Thursday, October 18, 2018
For the Spring 2019 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of next spring’s online Ag Law course – that’s the topic of today’s post.
The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?
Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.
Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.
Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate. A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.
Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.
Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.
Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.
Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.
Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.
Further Information and How to Register
Information about the course is available here:
You can also find information about the text for the course at the following link (including the Table of Contents and the Index):
If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution. Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.
If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.
I hope to see you in January!
Checkout the postcard (401 KB PDF) containing more information about the course and instructor.
October 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Friday, August 31, 2018
Economic and financial conditions remain tough in much of agriculture. Bankruptcy filings have seen an increase, and that includes the number of Chapter 12 filings. In a Chapter 12 the debtor must file a reorganization plan under which the debtor proposes a plan for paying off creditors. Plan payments generally must pass through the hands of the bankruptcy trustee. The trustee is compensated out of a portion of the plan payments.
But, what if a debtor proposes to make payments directly to the creditors? Doing so would bypass the trustee, and would also bypass the trustee’s fee. It would also mean that all of the payments made under the bankruptcy plan would go to the creditors instead of some of it syphoned off to pay the trustee.
That’s the focus of today’s post – whether a debtor in reorganization bankruptcy can make direct payments to creditors under the debtor’s reorganization plan.
The Reorganization Plan
A Chapter 12 debtor has an exclusive 90-day period after filing for Chapter 12 bankruptcy to file a plan for reorganization unless the court grants an extension. A court may grant additional time only if circumstances are present for which the debtor should not fairly be held accountable. 11 U.S.C. §1221. See e.g., In re Davis, No. CC-16-1390-KuLTa, 2017 Bankr. LEXIS 2169 (B.A.P. 9th Cir. Aug. 2, 2017). If the court determines that the debtor will be unable to make all payments as required by the plan, the court may require the debtor to modify the plan, convert the case to a Chapter 7, or request the court to dismiss the case. In other words, the plan must be feasible. It must also be proposed in good faith. Good faith can be viewed as practically synonymous the requirement that the plan be feasible. See, e.g., In re Lockard, 234 B.R. 484 (Bankr. W.D. Mo. 1999).
The Bankruptcy Trustee
Duties. A trustee is appointed in every Chapter 12 case. A Chapter 12 trustee’s duties are similar to those under Chapter 13. Specifically, a trustee under Chapter 12, is directed to:
* be accountable for all property received;
* ensure that the debtor performs in accordance with intention;
* object to the allowance of claims which would be improper;
* if advisable, oppose the discharge of the debtor;
* furnish requested information to a party in interest unless the court orders otherwise;
* make a final report;
* for cause and upon request, investigate the financial affairs of the debtor, the
operation of the debtor’s business and the desirability of the continuance of the business;
* participate in hearings concerning the value of property of the bankruptcy estate; and
* ensure that the debtor commences making timely payments required by confirmed plan.
In specifying the duties of trustees, Chapter 12 modifies the duty applicable to trustees under other chapters of the Bankruptcy Code to “investigate the financial affairs of the debtor.” Chapter 12 authorizes an investigative role for trustees, as noted above, “for cause and on request of a party in interest....” Thus, it would appear, in a routine case where there is no fraud, dishonesty, incompetence or gross mismanagement, the debtor should be allowed to reorganize without significant interference from the trustee.
Compensation. The compensation of trustees is not to exceed 10 percent of payments made under the debtor’s plan for the first $450,000 of payments. The fee is then not to exceed three percent of aggregate plan payments above that amount. 28 U.S.C. §586(e)(1). The trustee collects the fee from payments received under the plan. 28 U.S.C. § 586(e)(2). That’s an important point - the fee is based on all payments the debtor makes under the plan to the trustee rather than on amounts the trustee disperses to creditors. See, e.g., Pelofsky v. Wallace, 102 F.3d 350 (8th Cir. 1996).
Except as provided in the plan or in order confirming the plan, it is the trustee that is to make payments to creditors under the plan. Courts have generally recognized that payments on fully secured claims that the bankruptcy plan does not modify can be paid directly to the creditor, as can claims not impaired by the plan. However, for claims that are impaired, courts are divided as to whether a court may approve direct payments to creditors.
The issue of who actually disburses the debtor’s payments is important to the trustee because, as noted above, the trustee is entitled to a statutory commission only on funds actually received from the debtor pursuant to the reorganization plan. But, the bankruptcy code does not prevent a debtor from making payments directly to creditors.
So, how does a court decide whether a debtor can make payments directly to creditors and bypass the trustee (and the trustee fee)? Historically, the courts have utilized three approaches for deciding whether a debtor can make direct payment under a Chapter 12 reorganization plan (and thereby bypass the trustee fee). One approach utilizes a blanket rule barring the direct payment of impaired secured creditors. See, e.g., In re Fulkrod, 973 F.2d 801 (9th Cir. 1992). Another approach is, essentially, the direct opposite. Under this approach, debtors can pay secured creditors directly, regardless of their impaired status. See, e.g., In re Wagner, 36 F.3d 723 (8th Cir. 1994). But, the majority approach is to weigh a number of factors in the balance on a case-by-case basis to determine whether direct payments can be made. See, e.g., In re Beard, 45 F.3d 113 (6th Cir. 1995)
The issue came up again in a recent case.
In In re Speir, No. 16-11947-JDW, 2018 Bankr. LEXIS 2359 (Bankr. N.D. Miss. Aug. 8, 2018), the debtor filed Chapter 12 in mid-2016 and a reorganization plan later that year. The plan called for direct payments to the secured creditors but payments to the unsecured creditors would be made to the trustee for distribution. The trustee objected, but the court upheld the direct payments except as applied to one secured creditor based on the application of a 13-factor test. Those factors are:
- The debtor’s past history;
- The debtor’s business acumen;
- Whether the debtor has complied post-filing statutory and court-imposed duties;
- Whether the debtor is acting in good-faith;
- The debtor’s ability to achieve meaningful reorganization absent direct payments;
- How the reorganization plan treats each creditor to which a direct payment is proposed to be made;
- The consent, or non-consent, of the affected creditor to the proposed plan treatment;
- How sophisticated a creditor is, and whether the creditor has the ability and incentive, to monitor compliance;
- The ability of the trustee and the court to monitor future direct payments;
- The potential burden on the trustee;
- The possible effect on the trustee’s salary or funding of the U.S. Trustee system;
- The potential for abuse of the bankruptcy system; and
- The existence of other unique or special circumstances
In balancing the factors, the In re Speir court noted that each factor may be considered, but it is not necessary that equal weight be given to each factor or even to different claims in the same case. Ultimately, what the analysis came down to in In re Speir was a weighing of the necessary compensation for the Trustee against a feasible plan for the debtor. The court noted that the debtor had used the bankruptcy process to substantially modify one secured creditor’s claim and, as a result, had to pay that creditor’s claim through the Trustee. The other secured creditors, the court noted, remained mostly unaffected by the debtor’s bankruptcy and could be paid directly.
While times remain tough in agriculture for some ag producers, Chapter 12 bankruptcy was created specifically to assist farm debtors in distress. The ability to pay creditors directly and bypass the Trustee (and the Trustee’s fee) might be possible. For those in Chapter 12, the issue should be evaluated.
Wednesday, July 18, 2018
Next month, Washburn Law School and Kansas State University (KSU) will team up for its annual symposium on agricultural law and the business of agriculture. The event will be held in Manhattan at the Kansas Farm Bureau headquarters. The symposium will be the first day of three days of continuing education on matters involving agricultural law and economics. The other two days will be the annual Risk and Profit Conference conducted by the KSU Department of Agricultural Economics. That event will be on the KSU campus in Manhattan. The three days provide an excellent opportunity for lawyers, CPAs, farmers and ranchers, agribusiness professionals and rural landowners to obtain continuing education on matters regarding agricultural law and economics.
This year’s symposium on August 15 will feature discussion and analysis of the new tax law, the Tax Cuts and Jobs Act, and its impact on individuals and businesses engaged in agriculture; farm and ranch financial distress legal issues and the procedures involved in resolving debtor/creditor disputes, including the use of mediation and Chapter 12 bankruptcy; farm policy issues at the state and federal level (including a discussion of the status of the 2018 Farm Bill); the leasing of water rights; an update on significant legal (and tax) developments in agricultural law (both federal and state); and an hour of ethics that will test participant’s negotiation skills.
The symposium can also be attended online. For a complete description of the sessions and how to register for either in-person or online attendance, click here: https://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
Risk and Profit Conference
On August 16 and 17, the KSU Department of Agricultural Economics will conduct its annual Risk and Profit campus. The event will be held at the alumni center on the KSU campus, and will involve a day and a half of discussion of various topics related to the economics of the business of agriculture. One of the keynote speakers at the conference will be Ambassador Richard T. Crowder, an ag negotiator on a worldwide basis. The conference includes 22 breakout sessions on a wide range of topics, including two separate breakout sessions that I will be doing with Mark Dikeman of the KSU Farm Management Association on the new tax law. For a complete run down of the conference, click here: https://www.agmanager.info/risk-and-profit-conference
The two and one-half days of instruction is an opportunity is a great chance to gain insight into making your ag-related business more profitable from various aspects – legal, tax and economic. If you are a producer, agribusiness professional, or a professional in a service business (lawyer; tax professional; financial planner; or other related service business) you won’t want to miss these events in Manhattan. See you there, or online for Day 1.
July 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Tuesday, May 29, 2018
Economic times continue to be difficult in much of agriculture. Many crop prices have declined from their peak a few years ago. The same is true for much of livestock agriculture. What’s more, great yields rarely if ever make up for low prices. As a result, farm bankruptcy filings are occurring at an increased rate, particularly in areas that have both crops and dairy operations.
An important issue that can come up in a farm bankruptcy is known as the “preferential payment rule.” It can be a surprise not only to farmers in financial distress, but also to creditors who receive payment or buy agricultural goods shortly before the debtor files bankruptcy. It’s an issue that can arise in the normal course of doing business before bankruptcy is filed when nothing “unusual” appears to be happening.
Today’s post takes a look at this unique bankruptcy provision – the preferential payment rule.
11 U.S.C. §547 provides in general that when a debtor makes a payment to a creditor and the debtor files bankruptcy within 90 days of making the payment, the bankruptcy trustee can “avoid” the payment by making the creditor pay the amount received to the bankruptcy estate where it will be distributed to the general creditors of the debtor. The timeframe expands from 90 days to one year is the creditor is an “insider.” The rule can come as a shock to a creditor that has received payment, paid their own creditors from the funds received from the debtor, and now has no funds to pay the bankruptcy estate to satisfy the bankruptcy trustee’s avoidance claim.
The preferential payment rule does come with some exceptions. The exceptions basically comport with usual business operations. In other words, if the transaction between the debtor and the creditor occurred in the normal course of the parties doing business with each other, then the trustee’s “avoidance” claim will likely fail. So, if the payment was made as part of a contemporaneous exchange for new value given, the trustee’s avoidance claim will be rejected. Also, if the payment was made in the “ordinary course of business” between the debtor and the creditor where invoices are paid in the time period required on the invoice, or payment is made in accordance with industry custom or past dealings, the trustee’s claim will likely fail. Likewise, if the transfer creates a security interest in property that the debtor acquires that secures new value given in accordance with a security agreement, the trustee’s claim will also likely not be granted.
A recent court decision from Arkansas illustrates how the preferential payment rule can apply in an agricultural setting. In Rice v. Prairie Gold Farms, No. 2:17CV126 JLH, 2018 U.S. Dist. LEXIS 51678 (E.D. Ark. Mar. 28, 2018), the debtor was a partnership engaged in wheat farming activities. The debtor entered into two contracts for the sale of wheat with a grain broker. The contracts called for a total of 10,000 bushels of wheat to be delivered to the broker anytime between June 1, 2014 and July 31, 2014. In return, the debtor was to be paid $6.78/bushel for 5,000 bushels and $7.09/bushel for the other 5,000 bushels for a total price of $69,350. The debtor delivered the wheat in fulfillment of the contracts on July 21, 2014 and August 4, 2014 and received $71,957.10 later in August, in return for a total delivery of 10,813.07 bushels.
The debtor subsequently filed Chapter 11 bankruptcy on October 23, 2014 (which was later converted to Chapter 7). The Chapter 7 trustee sought to avoid the transfer of the debtor’s wheat crop as a preferential transfer under 11 U.S.C. §547(b) and return the wheat crop to the bankruptcy estate for distribution to creditors. The trial court disagreed with the trustee, noting that 11 U.S.C. §547(c)(1) disallowed avoidance of a transfer if it is made in a contemporaneous exchange for new value that the debtor received. The trustee claimed that the transfer of wheat was not contemporaneous because the contract was entered into in May and the wheat was not delivered and payment made until over two months later.
The trial court determined that the transfer was for new value and payment occurred in a substantially contemporaneous manner corresponding to the delivery of the wheat. Thus, the exception of 11 U.S.C. §547(c)(1) applied. The court also noted that the wheat sale contracts were entered into in the ordinary course of the debtor’s business and, thus, also met the exception of 11 U.S.C. §547(c)(2). The debtor and the grain broker had a business history of similar transactions, and the court noted that the trustee failed to establish that the wheat contracts were inconsistent with the parties’ history of business dealings.
The preferential payment rule is important to know about, especially in the context of agricultural bankruptcies. The matter can get complicated in agricultural settings with the use of deferred payment contracts, forward grain contracts and the various types of unique business relationships that farmers often find themselves in. In the Arkansas case, the court noted that the parties had prior dealings that they conducted in the same manner and that nothing was out of the ordinary. There wasn’t any attempt to defraud creditors or shield assets from the reach of creditors. That’s really the point behind the rule. Continue conducting business as usual and the rule won’t likely come into play.
Friday, March 16, 2018
From an economic standpoint, recent years have not been friendly to many agricultural producers. Low commodity prices for various grains and milk and increasing debt loads have made it difficult for some farmers to continue. Chapter 12 bankruptcy filings have been on the rise. In parts of the Midwest, for instance, filings have been up over 30 percent in the past couple of years compared to prior years.
