor must agree to contribute his or her entire disposable income to the payment of this debt during the term of the plan. However, the statute specifically defines "disposable income," to include only that income which remains after all farm and living expenses have been paid. Again, the term of the plan must run three years or less, unless the court approves an extension. In no event may a plan run longer than five years. Under either alternative, the plan must offer unsecured creditors at least as much as they would receive through a Chapter 7 liquidation.
With regard to secured debts, there are also options. For the debtor's plan to be confirmed, the secured creditors must either approve the plan and retain the lien securing the claim while payments are made, or receive the collateral. If the debtors' plan provides for the repayment of a secured debt, the creditor's security interest remains intact during the repayment period. The amount of the debt will generally be reduced to the present value of the secured property. Thus, in certain situations it may be possible for the debtor to cash out the secured creditor by obtaining financing equal to the appraised value of the collateral. In this case, valuation may well be a disputed issue.
Instead of cashing out the creditor, the debtor's plan may provide for a repayment schedule which extends beyond the terms of the original secured debt. The plan itself is limited to five years, but there is an exception for specific long-term debt. Long-term debt may be paid over a period exceeding five years.
Under any such repayment plan, whether the term of the original debt is extended or not, the creditor's claim is reduced to the value of that collateral. However, the creditor must receive the present value of the collateral. The creditor is generally entitled to interest at a market rate based upon this value for the duration of the repayment plan. During the entire repayment term, secured creditors retain their security interest in the collateral.
Conversion and Dismissal
Discharge of Debts
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