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Reviewing the U.S. Department of Agriculture’s 2016 statistics gives a completely different perspective on the state of America’s farms than many non-farmers might initially have. We see that 506,001 farms, or 24.7% of the total number of U.S. farms, produced less than $150,000 in income in 2016. That same year, small farms with owners who were generating income through another principal occupation made up 41.9% of the U.S. farm population.
Looking at these numbers, it’s easy to understand that a majority of U.S. farms are small, family-owned organizations making less than $350,000 a year. Sadly, not all these farms can make it without dealing with cash flow problems, debt issues and general financial struggles that make it difficult, if not impossible, to get ahead.
For some, going out of business is the only solution. But for others, Chapter 12 bankruptcy is a viable alternative.
How Chapter 12 works
Chapter 12 bankruptcy offers a chance for some family farmers and family fishermen to create a three-to-five year repayment plan to eliminate their debt. In the 12-month period ending Sept. 30, 2018, there were 468 Chapter 12 filings.
Ideally, according to attorney Tom Gilman of Hinkle Law Firm in Kansas, debtors will file Chapter 12 sooner rather than later once they start having financial difficulties. “Optimally, [debtors] should consider filing before the lender forecloses on the farm or equipment so we don’t have to hustle around and stop foreclosure sales or get equipment back from the lender who seized it,” he said.
One of the requirements for being eligible to file Chapter 12 is that the filer has a regular annual income from the activity. For an individual filer, such as a sole proprietor, that means more than 50% of the prior year’s gross income came from the operation. For family farmers, that requirement is adjusted to 50% of both the second and third prior tax years’ gross income.
Other eligibility requirements for individual filers include total debts not over $4,153,150 for farming operations and $1,924,550 for commercial fishing operations, as well as 50% of the farm debts being related to the farming operation (or 80% for fishing operations).
For non-individual filers, such as corporations and limited liability companies (LLCs), the requirements are that the operation be conducted by family and relatives, that more than 50% of outstanding stock or equity in the operation be owned by one family (and its relatives) and that the company’s stock not be publicly traded. Non-individual Chapter 12 filers have the same caps for debt amount and percentage of fixed debts related to the operation as outlined in the individual filer section.
Once the petition is filed, an automatic stay will stop most collection and foreclosure actions, including wage garnishments. The filer then needs to come up with a plan for repaying their debt. The order of priority for debt repayment within the plan is for priority claims (such as filing fees) and secured debt to be paid as the highest priority, and then priority unsecured debt, such as taxes or wages, to be paid before other unsecured debt. The lowest priority debt is nonpriority unsecured claims, such as professional fees and contract obligations. For family farms and fishing operations, only the first $6,325 of priority unsecured debt is considered a priority claim.
After the petition is filed, there is a meeting of creditors that allows creditors to ask questions to the filer, including about their income and repayment plan. After that, the trustee appointed to the filing and the creditors have a confirmation hearing to approve or reject the repayment plan.
What debts are forgiven or discharged under Chapter 12?
Some debts cannot be discharged under Chapter 12. Those include child support and alimony, debts created through false statements, debts due to drunken driving and debts that resulted from the willful and malicious injury of another.
Gilman said the debt forgiven through bankruptcy isn’t taxable. He also noted that there may be tax benefits to declaring Chapter 12 bankruptcy when a debtor has inherited a farm with a low cost basis since capital gains taxes — a priority unsecured debt — can be covered by paying all disposable income over five years. “[If] the bank sells through foreclosure, you will have capital gains taxes,” he said. “With Chapter 12, you can pay your disposable income for the next five years and discharge the tax.”
Another benefit to filing is that a farmer can restructure secured debt so that the balance is equal to the present value of the underlying collateral, which may be lower than its initial value.
How to file for Chapter 12 bankruptcy
The forms used for filing and the steps necessary depend on whether the family farmer or fisherman is filing as an individual or a non-individual. Filing as a non-individual should occur if the filer’s farm or fishing operation is an LLC, corporation or partnership. If the debtor is a sole proprietor, they must file an individual petition or a joint petition if the farm or fishing operation is jointly owned.