There are 94 bankruptcy judicial districts in the U.S. In 2017, the Western District of Wisconsin led all of them with 28 Chapter 12 cases filed. Next was Kansas and the Middle District of Georgia with 25 each. Nebraska was next with 20 Chapter 12 filings. Minnesota had 19. Both the Eastern District of Wisconsin and the Eastern District of California had 17. In the “leader” – the Western District of Wisconsin – filings were up over 30 percent from the prior year for the second year in a row.
One of the requirements that must be satisfied for a bankruptcy court to get a Chapter 12 reorganization plan confirmed by the bank. However, it’s becoming a more difficult proposition for some of the Chapter 12 filers.
The feasibility of a Chapter 12 reorganization plan – that’s the focus of today’s post.
Chapter 12 Plan Confirmation
Unless the time limit is extended by the court, the confirmation hearing is to be concluded not later than 45 days after the plan is filed. The court is required to confirm a plan if—(1) the plan conforms to all bankruptcy provisions; (2) all required fees have been paid; (3) the plan proposal was made in good faith without violating any law; (4) unsecured creditors receive not less than the amount the unsecured creditors would receive in a Chapter 7 liquidation; (5) each secured creditor either (a) accepts the plan, (b) retains the lien securing the claim (with the value of the property to be distributed for the allowed amount of the claim, as of the effective date of the plan, to equal not less than the allowed amount of the claim), or (c) the creditor receives the property securing the claim; and (6) the debtor will be able to comply with the plan.
Also, under a provision added by The Bankruptcy Act of 2005, an individual Chapter 12 debtor must be current on post-petition domestic support obligations as a condition of plan confirmation.
Feasibility of the Reorganization Plan
If the court determines that the debtor will be unable to make all payments as required by the plan, the court may require the debtor to modify the plan, convert the case to a Chapter 7, or request the court to dismiss the case. Over the years, numerous Chapter 12 cases have involved the feasibility issue. Most recently, a Chapter 12 case from (you guessed it) the Western District of Wisconsin, involved the question of whether a debtor’s reorganization plan was feasible.
In In re Johnson, No. 17-11448-12, 2018 Bankr. LEXIS 74 (Bankr. W.D. Wisc. Jan. 12, 2018), the debtor was a farmer who primarily raised corn and soybeans. He also was the sole owner of grain farming LLC. The debtor filed a Chapter 12 petition on April 25, 2017, and a Chapter 12 plan on August 22, 2017. On September 25, 2017 a bank objected to plan confirmation. The debtor filed an amended Chapter 12 plan on November 3, 2017 and a second amended Chapter 12 plan on December 14, 2017.
The amended plan proposed payments of $8,150 per month for 12 months, then $11,700 per month for 36 months, and finally $13,700 per month for 12 months. In total the plan proposed payments of $683,400 over 60 months. The debtor claimed that this would pay the creditors in full. However, the court determined that the debtor’s plan was not feasible. At confirmation, the debtor would be required to immediately pay $67,155.70 to cure defaults on leases to be assumed and $40,000 to another creditor. Other than vague testimony that funds were available to satisfy the immediate payments to the other creditor, there was no evidence presented that supported any ability to make the lease cure payments. In addition, the evidence to which the debtor pointed supporting his ability to make payments were his tax returns for the years 2012 through 2015. However, those returns also included crop insurance payments which the debtor was no longer eligible to receive. Yet, according to the debtor’s estimates, he would do better in each of the next three years than he did at any time between 2012 and 2015. The bankruptcy court determined that, based on the picture presented by the debtor’s tax returns and testimony, the debtor’s projections were unpersuasive and lacked credibility.
The debtor also estimated that his gross income from crop sale would swell over the next three years and that his expenses would be less than any of the last four years. Yet, the debtor offered no explanation for how he arrived at these estimates. The debtor claimed that his expenses would decrease because he was no longer paying for crop insurance. However, that would only lower his expenses by approximately $30,000 and there was no reserve for crop loss in the projections, which had ranged from $39,210 to $274,933 in the past. For these reasons, the court determined that the debtor failed to meet his burden in showing that the plan was feasible.
In addition, the debtor’s plan proposed paying the bank’s various secured claims at a 5.5 percent interest rate. The court determined that under Till v. SCS Credit Corp., 541 U.S. 465 (2004), the bank was entitled to a “prime-plus” interest rate. Moreover, in the context of chapter 12 cases, the court noted that risk is often heightened due to the unpredictable nature of the agricultural economy. The court found that the interest rate proposed for the bank in the debtor’s plan was inadequate under Till. The court noted that the current national interest rate was 4.5 percent and the debtor proposed the minimum risk adjustment of 1 percent. The fact that the debtor’s tax returns show that he was consistently reporting losses or barely breaking-even in addition to the many other risk factors led the court to hold that the bank would be subject to a significant degree of risk under the plan and that the debtor’s proposed interest rate was insufficient.
Finally, the court held that because the debtor’s projections lacked any credibility or support it would be impossible for the debtor to propose a confirmable plan. As such, the court dismissed the case.
Chapter 12 bankruptcy is a difficult experience for a farm debtor to experience. But, putting a feasible reorganization plan together is essential for getting a plan confirmed. In the current economic environment, that’s becoming more difficult for many farmers.
Wednesday, January 3, 2018
This week we are looking at the biggest developments in agricultural law and taxation for 2017. On Monday, I discussed those developments that were important but just not quite significant enough based on their national significance to make the top ten. Today I start a two-day series on the top ten developments of 2017 with a discussion of developments 10 through six. On Friday, developments five through one will be covered. To make my list, the development from the courts, IRS and federal agencies must have a major impact nationally on agricultural producers, agribusiness and rural landowners in general.
Without further delay, here we go - the top developments for 2017 (numbers 10 through six).
- 10 – South Dakota Enacts Unconstitutional Tax Legislation. In 2017, the South Dakota Supreme Court gave the South Dakota legislature and Governor what it wanted – a ruling that a recently enacted South Dakota law was unconstitutional. South Dakota’s thirst for additional revenue led it to enact a law imposing sales tax on businesses that have no physical presence in the state. That’s something that the U.S. Supreme Court first said 50 years ago that a state cannot do. Accordingly, the South Dakota Supreme Court struck the law down as an unconstitutional violation of the Commerce Clause. The legislature deliberately enacted the law so that it would be challenged as unconstitutional in order to set up a case in hopes that the U.S. Supreme Court would review it and reverse its longstanding position on the issue. See, e.g., National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967) and Quill Corporation v. North Dakota, 504 U.S. 298 (1992). If that happens, or the Congress takes action to allow states to impose sales (and/or use) tax on businesses with no physical presence in the state, the impact would be largely borne by small businesses, including home-based business and small agricultural businesses all across the country. It would also raise serious questions about how strong the principle of federalism remains. State v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. Sup. Ct. 2017), pet. for cert. filed, Oct. 2, 2017.
- 9 - Amendment to Bankruptcy Law Gives Expands Non-Priority Treatment of Governmental Claims. H.R. 2266, signed into law on October 26, 2017, contains the Family Farmer Bankruptcy Act (Act). The Act adds 11 U.S.C. §1232 which specifies that, “Any unsecured claim of a governmental unit against the debtor or the estate that arises before the filing of the petition, or that arises after the filing of the petition and before the debtor's discharge under section 1228, as a result of the sale, transfer, exchange, or other disposition of any property used in the debtor's farming operation”… is to be treated as an unsecured claim that arises before the bankruptcy petition was filed that is not entitled to priority under 11 U.S.C. §507 and is deemed to be provided for under a plan, and discharged in accordance with 11 U.S.C. §1228. The provision amends 11 U.S.C. §1222(a)(2)(A) to effectively override Hall v. United States, 132 Sup. Ct. 1882 (2012) where the U.S. Supreme Court held that tax triggered by the post-petition sale of farm assets was not discharged under 11 U.S.C. §1222(a)(2)(A). The Court held that because a Chapter 12 bankruptcy estate cannot incur taxes by virtue of 11 U.S.C. §1399, taxes were not “incurred by the estate” under 11 U.S.C. §503(b) which barred post-petition taxes from being treated as non-priority. The provision is effective for all pending Chapter 12 cases with unconfirmed plans and all new Chapter 12 cases as of October 26, 2017. H.R. 2266, Division B, Sec. 1005, signed into law on October 26, 2017.
- 8 – “Hobby Loss” Tax Developments. 2017 saw two significant developments concerning farm and ranching activities that the IRS believes are not conducting with a business purpose and are, thus, subject to the limitation on deductibility of losses. Early in 2017, the IRS issued interim guidance on a pilot program for Schedule F expenses for small business/self-employed taxpayer examinations. It set the program to begin on April 1, 2017 and run for one year. The focus will be on “hobby” farmers, and will involve the examination of 50 tax returns from tax year 2015. The program could be an indication that the IRS is looking to increase the audit rate of returns with a Schedule F, and it may be more likely to impact the relatively smaller farming operations. The interim guidance points out that the IRS believes that compliance issues may exist with respect to the deduction of expenses on the wrong form, or expenses that actually belonged to another taxpayer, or that should be subject to the hobby loss rules of I.R.C. §183. Indeed, the IRS notes that a filter for the project will be designed to identify those taxpayers who have W-2s with large income and who also file a Schedule F “and may not have time to farm.” In addition, the guidance informs IRS personnel that the examined returns could have start-up costs or be a hobby activity which would lead to non-deductible losses. The interim guidance also directs examiners to look for deductions that “appear to be excessive for the income reported.” The implication is that such expenses won’t be deemed to be ordinary and necessary business expenses. How that might impact the practice of pre-paying farm expenses remains to be seen. The guidance also instructs examiners to pick through gas, oil, fuel, repairs, etc., to determine the “business and non-business parts” of the expense without any mention of the $2,500 safe harbor of the repair regulations. The interim guidance would appear to be targeted toward taxpayers that either farm or crop share some acres where the income ends up on Schedule F, but where other non-farm sources of income predominate (e.g., W-2 income, income from leases for hunting, bed and breakfast, conservation reserve program payments, organic farming, etc.). In those situations, it is likely that the Schedule F expenses will exceed the Schedule F income. That’s particularly the case when depreciation is claimed on items associated with the “farm” - a small tractor, all-terrain vehicle, pickup truck, etc. That’s the typical hobby loss scenario that IRS is apparently looking for.
The second development on the hobby loss issue was a Tax Court opinion issued by Judge Paris in late 2017. The case involved a diversified ranching operation that, for the tax years at issue, had about $15 million in losses and gross income of $7 million. For those years, the petitioner’s primary expense was depreciation. The IRS claimed that the ranching activity was not engaged in for profit and the expenses were deductible only to the extent of income. The Tax Court determined that all of the petitioner’s activities were economically intertwined and constituted a single ranching activity. On the profit issue, the court determined that none of the factors in the Treasury Regulations §1.183-2(b) favored the IRS. Accordingly, the petitioner’s ranching activity was held to be conducted for-profit and the losses were fully deductible. The court specifically rejected the IRS argument that a profit motive could not be present when millions of dollars of losses were generated. That’s a very important holding for agriculture. Depreciation is often the largest deduction on a farm or ranch operation’s return. Welch, et al. v. Comr., T.C. Memo. 2017-229.
- 7 - Beneficial Use Doctrine Established Water Right That Feds Had Taken. In late 2017, the U.S. Court of Federal Claims issued a very significant opinion involving vested water rights in the Western United States. The court ruled that the federal government had taken the vested water rights of the plaintiff, a New Mexico cattle ranching operation, which required compensation under the Fifth Amendment. The court determined that the plaintiff had property rights by virtue of having “made continuous beneficial use of stock water sources” predating federal ownership. Those water rights pre-dated 1905, and the U.S. Forest Service (USFS) had allowed that usage from 1910 to 1989. The court also agreed with the plaintiff’s claim the water was “physically taken” when the United States Forest Service (USFS) blocked the plaintiff’s livestock from accessing the water that had long been used by the plaintiff and its predecessors to graze cattle so as to preserve endangered species.
More specifically, the plaintiff held all “cattle, water rights, range rights, access rights, and range improvements on the base property, as well as the appurtenant federally-administered grazing allotment known as the Sacramento Allotment” in New Mexico. The plaintiff obtained a permit in 1989 from the USFS to graze cattle on an allotment of USFS land which allowed for the grazing of 553 cows for a 10-year period. At the time the permit was obtained, certain areas of the allotment were fenced off, but the USFS allowed the plaintiff’s cattle access to water inside the fenced areas. However, in 1996, the USFS notified the plaintiff that cattle were not permitted to graze inside the fenced areas, but then later allowed temporary grazing due to existing drought conditions. In 1998, the USFS barred the plaintiff from grazing cattle inside the fenced areas, but then reissued the permit in 1999 allowing 553 cattle to graze the allotment for 10 years subject to cancellation or modification as necessary. The permit also stated that “livestock use” was not permitted inside the fenced area. In 2001, the USFS denied the plaintiff’s request to pipe water from the fenced area for cattle watering and, in 2002, the USFS ordered the plaintiff to remove cattle that were grazing within the fenced area. Again in 2006, the plaintiff sought to pipe water from a part of the fenced area, but was denied. A U.S. Fish and Wildlife Service Biological Opinion in 2004 recommended the permanent exclusion of livestock from the allotment, and the plaintiff sued for a taking of its water rights which required just compensation. While the parties were able to identify and develop some alternative sources of water, that did not solve the plaintiff’s water claims and the plaintiff sued.
