A New and Permanet Chapter 12 Bankruptcy Law Becomes Effective

Since its inception in 1986, Chapter 12 – the federal bankruptcy law pertaining to farm bankruptcies – has been a temporary section of the U.S. Bankruptcy Code. The original law contained a sunset provision that automatically repealed Chapter 12 on October 1, 1993 unless Congress allowed for an extension. However, because Chapter 12 extension was tied to the larger and more controversial issue of overall bankruptcy reform, it has often lapsed while Congress wrangled over revision of the bankruptcy code. Temporary extensions of Chapter 12 eventually passed Congress several times, but often after long gaps during which Chapter 12 was not available to farmers.

Chapter 12’s turbulent history finally changed with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. The new law made Chapter 12 a permanent part of the Bankruptcy Code as of July 1, 2005.

Generally, Chapter 12 gives family farmers in financial distress a chance to reorganize debts while keeping the farm operation. The debtor must have a “plan” approved by the Bankruptcy Court that lists all debts and proposes an equitable payment schedule that proportions payments based upon a debt’s “priority”, i.e., the type of debt and whether and when the debt was secured. Upon successful completion of the payments approved under a Chapter 12 plan, the debtor will receive a “discharge” that extinguishes the debtor’s obligation to pay further on debts included in the plan, even those debts that were not paid in full.

In addition to making Chapter 12 permanently available to farmers, the recent legislation made other changes to Chapter 12. With a few exceptions, most of those revisions will become effective in October of 2005. Changes to the general bankruptcy code might also impact Chapter 12 filings. The following is a brief summary of the major provisions of the new law that will affect farm bankruptcies:

• Expanded eligibility for Chapter 12. New eligibility requirements will make Chapter 12 applicable to more farm bankruptcy situations. The old debt maximum for Chapter 12 filings has been increased from $1.5 million to $3.237 million and will be tied to the Consumer Price Index. The allowance for total debt attributable to the farm operation has been lowered from 80% to 50%, and the look back for the 50% income from farming requirement has been extended beyond the first year to the second and third year preceding the bankruptcy filing. The new law also makes a “family fisherman” eligible for Chapter 12, but with the previous rather than new income and debt limitations. Collectively, these changes will allow more farmers to meet the eligibility requirements for utilizing Chapter 12.

• Changes to priority for tax obligations. The new law makes a significant change in the treatment of tax debts. Under the new law, taxes owed to a governmental unit as a result of the sale, transfer, exchange or other disposition of a farm asset will be treated as unsecured debt that does not have priority over other claims, provided the debtor receives a discharge in the bankruptcy plan. The old law gave priority to such tax claims, even if a gain was inadvertently triggered by a sale of farm assets that was necessary to make the farm more economically viable for the purposes of the bankruptcy plan.

• Disposable income assessment changed. The old law required payment of secured debts on the basis of the farmer’s “projected disposable income” for the bankruptcy plan period; secured debts could be discharged if the disposable income was not sufficient to pay the debts. However, creditors often successfully objected to such discharges of debt by arguing that the farmer’s actual disposable income was more than projected, thereby requiring the farmer to pay based upon a retroactive assessment of his or her disposable income rather than the projected amount of disposable income as approved in the bankruptcy plan. Changes to the law prohibit this type of retroactive assessment of disposable income, requiring instead that the plan be confirmed and debts paid or discharged only on the basis of projected disposable income. Certain modifications of the disposable income provisions are permitted, but safeguards will prevent a creditor from leaving the debtor with “insufficient funds to carry on the farming operation after the plan is completed.”

As with any new law, additional analysis and case law interpretations are necessary to fully comprehend the impact of the revisions to the bankruptcy code. The agricultural community should watch for emerging information on the revisions and how other provisions in the Act, such as mandated credit counseling and caps on the homestead exemption for recent home purchases, will affect agricultural bankruptcies.

For more detailed information on the new law and changes to Chapter 12 specifically, see the American Bankruptcy Institute’s website at http://abiworld.net/bankbill/ , “Cracking the Code—Major Developments in Chapter 12 Bankruptcy” at http://abiworld.net/crackingthecode/index.php?p=25 and “New Chapter 12 Bankruptcy Rules at http://www.agprofessional.com/show_story.php?id=33341. Additional explanations might soon be available on the National Agricultural Law Center’s website at http://www.nationalaglawcenter.org/.

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