Filing for Chapter 12 as an individual
An individual or joint bankruptcy filing begins with credit counseling from an approved counseling agency. The counseling, which can take place online, in person or by phone, will discuss some of the causes behind the debt and alternatives to filing bankruptcy. This counseling must be completed within the six months before filing for Chapter 12. Once it’s complete, you will be given a certificate that needs to be provided to the courts.
The next step is to find out the court in which you need to file based on your district, as well as the court-specific forms and processes you need to follow.
The final pre-filing step is to review Form B2010, which reviews the qualifications of each type of bankruptcy and discloses the filing and administrative fees, which for Chapter 12 total $275.
When filing as an individual, you will mostly use forms from the 100 series. The process begins with the official voluntary filing on Form 101. Next is the Social Security statement, Form 121. For those who want to pay the filing fee in installments, Form 103A should be completed. Next, the filer must compile a list of the names and addresses of their creditors, following the formatting instructions supplied by their court. If the filer has an eviction judgment against them, Form 101A should be included, or Form 101B if there has been payment of an eviction judgment against them. Finally, filers should include a copy of their credit counseling completion certificate and the preparer’s notice (Form 119), as well as the disclosure of the petition preparer’s compensation on Form 2800.
At the time the individual (or married couple) is filing, or at least within 14 days of filing, they must complete the schedule of assets and liabilities that begins on Form 106 and goes through Form 106J, including forms 106Sum and 106Dec. The last few forms are a statement of financial affairs (Form 107) and disclosure of attorney compensation (Form 2030). If the credit counseling certificate wasn’t included in the initial filing forms, it must be included with the above forms, as should a copy of all pay stubs and other income receipts received within the 60 days before filing.
Filing for Chapter 12 as a non-individual
Farms and fishing operations filing for Chapter 12 as non-individuals have a different set of forms to complete. For them, it’s the 200 series forms, starting with the voluntary petition Form 201. Next, the filer should determine in which court they need to file and how that court wants the list of creditors formatted.
Within 14 days of submitting the voluntary petition and list of creditors, a non-individual filer needs to complete the schedule of assets and liabilities, a series of forms that begins with Form 206 and goes through Form 206H. Next is the summary of assets and liabilities on Form 206Sum and the perjury declaration on Form 202-Declaration. The final two official forms required are Form 207, the statement of financial affairs, and Form 2030, the disclosure of attorney compensation — although, in some districts, this form may not be required.
The filing and administration fees for filing for Chapter 12 as a non-individual total $275.
One of the goals of filing for Chapter 12 as an individual or non-individual is to create a repayment plan for your debt. This is something you can prepare based on the formatting requirements of your local court. The plan must be submitted within 90 days of filing either as an individual or non-individual.
Within the instructions for filing for Chapter 12 as an individual, there is a note that reminds filers of the difficulty in successfully filing without an attorney. For non-individuals, an attorney is required.
Pros and cons of declaring Chapter 12 bankruptcy
Can give a family farm/fisherman the time and space needed to pay off debts over time as income and cash flow improve
Might be expensive depending on how the farm is organized and the attorney fees
Often reduces the cost of the debt paid
Weather, pests and other factors can impact the organization’s earnings and ability to stick to the repayment plan
Can reduce debt obligations to the current value of the underlying collateral
May not be a viable option if the filer has no realistic expectation to make a reorganization plan work
Triggers an automatic stay on most foreclosure and collection activities
Can limit capital gains tax obligations
Alternatives to Chapter 12
Chapter 12 isn’t the perfect fit for every family farm and fishing operation — and many might not qualify due to the eligibility requirements.
“Bankruptcy should be the last choice,” Gilman said. “If we can work out a favorable agreement with creditors and avoid bankruptcy, take that first.”
If you want to avoid filing for Chapter 12 or you don’t qualify, consider one of these alternatives:
- Debt management plan: Allows a debtor to get credit counseling to better understand how they can manage their debt.
- DIY debt consolidation: Uses a home equity loan or other means to pay off debt and end up with a single payment, possibly stretched out over a longer term. You can explore personal loan options for debt consolidation from lenders using LendingTree’s personal loan tool. (LendingTree owns MagnifyMoney.)
- Negotiating with lenders: Some lenders may be amenable to reducing debt without a Chapter 12 repayment plan.
- Working with a debt settlement company: Uses a for-profit company to settle or reduce debt.