The court determined that the plaintiff’s claim was not barred by the six-year statute of limitations because the plaintiff’s claim accrued in 1998 when the USFS took the first “official” action barring the grazing of cattle in the fenced area. The court also determined that under state (NM) law, the right to the beneficial use of water is a property interest that is a distinct and severable interest from the right to use land, with the extent of the right dependent on the beneficial use. The court held that the “federal appropriation of water does not, per se constitute a taking….Instead, a plaintiff must show that any water taken could have been put to beneficial use.” The court noted that NM law recognizes two types of appropriative water rights – common law rights in existence through 1907 and those based on state statutory law from 1907 forward. The plaintiff provided a Declaration of Ownership that had been filed with the New Mexico State Engineer between 1999 and 2003 for each of the areas that had been fenced-in. Those Declarations allow a holder of a pre-1907 water right to specify the use to which the water is applied, the date of first appropriation and where the water is located. Once certified, the Declaration of Ownership is prima facie evidence of ownership. The court also noted that witnesses testified that before 1907, the plaintiff’s predecessor’s in interest grazed cattle on the allotment and made beneficial use of the water in the fenced areas. Thus, the court held that the plaintiff had carried its burden to establish a vested water right. The plaintiff’s livestock watering also constituted a “diversion” required by state law. Thus, the USFS action constituted a taking of the plaintiff’s water right. Importantly, the court noted that a permanent physical occupation does not require in every instance that the occupation be exclusive, or continuous and uninterrupted. The key, the court noted, was that the effects of the government’s action was so complete to deprive the plaintiff of all or most of its interest. The court directed the parties to try to determine whether alternative water sources could be made available to the plaintiff to allow the ranching operation to continue on a viable basis. If not, the court will later determine the value of the water rights taken for just compensation purposes. Sacramento Grazing Association v. United States, No. 04-786 L. 2017 U.S. Claims LEXIS 1381 (Fed. Cl. Nov. 3, 2017).
- 6 – Department of Labor Overtime Rules Struck Down. In 2017, a federal court in Texas invalidated particular Department of Labor (DOL) rules under the Fair Labor Standards Act (FLSA). The invalidation will have a significant impact on agricultural employers. The FLSA exempts certain agricultural employers and employees from its rules. However, one aspect of the FLSA that does apply to agriculture are the wage requirements of the law, both in terms of the minimum wage that must be paid to ag employment and overtime wages. But, an exemption denies persons employed in agriculture the benefit of mandatory overtime payment. 29 U.S.C. § 213(b)(12). The agricultural exemption is broad, defining “agriculture” to include “farming in all its branches [including] the raising of livestock, bees, fur-bearing animals, or poultry,…and the production, cultivation, growing, and harvesting of...horticultural commodities and any practices performed by a farmer or on a farm as an incident to or in conjunction with farming operations.” In addition, exempt are “executive” workers whose primary duties are supervisory and the worker supervises 2 or more employees. Also exempt are workers that fall in the “administrative” category who provide non-manual work related to the management of the business, and workers defined as “professional” whose job is education-based and requires advanced knowledge. Many larger farming and ranching operations have employees that will fit in at least one of these three categories. For ag employees that are exempt from the overtime wage payment rate because they occupy an “executive” position, they must be paid a minimum amount of wages per week.
Until December 1, 2016, the minimum amount was $455/week ($23,660 annually). Under the Obama Administration’s DOL proposal, however, the minimum weekly amount was to increase to $913 ($47,476 annually). Thus, an exempt “executive” employee that is paid a weekly wage exceeding $913 is not entitled to be paid for any hours worked exceeding 40 in a week. But, if the $913 weekly amount was not met, then the employee would generally be entitled to overtime pay for the hours exceeding 40 in a week. Thus, the proposal would require farm businesses to track hours for those employees it historically has not tracked hours for – executive employees such as managers and those performing administrative tasks. But, remember, if the employee is an agricultural worker performing agricultural work, the employee need not be paid for the hours in excess of 40 in a week at the overtime rate. The proposal also imposes harsh penalties for noncompliance. Before the new rules went into effect, many states and private businesses sued to block them. The various lawsuits were consolidated into a single case, and in November of 2016, the court issued a temporary nationwide injunction blocking enforcement of the overtime regulations. Nevada v. United States Department of Labor, 218 F. Supp. 3d 520 (E.D. Tex. 2016).
On Aug. 31, 2017, the court entered summary judgment for the plaintiffs in the case thereby invalidating the regulations. In its ruling, the court focused on the congressional intent behind the overtime exemptions for “white-collar” workers as well as the authority of the DOL to define and implement those exemptions. The court also concluded that the DOL did not have any authority to categorically exclude workers who perform exempt duties based on salary level alone, which is what the court said that the DOL rules did. The court noted that the rules more than doubled the required salary threshold and, as a result, “would essentially make an employee’s duties, functions, or tasks irrelevant if the employee’s salary falls below the new minimum salary level.” The court went on to state that the overtime rules make “overtime status depend predominantly on a minimum salary level, thereby supplanting an analysis of an employee’s job duties.” The court noted that his was contrary to the clear intent of the Congress and, as a result, the rules were invalid. The court’s ruling invalidating the overtime rules is an important victory for many agricultural (and other) businesses. It alleviates an increased burden to maintain records for employees in executive positions (e.g., managers and administrators), and the associated penalties for non-compliance. The case is Nevada v. United States Department of Labor, No. 4:16-cv-731, 2017 U.S. Dist. LEXIS 140522 (E.D. Tex. Aug. 31, 2017).
Those are the "bottom five" of the "top 10" developments of 2017. On Friday I will reveal what I believe to be the top five developments.
Wednesday, December 20, 2017
Under current law, a business has options concerning where it can file bankruptcy. Those places include the state in which the business is organized, the location where the business has significant business assets or conducts business, or (in certain situations) where the parent company or affiliate has filed bankruptcy. That can create a tough situation for a farmer that has a claim against the bankrupt company if they have to travel far from their farming operation to participate in the bankruptcy. An example of this was the VeraSun bankruptcy that impacted farmers across parts of the Midwest and the Great Plains a few years ago.
Now, according to Bloomberg News and the Wall Street Journal, it looks like legislation will be introduced into the Congress that would change where a bankrupt company can file bankruptcy. See, e.g., https://www.wsj.com/articles/lawmakers-to-propose-making-bankrupt-companies-file-for-protection-close-to-home-1513644954?reflink=djemBankruptcyPro&tpl=db; This is known as “venue” and the bill is known as the “Bankruptcy Venue Reform Act of 2017.” If introduced this week, the bill may be tucked into the Omnibus spending bill that the Congress will vote on late this week. It’s a big deal for farmers, employees, retirees of bankrupt debtors (and other creditors).
Bankruptcy venue reform – today’s blog post topic.
Why Tightening Venue Matters
Several prominent bankruptcy cases filed in recent years illustrate why modifying existing venue rules matters.
VeraSun Energy Corporation (VeraSun). In early November 2008, Sioux Falls-based VeraSun and twenty-four of its subsidiaries filed for Chapter 11 bankruptcy protection to enhance liquidity while it reorganized. VeraSun got in financial trouble when it bought corn contracts at a high price and then corn prices dropped by about 50 percent before the specified delivery date in the contracts. VeraSun had failed to protect itself on the board of trade. That big price drop caused VeraSun to lose hundreds of millions of dollars. Of course, VeraSun was using the contract to hedge against corn prices going up and the farmer sellers were using them to hedge against a price decline. The corn farmers guessed right and the contracts worked to their advantage. However, VeraSun’s bankruptcy meant that VeraSun could force farmer sellers to hold their grain in a dropping market since it was not required to assume or reject the contracts until its plan of reorganization was to be heard several months down the line. If the contracting farmer sold his corn to minimize his loss, and the price of corn increased so that it made economic sense for VeraSun to enforce the purchase contract, the farmer would be forced to make up the difference. Many farmers sought to have the bankruptcy court force VeraSun to make decisions regarding assuming or rejecting the out-of-the money corn contracts quickly, so they would not be faced with a problem if the market rebounded. The bankruptcy court in Delaware was not willing to force VeraSun to act on a plant-by-plant basis, opting instead to allow each individual farmer to hire counsel in Delaware to press his case involving his contracts. This was cost prohibitive. There were over 6,000 midwestern farmers affected by this bankruptcy.
Later in the case, lawyers from Delaware and New York sent threatening letters to the farmers who had been paid for their corn promptly in accordance with state grain elevator laws demanding that they repay all sums they had been paid within 90 days of the case filing claiming that they were preferential transfers. The farmers organized, and defensive letters were sent back to the threatening lawyers who then opted to not file the threatened preference lawsuits. If the case had been filed in the Midwest, it would have been more likely that lawyers familiar with agricultural law would not have sent the preference demand letters because they would have known the prompt payment requirements of state grain elevator laws and would have recognized that these payments were in the ordinary course of business of both VeraSun and the farmers it paid.
In addition, farmers who were unpaid when the bankruptcy was filed became creditors in the VeraSun bankruptcy and had to file claims and participate in the bankruptcy process to have any hope of getting paid. Those farmers were scattered across the Midwest and Great Plains where Verasun had ethanol and biodiesel plants. None of them were located in Delaware, where VeraSun filed its bankruptcy petition.
Why did Verasun file bankruptcy in Delaware when it didn’t have any ethanol plants located in Delaware and wasn’t headquarted there? Because the an affiliated company organized in Delaware filed Chapter 11 filed bankruptcy in Delaware. Because of that, all of the affiliated companies could also file in Delaware under the applicable venue rule of the Bankruptcy Code. That meant that farmers with claims against VeraSun had to participate in Delaware bankruptcy proceedings rather than in the jurisdiction where the contracts were to be performed. That’s a frustrating, and expensive, proposition for farmers. Ultimately, VeraSun ended up selling seven of the plants to Valero Energy Corporation, and the rest to other companies in 2009.
A short video about the VeraSun bankruptcy effects on farmers, as told by an Iowa farmer, can be found at: https://www.youtube.com/watch?v=7GdifLvuRdw
Peregrine Financial Group, Inc. (PFG). PFG was an Iowa-based financial firm that was shut down in 2012 after it was put under investigation for a $200 million shortfall in customer funds. PFG’s Peregrine’s chief executive office was arrested and charged with making false statements to the Commodity Futures Trading Commission (CFTC). At the time of PFG filed Chapter 7 it had over $500 million in assets and over $100 million in liabilities. PFG filed bankruptcy in Illinois even though it was headquartered in Iowa. Similar to the VeraSun bankruptcy, many Midwest farmers were impacted by PFG’s bankruptcy.
Solyndra, LLC. The solar-panel maker Soyndra, LLC, filed Chapter 11 in 2011 in Delaware. Solyndra had received $535 million in federal financing (under the Obama Administration’s “stimulus” program) and a $25.1 million tax break from the State of California. Upon filing, the California-based company suspended its manufacturing operations and laid-off approximately 1,100 employees triggering both Federal and California Worker Adjustment and Retraining Notification Act issues. The employees affected by the mass layoffs resided in California. By filing in Delaware, Solyndra made it more expensive and burdensome for the laid-off employees to pursue their claims. The result for the employees was an out-of-court settlement of only $3.5 million (less 33% for their attorneys' contingent fee) on their claim of $15 million. One can only imagine the result if the case had been filed in California and the employees had easy access to the court deciding their fates.
Winn-Dixie Stores, Inc. (WD). WD was a supermarket chain headquartered in Florida. In April 2004, Winn-Dixie announced the closure of 156 stores, including all 111 stores located in the Midwest. On early 2005, WD filed Chapter 11 bankruptcy. To establish venue in technical compliance with the statute, the WD formed a new entity in New York shortly before the Chapter 11 filing and admitted it did so to establish venue. The bankruptcy court stated that the current statute contains a loophole allowing companies to file in venues that are not proper even if they have literally complied with the statute. The court transferred the case to Florida, with the judge stating, “…simply because I don’t believe it just to exploit the loophole in the statute to obtain venue here.” In re Winn-Dixie Stores, Inc., Case No. 05-11063 (RDD) (Bankr. S.D.N.Y. April 12, 2005) Hearing Transcript at 167.
In re Houghton Mifflin-Harcourt Publishing Co. (HM). HM was a publishing company that filed its case in the Southern District of New York in 2012. The United States Trustee filed a Motion to Change Venue. Unlike the court in WD that transferred venue, the bankruptcy court in HM found there was no statutory basis for venue in the Southern District of New York, but chose to defer transfer of venue until after confirmation of the plan. The court even chided the United States Trustee for filing the Motion to Change Venue. In re Houghton Mifflin Harcourt Publishing Co., Case No. 12‐12171 (RFG), Decision on U.S. Trustee Motion to Transfer Venue of these Cases, (June 22, 2012, Bankr. SDNY).
Boston Herald. Last week, provided another example of forum shopping at the expense of retirees, employees and the local community. The Boston Herald (Herald), a local Boston, MA, newspaper announced plans to sell the newspaper to GateHouse Media after filing Chapter 11 bankruptcy in Delaware. The only connection that the Herald has to Delaware is that its holding company is incorporated in Delaware. Eighteen of its 30 largest creditors reside in Massachusetts or New Hampshire and most are individual retirees.
Changing Venue as an Option?
The WD bankruptcy judge’s transfer of the case is a rarity. Very few cases are ever transferred. Indeed, some venue-change proceedings have turned into costly extended proceedings with evidentiary trials and extensive briefing. For instance, the Patriot Coal Corporation (a St. Louis-based spin-off of Peabody Energy Corporation) filed Chapter 11 bankruptcy in 2015. On a motion to transfer venue from the Southern District of New York, the bankruptcy court took four months to issue a 61-page decision based on facts that were largely uncontested and involved the manipulation of current venue law. Venue was determined to be in the Southern District of New York. Based on a review of the interim fee applications filed in the Patriot Coal case, it can be estimated that the debtor spent approximately $2 million and the creditors spent an additional $1 million to litigate the venue challenge. The court’s opinion “demonstrates the near impossibility of having venue transferred away from New York.” See Bill Rochelle, Patriot Shows Futility of Moving Cases from NY, Bloomberg (11/29/12).
