The 411 On Chapter 12

Know your options when facing severe financial challenges. ( Lori Hays )

Financial pain is real in farm country. If you’re facing consecutive years of low profits or a devastating event that left you upside down on a large loan, the options can seem dismal. You might even be considering filing for bankruptcy, which provides both opportunities and challenges.

Many think filing for bankruptcy is the finish line for a business, but that’s not always the case. Chapter 12 bankruptcy helps financially distressed farmers propose and carry out a plan to repay all or part of their debts, with the goal of keeping a farm in business.

“Chapter 12 is about fixing the balance sheet and rightsizing the debt for the operation,” says David Warfield, an attorney with Thompson Coburn.

To file Chapter 12, a farmer fills out forms and pays a $275 filing fee. At that point, an “automatic stay” goes into place, which means creditors can take few actions against you.

“As part of the filing, you disclose all assets and liabilities,” Warfield explains. “This is an extensive process, and the penalties for trying to hide something are significant and can even result in jail time. If you’re going to file bankruptcy and take advantage of automatic stay, you live in a financial fishbowl.”

Claims against a Chapter 12 farmer fall into several buckets:

  • Secured claims, which are secured by collateral, can be restructured, but the lender will retain the collateral.
  • Unsecured priority claims, which include most  taxes, are generally paid in full over time, although there’s an exception for certain capital gains taxes.
  • General unsecured claims are at the bottom of the pile and frequently aren’t paid in full.  

After the initial filing, you have 90 days to file a plan, which shows how you will pay your claims. For instance, you can decide which leases and contracts to assume or reject, Warfield says. If you’re locked into a long-term cash rental lease that’s on economically unfavorable terms, you can reject that contract.

Chapter 12 allows you to realign your debt. If asset values have fallen, you can write down that secured creditor’s debt to the value of the collateral. For example, you owe a $1 million loan on a piece of ground that’s now worth $700,000. You can write down the secured claim to $700,000 and adjust the terms and interest rate. The $300,000 doesn’t go away—it goes into the unsecured section.

Farmers present their plans at a confirmation hearing, where a judge will confirm or reject the plan. The plan usually lasts three to five years.

“If a judge confirms the plan, that becomes the new contract between you and your creditors,” Warfield says. “As long as you devote all of your disposable income over the life of the plan, you can discharge any unpaid general unsecured claims at the end of the plan. For example, if at the end of five years, you’ve only paid 18% of the general unsecured claims, the other 82% is discharged.”

Chapter 12 can help farmers stay in business, says Roger McEowen, professor of agricultural law and taxation at Washburn University. But it’s a public process, which can be intimidating. He suggests working with an attorney knowledgable in Chapter 12 bankruptcy law.

Don’t delay in working through your financial problems. If making your secured debt payments is difficult, Warfield says, contact your lender. “You might find a better option than Chapter 12,” he adds.