BANKRUPTCYWhat Ag Lenders Should Know

Michael S. Dovemdove@gislason.com

Jennifer G. Lurkenjlurken@gislason.com

Dean M. Zimmerlidzimmerli@gislason.com

Bankruptcy – Types of Cases

• Chapter 7 (Liquidation) • Chapter 11 (Business Reorganization) • Chapter 12 (Farm Reorganization) • Chapter 13 (Individual Reorganization)

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Types of Cases

• Chapter 7• “Straight Liquidation” • Most common for individual debtors• Fresh start – personal liability discharged• Debtor’s non-exempt assets are liquidated and proceeds paid to creditors. • Encumbered assets often abandoned to creditors with secured claims• Secured Creditors – Motion for Relief from Stay

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cont.Types of Cases

• Chapter 11• “Business” Reorganization

• Though individuals can and do file Chapter 11 cases if beyond the debt limits of Chapter 13 (approx. $400,000 unsecured, $1.18 million secured)

• Allows debtor to restructure debt, e.g.,• Extend payment terms on secured debt• Shed unnecessary liabilities• Limit payments to unsecured creditors

• Debtor, or rarely, creditor, may propose a reorganization plan that is voted on by creditors

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cont.Types of Cases

• Chapter 12• Family Farmer or Fisherman Reorganization • Eligibility:

• More than 50% of income from farming• Total debt does not exceed $4.15 million• 50% of debts (excluding home) from farming operation • Look back period: income req’s based on prior years tax returns or two

consecutive years before that • Allows farmer to restructure debts like Chapter 11• No voting; court approval of reorganization plan• Quicker and cheaper than Chapter 11

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cont.Types of Cases

• Chapter 13 • Individual Reorganization• Required for certain individuals with sufficient income • 3-5 year plan of reorganization

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cont.Types of Cases

• Subchapter V of Chapter 11• Small Business Reorganization Act- signed August 2019, effective February 2020.• Relatively small jurisdictional limits: total debts of no more than approximately $2.7

million• Some attempts at raising this to $7.5 million

• Optional to the debtor- “standard” Chapter 11 provisions continue to be available if the debtor so chooses

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Subchapter V – Special Rules

• Goal: Cheaper, simpler, faster than traditional Chapter 11• No quarterly US Trustee fees• Status conference within 60 days• Separate Trustee appointed by UST:

• Either on a case-by-case basis or • By a “standing Chapter V Trustee” similar to what we have for Chapter 13 (consumer

payment plans) and Chapter 12 (farm cases)• But Debtor has the powers of a “DIP” - retains control of the assets and

operations

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cont.Subchapter V – Special Rules

• Only the Debtor can file a Plan• Generally the Plan must be filed within 90 days

• Exception “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.”

• Courts more likely to grant this in the COVID-19 economy

• No Disclosure Statement• Certain things that would be in a disclosure statement are required to be set out in

the Plan

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The Background

• Generally: • Lender retains security interests as of the date of filing • Lender retains same priority as existed as of the date of filing • Lender’s “after-acquired property” clause is not effective – no lien for property

acquired after filing• But lien will still attach to proceeds of existing collateral, e.g., crops growing at

time of filing • Lender is prohibited from taking actions to collect its debt outside of bankruptcy

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Motions to Use Cash Collateral

• Upon entering bankruptcy, debtor who needs to pay ongoing debts for operations will bring motion to use cash collateral• Interim/Emergency• Final

• Even though court permission required: • Send letter stating debtor is not authorized to use cash collateral

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cont.Motions to Use Cash Collateral

• “Cash Collateral” is cash, deposit accounts, and other cash equivalents• 11 U.S.C. 363(c)(2):

• “trustee may not use, sell, or lease cash collateral…unless:”• Secured party consents • Court authorizes use and conditions use on providing “adequate protection” to

the secured party

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Bankruptcy – Cash Collateral

• What is “Adequate Protection?”• Includes:

• Granting secured party an additional or replacement lien in other of debtors’ assets• “Granting such other relief…as will result in the realization by such entity of the

indubitable equivalent of such entity’s interest” • Something to clearly equal in amount and certainty as what is being used

• In general, “Adequate Protection” is some method to preserve the status quo.