In In re Enron Corp., 274 B.R. 327 (Bankr. S.D. N.Y. 2002), the court stressed the importance of case administration, and noted the “learning curve” the court acquired in the first month of the case in denying a motion to change venue filed shortly after the filing of the case. Enron and other cases such as In re Jitney Jungle, Case No. 99‐3602 (Bankr. D. Del.) and the WD case mentioned above demonstrate that by the time courts consider venue transfer motions, most of the important first day or “second day” motions relating to debtor-in-possession financing, sale procedures, break-up fees and the like would have already been entered and have become final. The reorganization case would have progressed forward so far and taken such a direction that it bears the indelible imprint of the first court. Such was the case with Jitney Jungle. By the time this case was transferred to New Orleans there was little that the New Orleans bankruptcy judge said that he could do because of the actions taken or orders previously entered in Delaware. Similarly, in Winn-Dixie, by the time the Florida judge received the case, so much of substance had already been ordered in the case that there was little the Florida judge could do but administer the orders of the prior judge.
Bankruptcy Venue Reform Act of 2017
The goal of the legislation is to drastically reduce the ability of companies to forum shop bankruptcies by denying access to justice for creditors of companies that choose to file their bankruptcies primarily in the Southern District of New York and Delaware. The legislation does this will by eliminating place of incorporation as a proper venue as well as eliminating the affiliate rule allowing the companies to file a Delaware affiliate first in Delaware, then file the rest of the cases in Delaware. Under the bill, venue is appropriate only in the district court for the district where an individual debtor is domiciled, resides, or where their principal assets have been located for the 180-day period immediately preceding the bankruptcy petition, or for a longer portion of the 180-day period than the domicile, residence or principal asset were located anywhere else. The same 180-day rule applies to a business debtor, but in terms of the debtor’s principal place of business rather than residence or domicile.
Venue is also proper in jurisdictions where there is already a pending bankruptcy case concerning an affiliate that directly or indirectly owns, controls, is the general partner, or holds 50 percent or more of the outstanding voting securities, of the person or entity that is the subject of the later-filed case if the pending case was properly filed in that district. The bill also says that changes of ownership or control of a person or entity or assets or principal place of business within a year before bankruptcy filing that is done with the purpose of establishing venue are to be ignored. A court could still transfer a case in the interest of justice or for the convenience of the parties.
Currently, bankruptcies can be filed in several places, including the state of organization of the company, the district where a company has significant business assets or conducts business, or in the district where a parent or an affiliate has filed bankruptcy. The proposed legislation will make it difficult for bankruptcies to be filed remotely from the company’s assets or headquarters. The idea is to increase fair access to justice for the parties affected by a bankruptcy. The bill is a big deal for bankruptcy reform and fairness to creditors. While similar legislation was introduced in 2011, it was opposed by the Obama Administration. Individuals and businesses interested in the matter should contract their Congressional Representatives and Senators immediately and request Senators to Co-sponsor the bill and ask their Representatives to support it.
Wednesday, December 6, 2017
For Chapter 7 and 11 filers, there is a possibility that taxes could be dischargeable in bankruptcy. That’s because under those bankruptcy code provisions, a new tax entity is created at the time of bankruptcy filing. That’s not the case for individuals that file Chapter 12 (farm) bankruptcy or 13 and for partnerships and corporations under all bankruptcy chapters. In those situations, the debtor continues to be responsible for the income tax consequences of business operations and disposition of the debtor's property. Thus, payment of all the tax triggered in bankruptcy is the responsibility of the debtor. The only exception is that Chapter 12 filers can take advantage of a special rule that makes the taxes a non-priority claim.
A new Tax Court case involving a Chapter 7 filer, illustrates how timing the bankruptcy filing is important for purposes of being able to discharge taxes in a Chapter 7.
Taxes discharged in bankruptcy, that’s the focus of today’s post.
The Bankruptcy Estate as New Taxpayer
The creation of the bankruptcy estate as a new taxpayer, separate from the debtor, highlights the five categories of taxes in a Chapter 7 or 11 case.
- Category 1 taxes are taxes where the tax return was due more than three years before filing. These taxes are dischargeable unless the debtor failed to file a return or filed a fraudulent return.
- Category 2 taxes are the taxes due within the last three years. These taxes are not dischargeable but are entitled to an eighth priority claim in the bankruptcy estate, ahead of the unsecured creditors.
- Category 3 taxes are the taxes for the portion of the year of bankruptcy filing up to the day before the day of bankruptcy filing. If the debtor's year is closed as of the date of filing, the taxes for the first year, while not dischargeable, are also entitled to an eighth priority claim in the bankruptcy estate. If the debtor's year is not closed, the entire amount of taxes for the year of filing are the debtor's responsibility.
- Category 4 taxes are the taxes triggered on or after the date of filing and are the responsibility of the bankruptcy estate. Taxes due are paid by the bankruptcy estate as an administrative expense. If the taxes exceed the available funds, the tax obligation remains against the bankruptcy estate but does not return to the debtor.
- Category 5 taxes are for the portion of the year beginning with the date of bankruptcy filing (or for the entire year if the debtor's year is not closed) and are the responsibility of the debtor.
The Election To Close the Debtor’s Tax Year
In general, the bankrupt debtor’s tax year does not change upon the filing of bankruptcy. But, debtors having non-exempt assets may elect to end the debtor’s tax year as of the day before the filing.
Making the election creates two short tax years for the debtor. The first short year ends the day before bankruptcy filing and the second year begins with the bankruptcy filing date and ends on the bankrupt’s normal year-end date. If the election is not made, the debtor remains individually liable for income taxes for the year of filing. But, if the election is made, the debtor’s income tax liability for the first short year is treated as a priority claim against the bankruptcy estate, and can be collected from the estate if there are sufficient assets to pay off the estate’s debts. If there are not sufficient assets to pay the income tax, the remaining tax liability is not dischargeable, and the tax can be collected from the debtor at a later time. The income tax owed by the bankrupt for the years ending after the filing is paid by the bankrupt and not by the bankruptcy estate. Thus, closing the bankrupt’s tax year can be particularly advantageous if the bankrupt has substantial income in the period before the bankruptcy filing. Conversely, if a net operating loss, unused credits or excess deductions are projected for the first short year, an election should not be made in the interest of preserving the loss for application against the debtor’s income from the rest of the taxable year. Even if the debtor projects a net operating loss, has unused credits or anticipates excess deductions, the debtor may want to close the tax year as of the day before bankruptcy filing if the debtor will not likely be able to use the amounts, the items could be used by the bankruptcy estate as a carryback to earlier years of the debtor (or as a carryforward) and, the debtor would likely benefit later from the bankruptcy estate’s use of the loss, deduction or credits.
But, in any event, if the debtor does not act to end the tax year, none of the debtor’s income tax liability for the year of bankruptcy filing can be collected from the bankruptcy estate. Likewise, if the short year is not elected, the tax attributes (including the basis of the debtor’s property) pass to the bankruptcy estate as of the beginning of the debtor’s tax year. Therefore, for example, no depreciation may be claimed by the debtor for the period before bankruptcy filing. That could be a significant issue for many agricultural debtors.
Consider the following example:
Sam Tiller, a cash method taxpayer, on January 26, 2016, bought and placed in service in his farming business, a new combine that cost $402,000. Sam is planning on electing to claim $102,000 of expense method depreciation on the combine and an additional $150,000 (50 percent of the remaining depreciable balance) of first-year bonus depreciation as well as regular depreciation on the combine for 2016. However, during 2016, Sam’s financial condition worsened severely due to a combination of market and weather conditions. As a result, Sam filed Chapter 7 bankruptcy on December 5, 2016.
If Sam does not elect to close the tax year, the tax attributes (including the basis of his property) will pass to the bankruptcy estate as of the beginning of Sam’s tax year (January 1, 2016). Therefore, Sam would not be able to claim any of the depreciation for the period before he filed bankruptcy (January 1, 2016, through December 4, 2016).
Recent Tax Court Case
In Ashmore v. Comr., T.C. Memo. 2017-233, the petitioner claimed that his 2009 tax liability, the return for which was due on April 15, 2010, was discharged in bankruptcy. He filed Chapter 7 on April 8, 2013. That assertion challenged whether the collection action of the IRS was appropriate. As indicated above, the Tax Court noted that taxes are not dischargeable in a Chapter 7 bankruptcy if they become due within three years before the date the bankruptcy was filed. Because the petitioner filed bankruptcy a week too soon, the Tax Court held that his 2009 taxes were dischargeable and could be collected. As a result, the IRS settlement officer did not abuse discretion in sustaining the IRS levy. In addition, the Tax Court, held that the IRS did not abuse the bankruptcy automatic stay provision that otherwise operates to bar creditor actions to collect on debts that arose before the bankruptcy petition was filed.
The Tax Court’s conclusion in Ashmore is not surprising. The three-year rule has long been a part of the bankruptcy code. Indeed, in In re Reine, 301 B.R. 556 (Bankr. W.D. Mo. 2003), the debtor filed the Chapter 7 bankruptcy petition more than three years after filing the tax return, but within three years of due date of return. The court held that the debtor’s tax debt was not dischargeable.
Thursday, November 30, 2017
In 1930, the Congress enacted the Perishable Agricultural Commodities Act (PACA) to address unfair and fraudulent practices in the marketing of perishable agricultural commodities in interstate and foreign commerce. 7 U.S.C. §§ 499a et seq. A provision in the PACA requires a covered “dealer” to “promptly pay” for the purchase of perishable agricultural commodities. One way that the PACA ensures prompt payment is via the creation of a PACA trust to hold the proceeds of the sale of perishable commodities for the for the benefit of the unpaid seller until full payment is made. 7 U.S.C. § 499e(c)(2).
This PACA trust provision was added in 1984 to address the problem of buyers filing bankruptcy after purchasing perishable commodities, but before full payment was made. Basically, once an unpaid seller learns that a buyer has become insolvent, a PACA trust is created and the PACA trust funds (amounts owed to the seller) are escrowed for pro rata distribution to the PACA trust beneficiary or beneficiaries. The point is that the assets in a PACA trust are excluded from the bankruptcy estate of a bankrupt buyer.
A recent case involved an interesting question - whether the PACA trust bars a bankruptcy debtor-in-possession (DIP), from using the cash collateral of the PACA trust in the continued operation of the DIP’s business. Is the status of the perishable commodity seller as a PACA trust beneficiary sufficient, by itself, to bar the DIP’s use of the cash collateral?
The rights of a DIP to use cash collateral of a PACA trust, that’s the topic of today’s post.
Chapter 11 and the DIP
A DIP is a party (individual or corporation) that has filed a Chapter 11 (reorganization) bankruptcy petition. While creditors of the DIP have liens in the DIP’s property, the DIP remains in control of the property and continues to operate the underlying business. The DIP essentially continues to operate the business in a fiduciary capacity for the creditors’ best interest. Thus, ordinary business operations are permissible, but the DIP has to get court approval for actions that are beyond the scope of normal business practices.
Recent Bankruptcy Case
In a recent Chapter 11 bankruptcy case, In re Cherry Growers, Inc., No. 17-04127-swd, 2017 Bankr. LEXIS 3838 (W.D. Mich. Nov. 1, 2017), the debtor, as a Chapter 11 DIP, filed a motion for an order authorizing its use of cash collateral. A bank, the DIP’s principal secured creditor, supported the motion. However, a claimant asserting PACA rights opposed the motion because, in its view, such an order would violate the claimant’s PACA trust rights as well as the rights of others as beneficiaries of the PACA trust.
As mentioned above, the PACA creates a statutory trust to protect growers of perishable agricultural products against the risk of non-payment by buyers and others. A PACA claimant, as a seller of eligible produce, has a trust claim against the qualifying inventory and proceeds that is superior to the claims and liens of the buyer’s creditors with no regard to whether the creditors are secured or unsecured and without regard to the priority level of the claim. Under the facts of the case, the claimant held an equitable interest in the bankruptcy estate with respect to its $337,159.18 PACA claim, and the question before the court was whether that equitable interest was sufficient to deny the debtor’s requested (and otherwise consensual) use of its secured lender’s cash collateral, especially where a sufficient equity cushion existed to adequately protect the PACA claimant’s claim.
The court held an interim hearing on the motion at which it took testimony, granted interim relief and scheduled a final hearing. At the final hearing PACA claimant argued that its PACA claim reached all of the DIP’s property, at least if the DIP could not prove otherwise. The claimant asserted that its status as PACA trust beneficiary was sufficient to bar a debtor from utilizing the cash collateral. The claimant also argued that in the absence of proof the contrary from the DIP, all income derived during the case from any of the property in the DIP’s possession, would constitute proceeds of the PACA trust, and that the DIP could not use any of the property because it belonged to the PACA claimant and not the bankruptcy estate.
The court did note the power of the PACA trust. Specifically, the court pointed out that, under PACA, growers and suppliers of perishable agricultural products who have properly preserved their rights under the statute are entitled to the benefit of a broad and powerful “floating trust” in their buyer’s qualifying inventory and proceeds thereof. These trust claims are to be paid first from trust assets, even prior to any claims or interests of secured creditors in such property. Furthermore, the court noted that the commingling of trust assets is specifically contemplated under the federal regulations implementing PACA. As the court recognized, PACA is “designed to promote priority payment to the PACA claimant.”
However, the court held that to conclude that the subject matter of the PACA trust is excluded from the bankruptcy estate overstated the case holdings that the PACA claimant cited. Instead, the court determined that the PACA expressly contemplates the commingling of trust and non-trust property, the creation of a “floating trust,” and the continued operation of the PACA trustee. Thus, within the context of a Chapter 11 bankruptcy, the DIP presumptively continues operating its business in accord with applicable non-bankruptcy law. In turn, the court reasoned, this meant that it made sense to think in terms of permitting the DIP to use its buildings and equipment to conduct its business as it had done for years, along with the cash and cash equivalents derived from that use, even though they may be impressed to some extent with a statutory trust, as long as the DIP provides adequate protection of the PACA claimant’s interest in the estate property. In addition, because the value of the property of the estate that the PACA claimant believed to be impressed with the PACA trust far exceeded the claimant’s claim, the court concluded that the DIP had met its burden of showing that the claimant would be adequately protected. Therefore, the court granted the DIP’s motion authorizing the use of the cash collateral in the property in which the PACA claimant had an equitable interest, in accordance with 11 U.S.C. §363 “as long as the DIP provides adequate protection of [the PACA claimant’s] interests in the estate property.” Because the DIP’s property that the PACA claimant alleged was subject to the PACA trust was much greater than the PACA claimant’s $337,159.18 claim, the court found that the PACA claimant’s interests were adequately protected.
