When a farm operator, or any other business person, is unable to continue to service all of his or her indebtedness, he or she may face substantial pressure from creditors. This pressure may eventually take the form of legal action. One way a farmer can respond to pressure from creditors is to seek protection under the Bankruptcy Code. Farmers should understand bankruptcy procedures, their rights, and the rights of their creditors during bankruptcy. Bankruptcy should always be considered a last resort.

Voluntary Workouts
Many farmers prefer to negotiate an arrangement with creditors to restructure their debts or to repay them on terms different from what is specified in their various loan agreements. This type of informal workout may permit a farmer to continue operating the farm while ensuring that creditors are paid. Such agreements are common in situations in which the debtor's financial distress is temporary.

A workout may involve reamortizing existing indebtedness over a longer period of time; temporary arrangements to defer payment of principal; or reduction of the interest rate charged by a creditor. In addition, such arrangements may require the borrower to provide a lender additional collateral to secure the loan or otherwise provide the lender with additional credit enhancements.

Workout arrangements rarely resolve a current financial situation in a manner that is satisfactory to all parties. For one thing, such arrangements are voluntary. All creditors must agree to participate; the farm debtor can do nothing to force participation. If only some creditors cooperate with the borrower, the ultimate success of the workout arrangement is limited. There is no court supervision of such arrangements, and there is no discharge of indebtedness. Unless the debtor can get releases from creditors as part of a workout arrangement, creditors can attempt to collect any unsatisfied portion of their claims at a later time.

Bankruptcy Alternatives
If some type of workout cannot be negotiated, bankruptcy may be the only alternative. Although bankruptcy usually is viewed as "throwing in the towel," the Bankruptcy Code actually offers some choices. Under the Bankruptcy Reform Act of 1978, there are three types of bankruptcy protection available, two of which involve rearranging the debtor's financial affairs to allow continued operation of the business. This fact sheet examines the general features of bankruptcy. Separate fact sheets describe in detail the operation and effects of the various options.

Chapter 7 Bankruptcy
Under Chapter 7 proceedings, the debtor's property is collected by a trustee and distributed to creditors according to priorities established in the Bankruptcy Code. Chapter 7 bankruptcy is a liquidation or straight bankruptcy. Chapter 7 bankruptcy proceedings are described in detail in the fact sheet, Bankruptcy: Chapter 7 Liquidations.

Chapter 11 Bankruptcy
Under Chapter 11, a farmer can attempt to reorganize business operations as an alternative to liquidation. Farm operation may continue and a plan under which all or part of the farming operation continues and business debts are repaid may be proposed. Chapter 11 bankruptcy proceedings are described in detail in the fact sheet, Bankruptcy: Chapter 11 Reorganizations.

Chapter 12 Bankruptcy
Chapter 12 bankruptcy is a streamlined reorganization alternative for farmers. It allows for adjustment of the debts of a family farmer with regular annual income. Chapter 12 proceedings are discussed in detail in the fact sheet Bankruptcy: Chapter 12 Reorganizations.

Special Treatment of Farmers
In general, a debtor's creditors may petition to have him or her put into bankruptcy. If the debtor has 12 or more creditors, at least three creditors must join in the petition. Such involuntary proceedings are available only for Chapter 7 liquidations and Chapter 11 reorganizations. Involuntary proceedings may not be initiated under Chapter 12. Because of the uncertainties involved in farming operations, farmers are exempt from such involuntary bankruptcy. Farmers also are exempt from the involuntary conversion of a Chapter 11 case to a Chapter 7 case or from a Chapter 12 case to a Chapter 7 or a Chapter 11.

A creditor may propose a liquidation plan with the same results as a Chapter 7 liquidation if a farmer undertakes a voluntary bankruptcy proceeding under Chapter 11 and then proves unable or unwilling to file a plan of reorganization.

For purposes of the Bankruptcy Code, a farmer is defined as a person who, during the tax year immediately preceding the year in which the bankruptcy petition was filed, received more than 80 percent of gross income from a farming operation. A farming operation is defined broadly under the Bankruptcy Code. It is not necessary for the debtor to be involved in farming at the time a bankruptcy petition is filed. It is only necessary that the income test, based on the preceding year's income and established by the Bankruptcy Code, be met. It has been held that an individual who has sold his or her farm and is not currently involved in farming is, nonetheless, a farmer under the Bankruptcy Code. Unfortunately, not all individuals who consider themselves farmers are entitled to this protection. A farmer who depends on off-farm income will not be considered a farmer if more than 20 percent of gross income comes from such off-farm activities.

A family farmer under the Bankruptcy Code is an individual (and spouse, if a joint petition is filed) engaged in farming operations with (1) total debts not exceeding $1.5 million; (2) not less than 80 percent of debts arising out of a farming operation and (3) more than 50 percent of gross income coming from a farming operation during the tax year immediately preceding the year in which the bankruptcy petition was filed. Only family farmers are eligible for Chapter 12.

Automatic Stay
Several provisions of the Bankruptcy Code operate to protect the debtor and to provide some breathing space. The initiation of any Chapter 7, 11, or 12 case operates as a court order to halt, at least temporarily, a wide range of conduct for collecting a claim or debt against the debtor. In other words, the filing of any bankruptcy petition stops all collection efforts, all harassment, and all foreclosure actions. This automatic stay is one of the fundamental debtor protections provided by our bankruptcy laws. It permits the debtor to attempt a repayment or reorganization plan in the case of a Chapter 11 or Chapter 12, and it relieves the debtor of the financial pressures that drove him or her to bankruptcy. The automatic stay is broad in scope and is intended to prohibit creditors from taking action against the debtor that disorganizes efforts to deal with financial problems or that interferes with attempts to reorganize business operations.