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cont.Bankruptcy – Cash Collateral

• Interim Motion for use of cash collateral until final motion can be heard.• Expedited basis – 2-4 days notice• Short time frame – covers 2-4 weeks • Rarely denied• Request adequate protection – decided by judge• Can negotiate what is “necessary”

• Necessary – insurance, wages, utilities, feed• Not necessary – real estate taxes

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cont.Bankruptcy – Cash Collateral

• Final Motion for Use of Cash Collateral• Sets tone for the case – educate judge• Additional collateral available for adequate protection

• Real estate• Equipment

• Time limits for use - Budget

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cont.Bankruptcy – Cash Collateral

• Example: • Farmer files bankruptcy and wants to use $100,000 of proceeds from 2016 crop to

fund 2017 crop year, but First Bank, with security interest in crops, does not consent• Farmer must provide “adequate protection”

• E.g., $100,000 mortgage on unencumbered real estate• E.g., even replacement lien in 2017 crop year, if Farmer can convince court that

the new crop will generate sufficient proceeds

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cont.Bankruptcy – Cash Collateral

• Stipulation for Use of Cash Collateral • Require a budget that debtor cannot exceed• Require consent for certain amounts/uses• Require filing of monthly operating reports• Require “reader” access to DIP accounts• Require adequate protection• Require debtor to agree to debt amount and lender’s collateral• Set “end date” of when stipulation expires• IF terms not met, debtor can’t use cash collateral

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Relief from Stay Motion

• Filing bankruptcy creates an automatic “stay” against all collection efforts• Can bring a motion for relief from stay—to allow repossession,

foreclosure, etc.• Basis for a motion:

• Lack of Adequate Protection• Debtor has no equity AND property not necessary for effective reorganization • Bad faith bankruptcy filing

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cont.Relief from Stay Motion

• Lack of adequate protection • Entitled to maintain “status quo” • Diminution in value of collateral

• Examples: • Machinery being used/depreciation • Failure to carry property insurance

• Motion for Relief from Stay can also result in debtor being ordered to pay adequate protection

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cont.Relief from Stay Motion

• What is adequate protection?• Same as in cash collateral context • “Indubitable equivalent” • Must maintain the status quo

• Not entitled to payments under the note• Example:

• Entitled to payments equal to depreciation on machinery

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Bankruptcy – Adequate Protection

• Types• Cash payments• Additional or replacement liens

• Future crops• Other real estate or equipment

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cont.Bankruptcy – Adequate Protection

• If sufficient equity cushion, no relief from stay• E.g.:

• Machinery and equipment worth $500,000• Bank owed only $350,000• Even if debtor uses/depreciates equipment, bank still in the same position

• Enough collateral to pay off $350,000 loan

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Bankruptcy Plans – Timing

• Chapter 11• Debtor has the exclusive right to file a plan for 120 days after Order for Relief.• Interested party may file its “own” plan if:

i. The debtor does not file a plan during the 120-day period.ii. The debtor’s plan is not accepted by all impaired classes of claims within 180

days, or iii. A trustee is appointed.

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cont.Bankruptcy Plans – Timing

• Chapter 12• Debtor must file a repayment plan within 90 days after Order for Relief, unless

extended. • Creditors cannot file a plan.• If debtor does not file, case can be dismissed. • Courts routinely extend time

• Considering bringing motion to dismiss early

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Bankruptcy – Plan Confirmation

• Chapter 11• Disclosure Statement approved and served with order for confirmation hearing, plan

and ballot form.• Ballot form sent in to clerk’s office, unless ordered otherwise.• Can be approved over creditor objections

• Cramdown

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cont.Bankruptcy – Plan Confirmation

• Chapter 12• No disclosure statement necessary.• Ballots not necessary. Creditor consent not required.• Court determines if plan is feasible and meets legal requirements. • Cramdown allowed.

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Bankruptcy Plan – Common Issues

• Feasibility • Cramdown terms

• Interest Rate• Term/Duration• Value of collateral

• Negotiated plan terms

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Bankruptcy Plan – Feasibility

• Can they make the plan work• “reasonable likelihood”

• Review• Cash flows/tax returns• Prior yield history• Average yield• Contracting/Pricing v. Open market• Changes to farming practices/operation

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Bankruptcy Plan – Cramdown

• Under both Chapter 11 and 12, debtor can “cram down” secured creditors• What is a Cramdown?

