Farm bankruptcies are down according to an excellent article appearing in Market Intel. Farm Bureau Senior Economist Veronica Nigh analyzes Chapter 12 filings around the country and points out that such filings for the year ending June 30, 2021, are the lowest since 2015.
While that would normally be considered good news, we believe it is somewhat misleading.
In fact, we believe farm bankruptcies are not down at all. Instead, we conclude that more farmers are filing under a new form of Chapter 11: subchapter V (Sub V).
There are significant reasons to believe that the number of farm bankruptcies have not dropped. 2020 saw a pandemic. Remember pictures of farmers dumping milk? Remember the problems with supply chain and meat productions? 2020 also saw severe weather damage crops across large parts of the nation.
But we believe that the availability of Sub V reorganizations is the real reason behind the drop in Chapter 12 filings. In our office alone, we have filed more Sub V reorganizations for farmers than we have Chapter 12 cases. Before the availability of Sub V, all of those would have been Chapter 12 filings.
Chapter 12 was enacted because Chapter 11 did not work very well for farmers. During the farm crisis of the mid to late 1980s, farmers were going out of business, and Chapter 11 was not effective at keeping them going. Chapter 12 was designed as a cross between Chapter 11 and Chapter 13, and it has worked reasonably well.
About Sub V
In the summer of 2019 Congress enacted Sub V reorganizations as part of the Small Business Reorganization Act. It took effect in February 2020.
The purpose of Sub V was to enable small businesses to reorganize. As with farmers, Chapter 11 did not work very well for small businesses, due to its expensive cost, voluminous and unnecessary red tape and reporting requirements, and most importantly, the absolute priority rule.
Sub V reorganizations will generally cost much less than a regular Chapter 11 case would. A significant amount of this cost reduction is due to the elimination of bureaucracy, such as creditor committees. Some of the paperwork requirements are also reduced or eliminated.
Very important in reducing costs, though, is the elimination of trustee fees. Chapter 12 trustee fees can be very significant and expensive. Chapter 12 debtors often pay large amounts in debt service, and these trustee fees are based on the amount of the payments made under the plan.
These fees vary and are capped at 10%, but are now 6% in the Eastern District and 8% in the Western District. The percentages are applied to the amounts paid into the plan by the debtor.
So, the family farmer is likely paying about 5% interest on secured claims. But before that payment is made, the farmer is paying the trustee 6% to 8% off the top.
We have a farmer client right now whose trustee fees over the life of his plan will total about $65,000. His trustee fees in a Sub V care would likely be about $5,000. His case was filed and his Chapter 12 plan confirmed well before Sub V existed. If it had been an option, we would have filed under Sub V instead of Chapter 12. There are plenty of other farmers facing the same circumstances and decisions.
Important: Eliminating the Absolute Priority Rule
The most important advantage provided by Sub V, however, is the elimination of the absolute priority rule. Under Chapter 11 including under Sub V, the debtor proposes a plan and creditors get to vote on that plan. If the appropriate votes are garnered the plan is confirmed.
But it is difficult to get those votes. The way the votes are counted often gives one creditor or a small group of creditors complete veto power over the plan.
Without the necessary votes, the debtor can still have the plan confirmed, but can keep ownership of the business only if all creditors are paid in full. For most reorganizing businesses, this is impossible. The debtor would not be reorganizing if it could afford to pay all creditors in full.
Under Sub V, the debtor can have a plan confirmed, even without the affirmative vote and consent of creditors, and without having to pay all creditors in full. Rather, the debtor will have to pay all disposable income to creditors for a period of 3-5 years. Disposable income is defined as income not reasonably necessary to be spent for:
- maintenance or support of the debtor or dependent;
- domestic support obligations that come due during the bankruptcy case; and
- expense as necessary to continue, preserve, or operate the debtor’s business.
This standard is far less onerous than the absolute priority rule. Most reorganizing debtors can afford to pay disposable income to creditors.
This is not to say that it is easy to reorganize in any event. The system is not designed to permit the reorganizing debtor to have a cakewalk to success.
Sub V Is Up, Chapter 12 Down
Before we get too giddy about the drop in Chapter 12 filing numbers, we should take into account that farmers are making intelligent choices to file under Sub V.
We can still be happy that farmers are making these good choices and getting good results. Our firm has filed at least seven cases under Sub V. All of those cases have resulted in confirmed plans or are still pending.
We see Sub V as a great tool for small businesses, including family farmers, to stay in business.
This article was originally published on the State Bar of Wisconsin’s Agriculture Law and Rural Practice Blog of the Solo/Small Firm & General Practice Section. Visit the State Bar sections or the Solo/Small Firm & General Practice Section webpages to learn more about the benefits of section membership.