The court also disagreed with the PACA claimant’s assertion that the DIP bore the burden of proof that the property that the DIP wanted to utilize in its business operations were not property of the PACA trust. Instead, the court determined that the PACA claimant had to first prove that the claimant had an interest in the DIP’s property. After that, the DIP had to establish that adequate protection was provided to the PACA claimant. In so holding, the court distinguished a contested matter under 11 U.S.C. §363 from that involving a battle of competing property interests.
What’s the “take-home” from the court’s decision? Certainly, PACA claimants have substantial rights. But, there are limits on those rights. In addition, according to the court, a PACA claimant’s equitable interests in the PACA trust are not bankruptcy estate property, but the assets themselves are under 11 U.S.C. §541. The case could also indicate that DIPs may have more leverage with creditors in getting authority to use cash collateral to conduct continuing business operations.
Tuesday, November 14, 2017
In the context of Chapter 12 (farm) bankruptcy, unless a secured creditor agrees otherwise, the creditor is entitled to receive the value, as of the effective date of the plan, equal to the allowed amount of the claim. Thus, after a secured debt is written down to the fair market value of the collateral, with the amount of the debt in excess of the collateral value treated as unsecured debt which is generally discharged if not paid during the term of the plan, the creditor is entitled to the present value of the amount of the secured claim if the payments are stretched over a period of years.
What does “present value” mean? It means that a dollar in hand today is worth more than a dollar to be received at some time in the future. It also means that an interest rate will be attached to that deferred income. But, what interest rate will make a creditor whole? A recent decision by the Second Circuit Court of Appeals for the Second Circuit sheds some light on the issue.
Determining Present Value
Basically, present value represents the discounted value of a stream of expected future incomes. That stream of income received in the future is discounted back to present value by a discount rate. The determination of present value is highly sensitive to the discount rate, which is commonly express in terms of an interest rate. Several different approaches have been used in Chapter 12 bankruptcy cases (and nearly identical situations in Chapters 11 and 13 cases) to determine the discount rate. Those approaches include the contract rate – the interest rate used in the debt obligation giving rise to the allowed claim; the legal rate in the particular jurisdiction; the rate on unpaid federal tax; the federal civil judgment rate; the rate based on expert testimony; a rate tied to the lender’s cost of funds; and the market rate for similar loans.
In 2004, however, the U.S. Supreme Court, in, addressed the issue in the context of a Chapter 13 case that has since been held applicable in Chapter 12 cases. Till v. SCS Credit Corporation, 541 U.S. 465 (2004). In Till, the debtor owed $4,000 on a truck at the time of filing Chapter 13. The debtor proposed to pay the creditor over time with the payments subject to a 9.5 percent annual interest rate. That rate was slightly higher than the average loan rate to account for the additional risk that the debtor might default. The creditor, however, argued that it was entitled to a 21 percent rate of interest to ensure that the payments equaled the “total present value” or were “not less than the [claim’s] allowed amount.” The bankruptcy court disagreed, but the district court reversed and imposed the 21 percent rate. The United States Court of Appeals for the Seventh Circuit held that the 21 percent rate was “probably” correct, but that the parties could introduce additional concerning the appropriate interest rate.
On further review by the U.S. Supreme Court, the Court held that the proper interest rate was 9.5 percent. That rate, the Court noted, was derived from a modification of the average national loan rate to account for the risk that the debtor would default. The Court’s opinion has been held to be applicable in Chapter 12 cases. See, e.g., In re Torelli, 338 B.R. 390 (Bankr. E.D. Ark. 2006); In re Wilson, No. 05-65161-12, 2007 Bankr. LEXIS 359 (Bankr. D. Mont. Feb. 7, 2007); In re Woods, 465 B.R. 196 (B.A.P. 10th Cir. 2012). The Court rejected the coerced loan, presumptive contract rate and cost of funds approaches to determining the appropriate interest rate, noting that each of the approaches was “complicated, impose[d] significant evidentiary costs, and aim[ed] to make each individual creditor whole rather than to ensure the debtor’s payments ha[d] the required present value.” A plurality of the Court explained that these difficulties were not present with the formula approach. The Court opined that the formula approach requires that the bankruptcy court determine the appropriate interest rate by starting with the national prime rate and then make an adjustment to reflect the risk of nonpayment by the debtor. While the Court noted that courts using the formula approach have typically added 1 percent to 3 percent to the prime rate as a reflection of the risk of nonpayment, the Court did not adopt a specific percentage range for risk adjustment.
Since the Supreme Court’s Till decision, the Circuit Courts have split on whether the appropriate interest rate for determining present value should be the market rate or a rate based on a formula. In the most recent Circuit Court case on the issue, the Second Circuit held that a market rate of interest should be utilized if an efficient market existed in which the rate could be determined. In re MPM Silicones, L.L.C., No. 15-1682(l), 2017 U.S. App. LEXIS 20596 (2nd Cir. Oct. 20, 2017). In the case, the debtor filed Chapter 11 and proposed a reorganization plan that gave first-lien holders an option to receive immediate payment without any additional “make-whole” premium, or the present value of their claims by utilizing an interest rate based on a formula that resulted in a rate below the market rate. The bankruptcy court confirmed the plan, utilizing the formula approach of Till. The federal district court affirmed. On further review, the appellate court reversed noting that Till had not conclusively specified the use of the formula approach in a Chapter 11 case. The appellate court remanded the case to the bankruptcy court for a determination of whether an efficient market rate could be determined based on the facts of the case.
The interest rate issue is an important one in reorganization bankruptcy. The new guidance of the appropriate interest rate in a Chapter 11 is instructive. That’s particularly true because of the debt limit of $4,153,150 that applies in a Chapter 12. That limit is forcing some farmers to file Chapter 11 instead. There is no debt limit in a Chapter 11 case. Whether the Second Circuit’s recent decision will be followed by other appellate courts remains to be seen. But, the market rate, as applied to an ag bankruptcy, does seem to recognize that farm and ranch businesses are subject to substantial risks and uncertainties from changes in price and from weather, disease and other factors. Those risks are different depending on the type of agricultural business the debtor operates. A market rate of interest would be reflective of those factors.
Monday, October 9, 2017
The farm economy continues to struggle. Of course, certain parts of the country are experiencing more financial trauma than are other parts of the country, but recent years have been particularly difficult in the Corn Belt and Great Plains. Aggregate U.S. net farm income has dropped by approximately 50 percent from its peak in 2011. It is estimated to increase slightly in 2017, but it has a long way to go to get back to the 2011 level. In addition, the value of farmland relative to the value of the crops produced on it has fallen to its lowest point ever. A dollar of farm real estate has never produced less value in farm production, and real net farm income relative to farm real estate values have not been as low as presently since 1980 to 1983.
A deeper dive on farm financial data indicates that after multiple years of declining debt-to-asset ratios, there was an uptick in 2015 and 2016. Relatedly, default risk remains low, but it also increased in 2015 and 2016. Also, there has been a decline in the ratio of working capital to assets, and a drop in the repayment capacity of ag loans. As a financial fitness indicator, repayment capacity is a key. At the beginning of the farm debt crisis in the early 1980s, it dropped precipitously due to a substantial increase in interest payments and a decline in farm production. That meant that land values could no longer be supported, and they dropped substantially. Consequently, many farmers found themselves with collateral value that was lower than the amount borrowed. Repayment capacity is currently a serious issue that could lead to additional borrowing.
While financial conditions may improve a bit in 2017 and on into 2018, working capital may continue to erode in 2017 which could lead to increased debt levels. That’s because average net farm income will remain at low levels. This could lead to some agricultural producers and lenders having to make difficult decisions before next spring. It also places a premium on understanding clause language in lending document and the associated rights and obligations of the parties.
Two clauses deserve close attention. One clause contains “cross collateralization” language. “Cross-collateralization” is a term that describes a situation when the collateral for one loan is also used as collateral for another loan. For example, if a farmer takes out multiple loans with the same lender, the security for one loan can be used as cross-collateral for all the loans. A second clause contains a “co-lessee” provision. That’s a transaction involving joint and several obligations of multiple parties.
Today’s post takes a deeper look at the implications of cross-collateral and co-lessee language in lending documents. My co-author for today’s post is Joe Peiffer of Peiffer Law Office in Hiawatha, Iowa. Joe brought the issues with cross-collateralization and co-lessee clause language to my attention. Joe has many years of experience working with farmers in situations involving lending and bankruptcy, and has valuable insights.
As noted above, clause language in lending and leasing documents should be carefully reviewed and understood for their implications. This is particularly true with respect to cross-collateralization language. For example, the following is an example of such a clause that appears to be common in John Deere security agreements. Here is how the language of one particular clause reads:
“Security Interest; Missing Information. You grant us and our affiliates a security interest in the Equipment (and all proceeds thereof) to secure all of your obligations under this Contract and any other obligations which you may have to us or any of our affiliates or assignees at any time and you agree that any security interest you have granted or hereafter grant to us or any of our affiliates shall also secure your obligations under this Contract. You agree that we may act as agent for our affiliates and our affiliates may as agent for us, in order to perfect and realize on any security interest described above. Upon receipt of all amounts due and to become due under this Contract, we will release our security interest in the Equipment (but not the security interest for amounts due an affiliate), provided no event of default has occurred and is continuing. You agree to keep the Equipment free and clear of all liens and encumbrances, except those in favor of us and our affiliates as described above, and to promptly notify us if a lien or encumbrance is placed or threated against the Equipment. You irrevocably authorize us, at any time, to (a) insert or correct information on this Contract, including your correct legal name, serial numbers and Equipment descriptions; (b) submit notices and proofs of loss for any required insurance; (c) endorse your name on remittances for insurance and Equipment sale or lease proceeds; and (d) file a financing statement(s) which describes either the Equipment or all equipment currently or in the future financed by us. Notwithstanding any other election you may make, you agree that (1) we can access any information regarding the location, maintenance, operation and condition of the Equipment; (2) you irrevocably authorize anyone in possession of that information to provide all of that information to us upon our request; (3) you will not disable or otherwise interfere with any information gathering or transmission device within or attached to the Equipment; and (4) we may reactivate such device.”
So, what does that clause language mean? Several points can be made:
- The clause grants Deere Financial and its affiliates a security interest in the equipment pledged as collateral to secure the obligations owed to it as well as its affiliates.
- When all obligations (including debt on the equipment purchased under the contract and all other debts for the purchase of equipment that Deere Financial finances) to Deere under the contract are paid, Deere Financial will release its security interest in the equipment. That appears to be straightforward and unsurprising. However, the release does not release the security interest of the Deere’s affiliates. This is the cross-collateral provision.
- The clause also makes Deere Financial the agent of its affiliates, and it makes the affiliates the agent of Deere Financial for purposes of perfection. What the clause appears to mean is that if a financing statement was not filed timely, perfection by possession could be pursued.
- The clause also irrevocably authorizes John Deere to insert or correct information on the contract.
- The clause allows John Deere to access any information regarding the location, maintenance, operation and condition of the collateral.
- The clause also irrevocably authorizes anyone in possession of that information to provide it to John Deere upon request.
- Also, under the clause, the purchaser agrees not to disable or interfere with any information gathering or transmission device in or attached to the Equipment and authorizes John Deere to reactivate any device.
Example. Consider the following example of the effect of cross-collateralization by machinery sellers and financiers:
Equity by Item
JD 4710 Sprayer 90' Boom
JD 333E Compact Track Loader
JD 8410T Crawler Tractor
JD 612C 12 Row Corn Head
Equity with Cross Collateralization
Equity without Cross Collateralization
The equity in the equipment without cross-collateralization is the sum of the equity in the Compact Track Loader, the Crawler Tractor and the Row Corn Head.
Sellers that finance the purchase price of the item(s) sold (termed a “purchase money” lender) seem to be using cross-collateralization provisions with some degree of frequency. As noted, the cross-collateralization provisions of the John Deere security agreement will allow John Deere to offset its under-secured status on some machinery by using the equity in other financed machines to make up the unsecured portion of its claims. Other machinery financiers (such as CNH and AgDirect) are utilizing similar cross-collateral provisions in their security agreements.
Can A “Dragnet” Lien Defeat a Cross-Collateralization Provision?
Would a bank’s properly filed financing statement and perfected blanket security agreement be sufficient to defeat a cross-collateralization provision? It would seem inequitable to allow an equipment financier’s subsequently filed financing statement to defeat the security interest of a bank. So far, it appears that when a purchase money security interest holder has sought to enforce a cross-collateralization clause, the purchase money security interest holder has always backed down. For example, in one recent scenario, John Deere Financial sought to enforce its cross-collateralization agreement against a Bank in a situation similar to the one set forth above. The Bank properly countered that its blanket security interest in farm equipment perfected before any of the Deere Financial purchase money security interests were perfected defeated the Deere Financial cross-collateralization. Deere Financial backed down thereby allowing the Bank to have all the equity in the equipment, $80,000, be paid to the Bank by the auctioneer after the liquidation auction.
A “Co-Lessee” Clause
When a guarantee on a loan cannot be obtained, a proposal may be made for “joint and several obligations.” In that situation, the lessor tries to compel one lessee to cover another lessee’s obligations or joint obligations. It’s a lease-sublease structure, with the original lessee becoming the sublessor. While the original lessee/sublessor has no rights to use the equipment (those rights are passed to the sublessee), the original lessee/sublessor remains legally obligated for performance. The sublease can then be assigned as collateral to the original lessor.
