Fixing Farm Bankruptcy

By Childs, Kelly | Independent Banker, January 1999 | Go to article overview
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Fixing Farm Bankruptcy

Childs, Kelly, Independent Banker

Fixing Farm


Chapter 12, the section of the federal bankruptcy code created for farmers, has always been bad news for agricultural community banks. But now, bankers have the chance to shape that bad news into something better.

Agricultural bankers had hoped that the controversial bankruptcy provision would disappear late last year when it was scheduled by law to sunset, but a last-minute legislative extension by Congress kept it afloat through April. With farmers suffering in the current wave of economic troubles in the commodities markets and their heavy-hitting political advocates vowing to make Chapter 12 a permanent part of the bankruptcy code, the reality is that the provision will not go away. Pressures to reform consumer-related provisions within the bankruptcy code during the 106th Congress will also propel efforts to make Chapter 12 permanent within the law.

Chapter 12, also known as the Family Farmer Bankruptcy Act of 1986, arose in response to the farm financial crisis of the early to mid-1980s. Since its inception, Chapter 12 has left many agricultural banks struggling to recover loans from farmers, who through Chapter 12 can opt out of paying the full principal of their debts by "cramming down" secured loans over the objection of creditors.

A "cram down" occurs when farmers write down their secured debt to the current market value of collateral they own. Unfortunately, cram downs are problematic for creditors because of the way secured claims are treated under Chapter 12. For example, if a claim of $1 million is secured by real estate that is later appraised at $500,000, the debtor would be able to cram down the secured claim to $500,000, cutting in half the amount of the original claim.

Chapter 12 requires most debtors to pay in full over time secured claims with an appropriate interest rate, while unsecured claims generally receive little or no payment. In effect, the secured claim is "crammed down" to an appraised current value that becomes the principal amount to be repaid in full.

Chapter 12 gives family farmers considerably more power to demand concessions from lenders in the bankruptcy process than Chapter 11, under which other kinds of businesses file for reorganization. What makes Chapter 12 different from the normal Chapter 11 bankruptcy procedure is that farmers can submit a reorganization plan directly to the bankruptcy court with no review by creditors. Once that plan is accepted by the court, agricultural banks, by law, must accept it.

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