Although provisions of the automatic stay law are broad, they are not absolute. The automatic stay does not suspend the clock. For example, the automatic stay does not stop the running of a redemption period following a mortgage foreclosure sale or the running of the time period under Minnesota law to reinstate a contract for deed. In addition, creditors may seek court approval to obtain relief from the stay in certain cases. So the automatic stay is by no means permanent. Creditors may, in some instances, be able to obtain court approval to continue or initiate collection proceedings against the debtor.

Property of the Estate
When a case under the Bankruptcy Code is begun, an estate is created. The bankruptcy estate consists of all of the debtor's legal or equitable interests in property as of the filing date. Thus, all real property, crops, livestock, machinery and equipment, interests in cooperatives, farm program entitlements, contract rights, and leases are included in the bankruptcy estate. Besides property owned when the case is initiated, the property of the estate includes property recovered by the trustee from creditors or other third parties and property that the debtor becomes entitled to acquire within 180 days of the filing of the bankruptcy petition by inheritance, divorce decree, property settlement, life insurance policy, or death benefit plan. Finally, the estate also includes income from other assets that are the property of the estate. Significantly, however, a debtor's earnings from services performed after the filing but before the termination of the case are not included in the estate. (This is not the case when a Chapter 12 petition has been filed.) Thus, in a Chapter 7 or Chapter 11 case, income from a debtor's off-farm employment may not be looked to by creditors once the bankruptcy petition has been filed.

Discharge of Debts
One of the most important features of bankruptcy, regardless of which alternative is chosen, is the opportunity for discharging debts. In general, debts that arose prior to the filing of the bankruptcy petition are dischargeable in bankruptcy. But not all debtors are entitled to a discharge and not all debts are dischargeable. As a general rule, only individuals are entitled to a discharge. Partnerships and corporations may not obtain a discharge in bankruptcy.

Under the Bankruptcy Code, certain debts are not dischargeable. Obligations such as alimony, child support, claims based upon fraud, student loans obtained through a government program, certain taxes, and fines or penalties are not eligible for discharge. Creditors must object to the dischargeability of a particular debt within a time period established by the bankruptcy rules. If they fail to do so, all of the debtor's debts eligible for discharge will be discharged upon termination of the bankruptcy case. In addition, conduct of the debtor prior to the filing of the bankruptcy petition may prohibit the discharge of all debts. If, for example, a debtor engaged in fraudulent transactions; concealed, destroyed, or falsified records; or failed to explain the loss of property, his debts might not be discharged. A creditor or trustee may challenge the debtor's entitlement to a discharge on such grounds.

A discharge cannot be obtained if the debtor received a discharge under a Chapter 7 or Chapter 11 case initiated within six years before the filing of the petition in the current bankruptcy case. An earlier discharge under Chapter 12 does not bar a discharge under Chapter 7 within six years if the debtor paid all the unsecured claims in the earlier case or if the debtor paid 70 percent of the unsecured claims and if the plan was proposed in good faith and was the debtor's best effort.

Conclusion
Filing any bankruptcy petition should be undertaken only after carefully reviewing all the other options available with an attorney. If bankruptcy is the only course of action available, consider your options carefully. Regardless of which type of bankruptcy protection is sought, debtors will receive the protection of the automatic stay and generally will be eligible for the discharge of many obligations. Bankruptcy will thus enable a fresh start or relief of many financial burdens.

To order other publications in this series, contact the University of Minnesota Extension Service Distribution Center, 20 Coffey Hall, 1420 Eckles Avenue, St. Paul, MN 55108-6069, e-mail: order@extension.umn.edu or credit card orders at 800-876-8636 or (612) 624-4900 (local calls).

• Security Interests in Personal Property (FO-7292).
• Mortgages and Contracts for Deed (FO-7293).
• Termination of Contracts for Deed (FS-7294).
• Bankruptcy: Chapter 7 Liquidations (FO-7295).
• Bankruptcy: Chapter 11 Reorganizations (FS-7296).
• Mortgage Foreclosures (FO-7297).
• Termination of Security Interests in Personal Property (FO-7298).
• Rights of Unsecured Creditors (FO-7299).
• Tax Considerations in Liquidations and Reorganizations (FO-7300).
• Bankruptcy: Chapter 12 Reorganizations (FO-7301).
• Agricultural Production Contracts (FO-7302).
• Financing the Farm Operation (FS-2589).
• Contracts, Notes and Guaranties (FS-2590).
• Farm Leases (FS-2593).
• Bankruptcy: The Last Resort (FO-2598).

The fifteen publications are also available as a package: Farm Legal Series (PC-7291).

This publication is designed to provide accurate information in regard to the subject matter covered. It is published with the understanding that the authors and the University of Minnesota are not engaged in rendering legal, accounting or other professional services. If legal advice or other professional assistance is required, the services of a competent professional should be sought.

Produced by Communication and Educational Technology Services, University of Minnesota Extension Service.

In accordance with the Americans with Disabilities Act, this material is available in alternative formats upon request.  Please contact the University of Minnesota Extension Service Distribution Center at (800) 876-8636.

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