While a co-borrower situation is not uncommon, a transaction involving co-lessees is different inasmuch as a lease involves the right to use and possess property along with the obligation to pay for the property. A loan document simply involves the repayment of debt. So, what if a co-lessee arrangement goes south and the lessor tries to compel one lessee to cover another lessee’s joint obligation? What is the outcome? That’s hard to say simply because there aren’t any litigated cases on the issue with published opinions. But, numerous legal (and (tax) issues would be involved. For instance, with a true lease (see an earlier post on the distinction between a true lease and a capital lease), what if the lessees argue over the use and possession of the equipment or the removal of liens or maintenance of the property or the rental or return of the property? What about the payment of taxes? Similar issues would arise in a lease/purchase situation that encounters problems. What is known is that in such a dispute numerous Uniform Commercial Code issues are likely to arise under both Article 2 and Article 9.
The following is an example of John Deere’s co-lessee clause when it has an additional party sign on a lease:
“By signing below, each of the co-lessees identified below (each, a “Co-Lessee”) acknowledges and agrees that (1) the Lessee indicated on the above referenced Master Lease Agreement (the “Master Agreement”) and EACH CO-LESSEE SHALL BE JOINTLY AND SEVERALLY LIABLE FOR ANY AND ALL OF THE OBLIGATIONS set forth in the Master Agreement and each Lease Schedule entered into from time to time thereunder including, but not limited to, the punctual payment of any periodic payments or any other amounts which may become due and payable under the terms of the Master Agreement, whether or not said Co-Lessee signs each Lease Schedule or receives a copy thereof, and (2) it has received a complete copy of the Master Agreement and understands the terms thereof.
In the event (a) any Co-Lessee fails to remit to the Lessor indicated above any Lease Payment or other payment when due, (b) any Co-Lessee breaches any other provision of the Master Agreement or any Lease Schedule and such default continues for 10 days; (c) any Co-Lessee removes any Equipment (as such term is more fully described in the applicable Lease Schedule) from the United States; (d) a petition is filed by or against any Co-Lessee or any guarantor under any bankruptcy or insolvency law; (e) a default occurs under any other agreement between any Co-Lessee (or any of Co-Lessee's affiliates) and Lessor (or any of Lessor's affiliates); (f) or any Co-Lessee or any guarantor merges with or consolidates into another entity, sells substantially all its assets, dissolves or terminates its existence, or (if an individual) dies; or (g) any Co-Lessee fails to maintain the Insurance required by Section 6 of the Master Agreement, Lessor may pursue any and all of the rights and remedies available to Lessor under the terms of the Master Agreement directly against any one or more of the Co-Lessees. Nothing contained in the Addendum shall require Lessor to first seek or exhaust any remedy against any one Co-Lessee prior to pursuing any remedy against any other Co-Lessee(s).
Capitalized terms not defined in this Addendum shall have the meaning provided to them in the Master Agreement.”
Clearly, a party signing on as a co-lessee on a John Deere lease is assuming a great deal of risk.
Times are tough for many involved in production agriculture. The same is true for many agribusiness and agricultural lenders. If a producer is presented with a lending transaction that involves either a cross-collateralization or a co-lessee clause, legal counsel with experience in such transactions should be consulted. Fully understanding the risks involved can pay big dividends. Failing to understand the terms of these clauses can lead to the financial failure of the farmer that signs the document.
Tuesday, August 22, 2017
On September 18, Washburn School of Law will be having its second annual CLE conference in conjunction with the Agricultural Economics Department at Kansas St. University. The conference, hosted by the Kansas Farm Bureau (KFB) in Manhattan, KS, will explore the legal, economic, tax and regulatory issue confronting agriculture. This year, the conference will also be simulcast over the web.
That’s my focus today – the September 18 conference in Manhattan, for practitioners, agribusiness professionals, agricultural producers, students and others.
Financial situation. Midwest agriculture has faced another difficult year financially. After greetings by Kansas Farm Bureau General Counsel Terry Holdren, Dr. Allen Featherstone, the chair of the ag econ department at KSU will lead off the day with a thorough discussion on the farm financial situation. While his focus will largely be on Kansas, he will also take a look at nationwide trends. What are the numbers for 2017? Where is the sector headed for 2018?
Regulation and the environment. Ryan Flickner, Senior Director, Advocacy Division, at the KFB will then follow up with a discussion on Kansas regulations and environmental laws of key importance to Kansas producers and agribusinesses.
Tax – part one. I will have a session on the tax and legal issues associated with the wildfire in southwest Kansas earlier this year – handling and reporting losses, government payments, gifts and related issues. I will also delve into the big problem in certain parts of Kansas this year with wheat streak mosaic and dicamba spray drift.
Weather. Mary Knapp, the state climatologist for Kansas, will provide her insights on how weather can be understood as an aid to manage on-farm risks. Mary’s discussions are always informative and interesting.
Crop Insurance. Dr. Art Barnaby, with KSU’s ag econ department, certainly one of the nation’s leading experts on crop insurance, will address the specific situations where crop insurance does not cover crop loss. Does that include losses caused by wheat streak mosaic? What about losses from dicamba drift?
Washburn’s Rural Law Program. Prof. Shawn Leisinger, the Executive Director of the Centers for Excellence at the law school (among his other titles) will tell attendees and viewers what the law school is doing (and planning to do) with respect to repopulating rural Kansas with well-trained lawyers to represent the families and businesses of agriculture. He will also explain the law school’s vision concerning agricultural law and the keen focus that the law school has on agricultural legal issues.
Succession Planning. Dr. Gregg Hadley with the KSU ag econ department will discuss the interpersonal issues associated with transitioning the farm business from one generation to the next. While the technical tax and legal issues are important, so are the personal family relationships and how the members of the family interact with each other.
Tax – part two. I will return with a second session on tax issues. This time my focus will be on hot-button issues at both the state and national level. What are the big tax issues for agriculture at the present time? There’s always a lot to talk about for this session.
Water. Prof. Burke Griggs, another member of our “ag law team” at the law school, will share his expertise on water law with a discussion on interstate water disputes, the role of government in managing scarce water supplies, and what the relationship is between the two. What are the implications for Kansas and beyond?
Producer panel. We will close out the day with a panel consisting of ag producers from across the state. They will discuss how they use tax and legal professionals as well as agribusiness professionals in the conduct of their day-to-day business transactions.
The Symposium is a collaborative effort of Washburn law, the ag econ department at KSU and the KFB. For lawyers, CPAs and other tax professionals, application has been sought for continuing education credit. The symposium promises to be a great day to interact with others involved in agriculture, build relationships and connections and learn a bit in the process.
We hope to see you either in-person or online. For more information on the symposium and how to register, check out the following link: https://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
August 22, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Monday, July 31, 2017
Today's post is a deviation from my normal posting on an aspect of agricultural law and tax that you can use in your practice or business. That’s because I have a new book that is now available that you might find useful as a handbook or desk reference. Thanks to West Academic Publishing, my new book “Agricultural Law in a Nutshell,” is now available. Today’s post promotes the new book and provides you with the link to get more information on how to obtain you copy.
The Nutshell is taken from my larger textbook/casebook on agricultural law that is used in classrooms across the country. Ten of those 15 chapters are contained in the Nutshell, including some of the most requested chapters from my larger book – contracts, civil liabilities and real property. Also included are chapters on environmental law, water law and cooperatives. Bankruptcy, secured transactions, and regulatory law round out the content, along with an introductory chapter. Not included in this Nutshell are the income tax, as well as the estate and business planning topics. Those remain in my larger book, and are updated twice annually along with the other chapters found there.
The Nutshell is designed as a concise summary of the most important issues facing agricultural producers, agribusinesses and their professional advisors. Farmers, ranchers, agribusinesses, legal advisors and students will find it helpful. It’s soft cover and easy to carry.
Rural Law Program
The Nutshell is another aspect of Washburn Law School’s Rural Law Program. This summer, the Program placed numerous students as interns with law firms in western Kansas. The feedback has been tremendous and some lawyers have already requested to be on the list to get a student for next summer. Students at Washburn Law can take numerous classes dealing with agricultural issues. We are also looking forward to our upcoming Symposium with Kansas State University examining the business of agriculture and the legal and economic issues that are the major ones at this time. That conference is set for Sept. 18, and a future post will address the aspects of that upcoming event.
You can find out more information about the Nutshell by clicking here: https://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/agriculturallawnutshell/index.html
Thursday, July 27, 2017
Low commodity prices over the past couple of years for many commodities, particularly in the Midwest and the Great Plains, have resulted in financial stress for many farmers. For example, 2015 farm income in Kansas was the lowest since 1985. Prices have dropped and are volatile and subject to economic conditions around the world. In addition, the cost of production has continued to rise. All of this have an impact on a farmer’s ability to repay debt. That repayment capacity has dropped dramatically over the past two-three years. All of this makes marketing important as well as the proper utilization of crop revenue insurance. Ultimately, continued low prices will also have an impact on land values and, in some areas, that impact is already being noticed.
An associated concern is the strain placed on grain elevators. If an elevator fails, what’s the impact on farmers that have deposited grain and on the agricultural community? What are the rights that a farmer has when an elevator fails? How much can be recovered, and when can it be recovered? Are there any legal remedies? These issues are the focus of today’s post.
A farmer that has stored grain at an elevator that files bankruptcy is not a creditor of the elevator. That’s because the grain in storage is the farmer’s property. The farmer’s ownership of the grain is evidenced by a warehouse receipt or a scale ticket. Both of those serve as prima facie evidence of the farmer’s ownership of the stored grain. So, the farmer’s relationship with the elevator is not a creditor/debtor relationship, but a bailee/bailor one. Uniform Commercial Code (U.C.C.) §7-102(a)(1). In addition, that relationship is not impacted just because the elevator will return to the farmer grain of like quality rather than the identical grain that the farmer delivered to the elevator. See 54 A.L.R. 1166 (1928).
Under the UCC, commingled grain that is stored in an elevator is owned in common by the persons storing the grain. U.C.C. §7-207(b); see also, United States v. Luther, 225 F.2d 499 (10th Cir. 1955), cert. den., 350 U.S. 947 (1956); In re Bucyrus Grain, Co., Inc., 78 B.R. 296 (Bankr. D. Kan. 1987). So, if there isn’t a grain shortage when an elevator fails, a farmer with grain stored at the elevator can get his grain in accordance with his warehouse receipt or scale ticket. The bankruptcy trustee can’t retain farmer-stored grain in the bankruptcy estate if there isn’t a shortage. The trustee only succeeds to the rights the that bankrupt elevator had and, as noted above, stored grain is not the elevator’s property. Under the Bankruptcy Code, the bankruptcy trustee, after notice and hearing, can dispose of property which an entity other than the bankruptcy estate has an interest in. 11 U.S.C. §725. This all means that once a farmer establishes ownership to the grain and pays the associated storage costs, the farmer is entitled to his grain.
But, what if there isn’t enough grain in the elevator to cover all of the claims of farmers that have warehouse receipts or scale tickets. If that is the case at the time the elevator files bankruptcy, the farmers holding those indicia of ownership share pro rata in the remaining grain. In this situation, what typically happens is that the bankruptcy trustee will sell all of the grain that is in storage and make a pro rata distribution of the proceeds of sale along with any bond money that the elevator’s bonding company might have. If, after the pro rata distribution, a famer has not been made whole, the famer becomes a general, unsecured creditor of the elevator to the extent of the shortfall.
Farmer Priority in Bankruptcy
In the shortfall situation, there is a bit of relief that the Bankruptcy Code provides. Under 11 U.S.C. §507(a)(6), an unsecured claim of a farmer (grain producer) in an amount of up to $6,325 against a grain storage facility (e.g., grain elevator) has priority. The priority is a sixth priority claim. It’s after domestic support obligations, administrative expenses, certain types of other specified unsecured claims, “allowed” unsecured claims, and unsecured claims for contributions to an employee benefit plan, but before certain unsecured claims of individuals and governmental units. For purposes of the priority provision, a “grain producer” is someone (“an entity”) that engages in the growing of wheat, corn flaxseed, grain sorghum, barley, oats, rye, soybeans, other dry edible beans, and rice. 11 U.S.C. §557(b)(1). “Grain storage facility” means a site or physical structure used to store grain for producers or to store grain acquired from producers for resale. 11 U.S.C. §557(b)(2).
While the $6,325 provision is likely to be of limited assistance, the Bankruptcy Court for the District of Kansas, affirmed by the Kansas Federal District Court, has held that the priority provision also gives priority status ahead of secured creditors with respect to grain owned by farmers that the elevator stores. In re Esbon Grain Co., 55 B.R. 308 (Bankr. D. Kan. 1985), aff’d., First National Bank v. Nugent, 72 B.R. 528 (D. Kan. 1987). That means that the financier of the elevator cannot participate in the pro rata distribution of the elevator’s remaining grain to the farmers that stored grain in the elevator at the time the elevator filed bankruptcy. The court reached its decision based on a Kansas statutory provision that gives grain depositors priority over a warehouse owner and the owner’s creditors in the grain stored in the elevator. Kan. Stat. Ann. §34-2,107. A different court in a different state could reach a different conclusion.
There is also another bankruptcy priority provision that can aid a farmer with grain stored in an elevator that fails. 11 U.S.C. §503(b)(9) includes as an administrative expense, entitled to first-tier priority, “the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.” If a farmer can qualify for this provision, it is much stronger that the sixth-priority claim under 11 U.S.C. §507(a)(6). That’s because it is an administrative expense under the definition of 11 U.S.C. §507(a)(1) which makes it a first-tier priority. It also is not subject to the limit of $6,325 noted above that applies to sixth-priority claims.
There is also an expedited procedure for determining ownership of the grain that is stored at an elevator at the time the elevator files bankruptcy. 11 U.S.C. §557(c).
Grain Sold on Contract
One of the perils of grain contracting is the financial instability of the buyer. For grain that has been sold on contract to an elevator that then files bankruptcy before the delivery date specified in the contract, the farmer-seller can refuse to deliver the grain if the elevator is insolvent. The only exception to that rule is if the elevator can make cash payment. U.C.C. §2-702. If delivery has already been made as specified in the contract (whether under a forward, deferred payment or deferred pricing contract) and then the elevator files bankruptcy, the farmer-seller is an unsecured creditor and also is ineligible to participate in state indemnity/insurance funds or elevator bonding protection. See e.g., Iowa Code §203D; In re Woods Farmers Co-op Elevator Co., 107 B.R. 678 (Bankr. N.D. 1989). While ownership of grain stored under a warehouse receipt or scale ticket remains with the farmer, delivery of grain that is sold under a contract causes title to the grain to pass to the elevator. As noted, that makes the outcome different.