• Restructuring secured debt to pay off only an amount equal to the value of the collateral

• Treat balance as unsecured

• Example: • Machinery loan on combine worth $200k, but $250k remains outstanding. Plan

proposes payments equal to $200k only

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Confirmation and Cramdown Issues

• Statutes require secured creditors• Must retain liens securing such claim; AND• “the value…of property to be distributed by the trustee or the debtor under the plan

on account of such claim is not less than the allowed amount of such claim.”

• Present value of payments must equal value of collateral • Or total due, if equity cushion exists

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Bankruptcy Plan – Cramdown

• Issues: • Valuation• Interest Rate• Term

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Cramdown – Valuation

• Issues: How to measure the value of the collateral for purposes of determining secured status

• Measures:• If debtor retaining collateral, then use replacement value

• i.e. what debtor would pay to replace• In re Trimble, 50 F.3d 530 (8th Circuit) – used going concern value for dairy herd • Valued as of confirmation, not bky filing

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Confirmation – Valuation

• If undersecured:• Debt crammed down to value of collateral, with remainder treated as unsecured

• If oversecured: • Entitled to post-petition interest, reasonable attorney’s fees

• Expert appraisers may be necessary

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Confirmation - Interest Rate

• Issues: What interest rate should be paid to ensure present value of payments equal secured amount

• Measures:• Presumptive contract rate – start from the note rate, and adjust for risk factors, etc. • Formula Approach – prime rate, plus adjustment upward for risk for particular debt• Coerced loan rate – what would creditor charge for similar loan to similarly situated

borrower• Cost of funds – cash equivalent cost

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cont.Confirmation - Interest Rate

• 8th Circuit follows “Market Rate” – similar to formula approach • Looks at treasury bond yield for similar maturity, adds premium for risk, frequently

around 2%

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cont.Confirmation - Interest Rate

• Examples: • Ellis, 478 B.R. 132 (Bky. N.D.N.Y. 2012)

• 5%, 30yr rate unreasonable, compared to 10% note rate, given speculative nature of new farming venture

• Torelli, 338 B.R. 390, 396 (Bky. E.D. Ark. 2006)• 5%, 20yr rate rejected; compared to 6.5% prime plus 1.25% adjustment, rate

should have been 7.75%• Elk Creek Salers, 286 B.R. 387 (Bky. W.D. Mo. 2002)

• 2% above treasury bond of similar maturity approved.• Fuelling, 601 B.R. 665, 674 (Bky. N.D. Iowa 2019)

• 4.88% approved; 2% over treasury bond

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Confirmation – Amortization Term

• Debtors can re-amortize loans • Must be reasonable and customary for similar loans in the industry

• E.g., no 30 year cattle loans

• Factors• Original note term• Life expectancy of collateral • Risk of default• Risk of collateral losing value

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cont.Confirmation – Amortization Term

• Examples• Koch, 131 B.R. 128, 130 (Bky. N.D. Iowa 1991)

• 30 year loan rejected; original note was 10 years• Ellis, 478 B.R. 132 (Bky. N.D.N.Y. 2012)

• 30 year loan rejected; 15 years was average term for similar operation • Richards, 2004 WL 764526 (Bky. N.D. Iowa 2004)

• 10 year term on livestock debt approved, citing other cases approving 7 to 20 year terms.

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Confirmation – Settlement

• Can negotiate a consensual plan with debtor• Interest, Duration of payments• Monthly reporting • Specific covenants

• E.g., dairy must maintain minimum herd size, must maintain insurance, etc. • Default terms

• E.g., 10 days notice, filing affidavit of default • Automatic relief from stay • Deeds in lieu• Stipulated replevin

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Bankruptcy Plan Confirmation

• Order approving Plan is new contract with lender.

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This program is not intended to be responsive to any individual situation or concerns as the contents of this presentation are intended for general informational purposes only. Participants are urged not to act upon the information contained in this presentation without first consulting competent legal advice regarding implications of a particular factual situation. Questions and additional information can be submitted to your Gislason & Hunter Attorney or to the presenter of this session.

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