As noted in my blogpost of July 19, co-op directors are subject to fiduciary duties of obedience, loyalty and care. If a breach of any of those duties can be tied to the elevator’s failure, that might provide a legal remedy for disaffected farmers. However, that could be a difficult connection to make, and take time and money to establish it.
Tough economic times can lead to numerous legal issues. The failure of a grain elevator can cause large problems for farmers and for the local community it serves. A farmer that knows their rights and where they stand if an elevator fails, can be in a better position than are those farmers that aren’t as well informed.
Wednesday, March 29, 2017
The drop in crop prices in recent months has introduced financial strain for some producers. Bankruptcy practitioners are reporting an increase in clients dealing with debt workouts and other bankruptcy-related concerns.
An important part of debt resolution concerns the income tax consequences of any debt relief to the debtor. One of those rules concerns the tax treatment of discharged “qualified farm indebtedness.” The rule can be a useful tool in dealing with the income tax issues associated with debt forgiveness for farmers that are not in bankruptcy. There’s also another option that might come into play in certain situations – a purchase price adjustment.
That’s the focus of today’s post.
Except for debt associated with installment land contracts and Commodity Credit Corporation loans, most farm debt is recourse debt. With recourse debt, the collateral stands as security on the loan. If the collateral is insufficient to pay off the debt, the debtor is personally liable on the obligation and the debtor's non-exempt assets are reachable to satisfy any deficiency.
When the debtor gives up property, the income tax consequences involve a two-step process. Basically, it is as if the property is sold to the creditor, and the sale proceeds are applied on the debt. There is no gain or loss (and no other income tax consequence) up to the income tax basis on the property. Then, the difference between fair market value and the income tax basis is gain or loss. Finally, if the indebtedness exceeds the property's fair market value, the debtor remains liable for the difference and if it is forgiven, the amount is discharge of indebtedness income.
However, special rules can apply to minimize the tax impact of discharge of indebtedness income.
Under I.R.C. §108(a)(1)(A)-(C), a debtor need not include in gross income any amount of discharge of indebtedness if the discharge occurs as part of a bankruptcy case or when the debtor is insolvent, or if the discharge is of qualified farm debt. If one of these provisions applies to exclude the debt from income, Form 982 must be completed and filed with the return for the year of discharge.
Qualified Farm Indebtedness
What is it? The qualified farm debt rule applies to the discharge of qualified farm indebtedness that is discharged via an agreement between a debtor engaged in the trade or business of farming and a “qualified person.” A qualified person includes a lender that is actively and regularly engaged in the business of lending money and is not related to the debtor or to the seller of the property, is not a person from which the taxpayer acquired the property, or is a person who receives a fee with respect to the taxpayer’s investment in the property. I.R.C. §49(a)(1)(D)(iv). Under I.R.C. §108(g)(1)(B), a “qualified person” also includes federal, state or local governments or their agencies.
In addition, qualified farm debt is debt that is incurred directly in connection with the taxpayer’s operation of a farming business; and at least 50 percent of the taxpayer’s aggregate gross receipts for the three tax years (in the aggregate) immediately preceding the tax year of the discharge arise from the trade or business of farming. I.R.C. §§108(g)(2)(A)-(B). Off-farm income and passive rental arrangements can cause complications in meeting the gross receipts test.
Solvency. The qualified farm debt exclusion rule does not apply to the extent the debtor is insolvent or is in bankruptcy. Farmers are also under a special rule – for all debtors other than farmers, once solvency is reached there is income from the discharge of indebtedness. The determination of a taxpayer’s solvency is made immediately before the discharge of indebtedness. “Insolvency” is defined as the excess of liabilities over the fair market value of the debtor’s assets. Both tangible and intangible assets are included in the calculation. In addition, both recourse and nonrecourse liabilities are included in the calculation, but contingent liabilities are not. The separate assets of the debtor’s spouse are not included in determining the extent of the taxpayer’s insolvency. Property exempt from creditors under state law is included in the insolvency calculation. Carlson v. Comr., 116 T.C. 87 (2001).
Maximum amount discharged. There is a limit on the amount of discharged debt that can be excluded from income under the exception. The excluded amount cannot exceed the sum of the taxpayer’s adjusted tax attributes and the aggregate adjusted bases of the taxpayer’s depreciable property that the taxpayer holds as of the beginning of the tax year following the year of the discharge.
Reduction of tax attributes. The debt that is discharged and which is excluded from the taxpayer’s gross income is applied to reduce the debtor’s tax attributes. I.R.C. §108(b)(1). Unless the taxpayer elects to reduce the basis of depreciable property first, I.R.C. §108(b)(2) sets forth the general order of tax attribute reduction (which, by the way occurs after computing tax for the year of discharge (I.R.C. §108(b)(4)(A)). The order is as follows: net operating losses (NOLs) for the year of discharge as well as NOLs carried over to the discharge year; general business credit carryovers; minimum tax credit; capital losses for the year of discharge and capital losses carried over to the year of discharge; the basis of the taxpayer’s depreciable and non-depreciable assets; passive activity loss and credit carryovers; and foreign tax credit carryovers.
Those attributes that can be carried back to tax years before the year of discharge are accounted for in those carry back years before they are reduced. Likewise, any reductions of NOLs or capital losses and carryovers first occur in the tax year of discharge followed by the tax year in the order in which they arose.
The tax attributes are generally reduced on a dollar-for-dollar basis (i.e., one dollar of attribute reduction for every dollar of exclusion). However, any general business credit carryover, the minimum tax credit, the foreign tax credit carryover and the passive activity loss carryover are reduced by 33.33 cents for every dollar excluded.
If the amount of income that is excluded is greater than the taxpayer’s tax attributes, the excess is permanently excluded from the debtor’s gross income and is of no tax consequence. Alternatively, if the taxpayer’s tax attributes are insufficient to offset all of the discharge of indebtedness, the balance reduces the basis of the debtor’s assets as of the beginning of the tax year of discharge.
Discharged debt that would otherwise be applied to reduce basis in accordance with the general attribute reduction rules specified above and also constitutes qualified farm indebtedness is applied only to reduce the basis of the taxpayer’s qualified property. I.R.C. §1017(b)(4)(A). The basis reduction is to the qualified property that is depreciable property, then to the qualified property that is land used or held for use in the taxpayer’s farming business, and then to any other qualified property that is used in the taxpayer’s farming business or for the production of income. This is the basis reduction order unless the taxpayer elects to have any portion of the discharged amount applied first to reduce basis in the taxpayer’s depreciable property, including real property held as inventory. I.R.C. §§108(b)(5)(A); 1017(b)(3)(E).
Purchase Price Adjustment
Instead of triggering discharge of indebtedness income, if the original buyer and the original seller agree to a price reduction of a purchased asset at a time when the original buyer is not in bankruptcy or insolvent, the amount of the reduction does not have to be reported as discharge of indebtedness income. I.R.C. §108(e)(5)(A). The seller also doesn’t have immediate adverse tax consequences from the discharge. Instead, the profit ratio that is applied to future installment payments is impacted. Priv. Ltr. Rul. 8739045 (Jun. 20, 1987).
Farmers often have favorable tax rules. The qualified farm indebtedness rule is one of those. In the right situation, it can provide some relief from the tax consequences of financial distress.
Thursday, January 12, 2017
The current financial situation in agriculture is difficult for many producers. Low crop and livestock prices, falling land values and increasing debt levels are placing some ag producers in a serious bind. Chapter 12 bankruptcy is an option for some, although the current debt limits of Chapter 12 are barring some from utilizing its relief provisions.
When dealing with financial distress, restructuring debt is often involved. This is one of the topics that Joe Peiffer (of Peiffer Law in Cedar Rapids, Iowa) and I will be addressing at Washburn Law School on February 1 during our 3-hour CLE event, “Common Problems Faced by Farmers and Ranchers in Difficult Financial Times.” The seminar will also be simulcast live over the web for those that cannot attend in-person. Here’s the link for registration: https://washburnlaw.edu/farmersandrancherscleregister
One of the issues that we will be addressing are the strategies that can be used to negotiate with creditors and restructure debt. While many ag deals are done at the coffee shop or while leaning-up against the pick-up or a fencepost, debt restructuring negotiations with creditors don’t typically occur in that manner. Today’s post is a bit of a teaser of the upcoming seminar that is my summary of Joe’s thoughts on debt restructuring and the options and opportunities that might be present during that process.
Debt Restructuring Negotiations
Debt restructuring negotiations do not involve a formal, specifically prescribed process with one exception – mediation. Rather, debt restructuring negotiations take place informally. However, when mediation is utilized, it is a formal process that is often prescribed by state law. So, what makes for a successful debt restructuring negotiation? As with any negotiation on any subject, it is critical to understand what each party views as important. What are their priorities? For a creditor, collecting on a delinquent debt is always of supreme importance. Likewise, if there is a non-delinquent, marginal loan, the creditor will be interested in obtaining guarantees, either private or via government entities such as the USDA or the Small Business Administration. The creditor will also likely attempt to obtain additional collateral so that the farm debtor’s line of credit can continue and any projected loss to the creditor is minimized or eliminated.
On the other side, a farmer’s goals typically include staying on the farm and continuing the farming business. The farmer probably also wants to maintain ownership of assets and their lifestyle. Also, another common goal of farm debtors is to get the farming operation to the most economical size (often downsizing) without triggering a tax bill that can’t be paid.
Once the goals of the creditors and the farmer are identified, they must be prioritized. That’s when reality begins to set in. Are the goals realistic? Are there any that can’t be achieved? Those that can’t be achieved must be eliminated and the realistic goals focused on. Creditors have to realize that debts won’t be paid in full and on time. Farm debtors have to understand that they can’t retain all of their farm assets. So, the parties should strive to find common ground somewhere in the middle. There probably are some areas of agreement that can be reached. But, to get there, both parties will likely have to compromise. Neither the creditors nor the farm debtor should view negotiations in absolutist terms. Still, even if a mediation agreement is reached and a release obtained, that doesn’t meet that the parties still won’t end up in court. To avoid litigation, some “out-of-the-box” thinking will likely be required.
Being creative. Joe relates a matter that he dealt with a few years ago. He was representing a farm debtor and the banker showed a great willingness to be creative in dealing with the farmer’s debt situation. The balance on the loan owed the bank exceeded the collateral values by well over $1,000,000. The farm debtor had a dairy operation that was losing money to the tune of more than $70,000 every month, and there was virtually no likelihood of a successful reorganization. At mediation, the banker suggested that if the farmer would immediately surrender the cows, calves, grain, sileage and other personal property securing the loan, and agree to surrender the farm under non-judicial foreclosure he would pay Joe's clients $100,000. The banker's reasoning was that by paying the farm debtor $100,000, the amount he expected to pay his attorney if the farmer filed a Chapter 12 bankruptcy, the farmer could have a fresh start and he would speedily obtain control of the collateral minimizing his losses.
The farm debtor put a great deal of thought into the prospect of getting $100,000 and not having the uncertainty of a bankruptcy. They opted to take the money offered to them. The deal was structured so that the bank’s $100,000 payment was in consideration for them selling their homestead to the Bank. Because the money constituted proceeds from the sale of their homestead, the funds were exempt under state (IA) law from the claims of their other creditors for a reasonable time to allow purchase of a later homestead. After closing, the farm debtor held the proceeds in a “Homestead Account” separate from all other money they. They did not add other money to that account, nor did they spend the money in that account until they purchased a new homestead.
Non-Judicial Foreclosure Can be Beneficial
The use of a non-judicial foreclosure provided under state law (in Iowa, the procedure is set forth in Iowa Code § 654.18) allows farmers and their creditors to fashion remedies that can be mutually beneficial. This remedy can be utilized either before or as a part of a mediated settlement. The creditor gets possession and ownership of the real estate collateral much quicker than would be the case in a traditional foreclosure. The right of redemption and right of first refusal present in a traditional foreclosure are eliminated. The creditor waives any deficiency that could exist if the collateral cannot cover the indebtedness. But, of course, a farm debtor must be mindful of the potential for discharge of indebtedness income if this procedure is utilized and the farmer has exempt assets that could make them solvent once a deficiency is forgiven.
A benefit to a farm debtor of non-judicial foreclosure is that the creditor is generally able to make other beneficial concessions. Also, under a non-judicial foreclosure, the farmer deeds the farm to the creditor subject to a period of time (typically five-business days) during which the transaction can be cancelled. If the transaction is not cancelled, the creditor gives notice of the non-judicial foreclosure to junior lien holders who then a period of time (generally 30 days) to redeem from the creditor and each other.
Deed Back to Bank with Sale of Homestead Back to Farmer on Real Estate Contract
During the farm financial crisis of the 1980s in many parts of the Midwest and Great Plains, farm and ranch debt restructurings often involved debtors deeding back their farms to the creditor with the creditor then selling back the house and an acreage on a real estate contract. This approach allowed the farmer to retain the homestead while allowing the bank to realize cash from the balance of its real estate collateral. But, if the debtor missed a payment, the bank, could institute a contract forfeiture procedure that would take only 30 days to finish once the Notice of Forfeiture was properly served after mediation.
Sale of Non-Essential Assets in the Tax Year Before Filing Chapter 12
The “right-sizing” of a farm operation must always be considered as a part of a debt restructuring negotiation. If the farmer has over-encumbered assets it can be in his best interest to liquidate some assets, reduce debt and restructure the farming operation. The liquidation of assets that are not absolutely necessary to the “newer” farming operation can also have the effect of decreasing the farmer’s level of debt beneath the maximum allowable so that the farmer is eligible to file Chapter 12. However, selling-off of farm assets often leads to incurring significant income taxes. But, in a Chapter 12 farm bankruptcy, a special tax provision, 11 U.S.C. §1222(a)(2)(A), can be utilized to move taxes from a priority to a non-priority position which can then result in the taxes being discharged.
Formal Written Agreements Contained in Bank Minutes are Essential
Under federal law, to be enforceable in the event the institution is declared insolvent, debt restructuring agreement involving federally insured institutions must be in writing, approved by the board of directors, sealed and included in the bank’s minutes. Reliance on any oral agreements with a bank is not wise as they are unenforceable (see, e.g., Iowa Code § 535.17 and 12 U.S.C. §1823(e)). If the bank goes broke and the Debt Settlement Agreement is not memorialized as is required by 12 U.S.C. § 1823(e), the FDIC or the purchaser of the notes from the FDIC will not be bound by the Debt Settlement Agreement. Thus, if any agreement with a bank is to be enforced, it must be in writing signed by the proper parties and comply with any statutorily-required formalities.
As Joe has pointed out on numerous occasions, debt restructuring negotiations provide farmers and their creditors with substantial opportunities to reach an agreement that satisfies both parties’ needs. Preparation is the key to a successful negotiation for both creditors and farmers. Consideration of the other party’s priorities and needs can lead to opportunities for cooperation that will minimize the need for court intervention and bankruptcies. Frequently, the need to “right-size” a farming operation will lead to significant income tax consequences that can only be addressed in a Chapter 12 bankruptcy. When this occurs, cooperation between the creditor and farmer can allow the creditor to receive the liquidation proceeds of most of its collateral in the tax year before filing the bankruptcy while allowing the farmer to avail himself of the favorable tax provisions of 11 U.S.C. § 1222(a)(2)(A). All parties to debt restructuring negotiations should be prepared to accept reality, make reasonable concessions and consider the needs of the other party to reach agreement.
This is just a sample of one of the numerous issues that Joe and I will discuss at the law school seminar on February 1. Again, if you can’t attend in-person, you can watch a live simulcast over the web of our presentations. Here’s the link for registration information: https://washburnlaw.edu/farmersandrancherscleregister
Friday, January 6, 2017
Today we continue our look this week at the biggest developments in agricultural law and taxation during 2016. Out of all of the court rulings, IRS developments and regulatory issues, we are down to the top five developments in terms of their impact on ag producers, rural landowners and agribusinesses.
So, here are the top five (as I see them) in reverse order:
(5) Pasture Chiseling Activity Constituted Discharge of “Pollutant” That Violated the CWA. The plaintiff bought approximately 2,000 acres in northern California in 2012. Of that 2,000 acres, the plaintiff sold approximately 1,500 acres. The plaintiff retained an environmental consulting firm to provide a report and delineation map for the remaining acres and requested that appropriate buffers be mapped around all wetlands. The firm suggested that the plaintiff have the U.S. Army Corps of Engineers (COE) verify the delineations before conducting any grading activities. Before buying the 2,000 acres, the consulting firm had provided a delineation of the entire tract, noting that there were approximately 40 acres of pre-jurisdictional wetlands. The delineation on the remaining 450 acres of pasture after the sale noted the presence of intact vernal and seasonal swales on the property along with several intermittent and ephemeral drainages. A total of just over 16 acres of pre-jurisdictional waters of the United States were on the 450 acres – having the presence of hydric soils, hydrophytic vegetation and hydrology (1.07 acres of vernal pools; 4.02 acres of vernal swales; .82 acres of seasonal wetlands; 2.86 acres of seasonal swales and 7.40 acres of other waters of the United States). In preparation to plant wheat on the tract, the property was tilled at a depth of 4-6 inches to loosen the soil for plowing with care taken to avoid the areas delineated as wetlands. However, an officer with the (COE) drove past the tract and thought he saw ripping activity that required a permit. The COE sent a cease and desist letter and the plaintiff responded through legal counsel requesting documentation supporting the COE’s allegation and seeking clarification as to whether the COE’s letter was an enforcement action and pointing out that agricultural activities were exempted from the CWA permit requirement. The COE then provided a copy of a 1994 delineation and requested responses to numerous questions. The plaintiff did not respond. The COE then referred the matter to EPA for enforcement. The plaintiff sued the COE claiming a violation of his Fifth Amendment right to due process and his First Amendment right against retaliatory prosecution. The EPA refused the referral due to the pending lawsuit so the COE referred the matter to the U.S. Department of Justice (DOJ). The DOJ filed a counterclaim against the plaintiff for CWA violations.
The court granted the government’s motion on the due process claim because the cease and desist letter did not initiate any enforcement that triggered due process rights. The court also dismissed the plaintiff’s retaliatory prosecution claim. On the CWA claim brought by the defendant, the court determined that the plaintiff’s owner could be held liable as a responsible party. The court noted that the CWA is a strict liability statute and that the intent of the plaintiff’s owner was immaterial. The court then determined that the tillage of the soil causes it to be “redeposited” into delineated wetlands. The redeposit of soil, the court determined, constituted the discharge of a “pollutant” requiring a national pollution discharge elimination system (NPDES) permit. The court reached that conclusion because it found that the “waters” on the property were navigable waters under the CWA due to a hydrological connection to a creek that was a tributary of Sacramento River and also supported the federally listed vernal pool fairy shrimp and tadpole shrimp. Thus, a significant nexus with the Sacramento River was present. The court also determined that the farming equipment, a tractor with a ripper attachment constituted a point source pollutant under the CWA. The discharge was not exempt under the “established farming operation” exemption of 33 U.S.C. §1344(f)(1) because farming activities on the tract had not been established and ongoing, but had been grazed since 1988. Thus, the planting of wheat could not be considered a continuation of established and ongoing farming activities. Duarte Nursery, Inc. v. United States Army Corps of Engineers, No. 2:13-cv-02095-KJM-AC, 2016 U.S. Dist. LEXIS 76037 (E.D. Cal. Jun. 10, 2016).
(4) Prison Sentences Upheld For Egg Company Executives Even Though Government Conceded They Had No Knowledge of Salmonella Contamination. The defendant, an executive of a large-scale egg production company (trustee of the trust that owned the company), and his son (the Chief Operating Officer of the company) pled guilty as “responsible corporate officers” to misdemeanor violations of 21 U.S.C. §331(a) for introducing eggs that had been adulterated with salmonella into interstate commerce from the beginning of 2010 until approximately August of 2010. They each were fined $100,000 and sentenced to three months in prison. They appealed their sentences as unconstitutional on the basis that they had no knowledge that the eggs at issue were contaminated at the time they were shipped. They also claimed that their sentences violated Due Process and the Eighth Amendment insomuch as the sentences were not proportional to their “crimes.” They also claimed that incarceration for a misdemeanor offense would violate substantive due process.
The trial court determined that the poultry facilities were in poor condition, had not been appropriately cleaned, had the presence of rats and other rodents and frogs and, as a result, the defendant and his son either “knew or should have known” that additional salmonella testing was needed and that remedial and preventative measures were necessary to reduce the presence of salmonella. The appellate court agreed, finding that the evidence showed that the defendant and son were liable for negligently failing to prevent the salmonella outbreak and that 21 U.S.C. §331(a) did not have a knowledge requirement. The appellate court also did not find a due process violation. The defendant and son claimed that because they did not personally commit wrongful acts, and that due process is violated when prison terms are imposed for vicarious liability felonies where the sentence of imprisonment is only for misdemeanors. However, the court held that vicarious liability was not involved, and that 21 U.S.C. §331(a) holds a corporate officer accountable for failure to prevent or remedy “the conditions which gave rise to the charges against him.” Thus, the appellate court determined, the defendant and son were liable for negligently failing to prevent the salmonella outbreak. The court determined that the lack of criminal intent does not violate the Due Process Clause for a “public welfare offense” where the penalty is relatively small (the court believed it was), the defendant’s reputation was not “gravely” damaged (the court believed that it was not) and congressional intent supported the penalty (the court believed it did). The court also determined that there was no Eighth Amendment violation because “helpless” consumers of eggs were involved. The court also found no procedural or substantive due process violation with respect to the sentences because the court believed that the facts showed that the defendant and son “had reason to suspect contamination” and should have taken action to address the problem at that time (even though law didn’t require it).
The dissent pointed out that the government stipulated at trial that its investigation did not identify any corporate personnel (including the defendant and son) who had any knowledge that eggs sold during the relevant timeframe were contaminated with salmonella. The dissent also noted that the government conceded that there was no legal requirement for the defendant or corporation to comply with stricter regulations during the timeframe in issue. As such, the convictions imposed and related sentences were based on wholly nonculpable conduct and there was no legal precedent supporting imprisonment in such a situation. The dissent noted that the corporation “immediately, and at great expense, voluntarily recalled hundreds of millions of shell eggs produced” at its facilities when first alerted to the problem. As such, according to the dissent, due process was violated and the sentences were unconstitutional. United States v. Decoster, 828 F.3d 626 (8th Cir. 2016).
(3) The IRS and Self-Employment Tax. Two self-employment tax issues affecting farmers and ranchers have been in the forefront in recent years – the self-employment tax treatment of Conservation Reserve Program (CRP) payments and the self-employment tax implications of purchased livestock that had their purchase price deducted under the de minimis safe harbor of the capitalization and repair regulations. On the CRP issue, in 2014 the U.S. Court of Appeals ruled that CRP payments in the hands of a non-farmer are not subject to self-employment tax. The court, in Morehouse v. Comr., 769 F.3d 616 (8th Cir. 2014), rev’g, 140 T.C. 350 (2013), held the IRS to its historic position staked out in Rev. Rul. 60-32 that government payments attributable to idling farmland are not subject to self-employment tax when received by a person who is not a farmer. The court refused to give deference to an IRS announcement of proposed rulemaking involving the creation of a new Rev. Rul. that would obsolete the 1960 revenue ruling. The IRS never wrote the new rule, but continued to assert their new position on audit. The court essentially told the IRS to follow appropriate procedure and write a new rule reflecting their change of mind. In addition, the court determined that CRP payments are “rental payments” statutorily excluded from self-employment tax under I.R.C. §1402(a). Instead of following the court’s invitation to write a new rule, the IRS issued a non-acquiescence with the Eighth Circuit’s opinion. O.D. 2015-02, IRB 2015-41. IRS said that it would continue audits asserting their judicially rejected position, even inside the Eighth Circuit (AR, IA, MN, MO, NE, ND and SD).
In 2016, the IRS had the opportunity to show just how strong its opposition to the Morehouse decision is. A Nebraska non-farmer investor in real estate received a CP2000 Notice from the IRS, indicating CRP income had been omitted from their 2014 return. The CP2000 Notice assessed the income tax and SE Tax on the alleged omitted income. The CRP rental income was in fact included on the return, but it was included on Schedule E along with cash rents, where it was not subject to self-employment tax. The practitioner responded to the IRS Notice by explaining that the CRP rents were properly reported on Schedule E because the taxpayer was not a farmer. This put the matter squarely before the IRS to reject the taxpayer’s position based on the non-acquiescence. But, the IRS replied to the taxpayer’s response with a letter informing the taxpayer that the IRS inquiry was being closed with no change from the taxpayer’s initial position that reported the CRP rents for the non-farmer on Schedule E.
On the capitalization and repair issue, taxpayers can make a de minimis safe harbor election that allows amounts otherwise required to be capitalized to be claimed as an I.R.C. §162 ordinary and necessary business expense. This de minimis expensing election has a limit of $5,000 for taxpayers with an Applicable Financial Statement (AFS) and $2,500 for those without an AFS. Farmers will fall in the latter category. In both cases, the limit is applied either per the total on the invoice, or per item as substantiated by the invoice. One big issue for farmers and ranchers is how to report the income from the sale of purchased livestock that are held for productive use, such as breeding or dairy animals for which the de minimis safe harbor election was made allowing the full cost of the livestock to be deducted. It had been believed that because the repair regulations specify when the safe harbor is used, the sale amount is reported fully as ordinary income that is reported on Schedule F where it is subject to self-employment tax for a taxpayer who is sole proprietor farmer or a member of a farm partnership. In that event, the use of the safe harbor election would produce a worse tax result that would claiming I.R.C. §179 on the livestock.
An alternative interpretation of the repair regulations is that the self-employment tax treatment of the gain or loss on sale of assets for which the purchase price was deducted under the de minimis safe harbor is governed by Treas. Reg. §1.1402(a)-6(a). That regulation states that the sale of property is not subject to selfemployment tax unless at least one of two conditions are satisfied: (1) the property is stock in trade or other property of a kind which would properly be includible in inventory if on-hand at the close of the tax year; or (2) the property is held primarily for sale to customers in the ordinary course of a trade or business. Because purchased livestock held for dairy or breeding purposes do not satisfy the first condition, the question comes down to whether condition two is satisfied – are the livestock held primarily for sale to customers in the ordinary course of a trade or business? The answer to that question is highly fact-dependent. If the livestock whose purchase costs have been deducted under the de minimis rule are not held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business, the effect of the regulation is to report the gain on sale on Part II of Form 4797. This follows Treas. Reg. §1.1402(a)-6(a) which bars Sec. 1231 treatment (which would result in the sale being reported on Part I of Form 4797). In that event, the income received on sale would not be subject to self-employment tax.
In 2016, the IRS, in an unofficial communication, said that the alternative interpretation is the correct approach. However, the IRS was careful to point out that the alternative approach is based on the assumptions that the livestock were neither inventoriable nor held for sale, and that those assumptions are highly fact dependent on a case-by case basis. The IRS is considering adding clarifying language to the Farmers’ Tax Guide (IRS Pub. 225) and/or the Schedule F Instructions.
(2) TMDLs and the Regulation of Ag Runoff. Diffused surface runoff of agricultural fertilizer and other chemicals into water sources as well as irrigation return flows are classic examples of nonpoint source pollution that isn’t discharged from a particular, identifiable source. A primary source of nonpoint source pollution is agricultural runoff. As nonpoint source pollution, the Clean Water Act (CWA) leaves regulation of it up to the states rather than the federal government. The CWA sets-up a “states-first” approach to regulating water quality when it comes to nonpoint source pollution. Two key court opinions were issued in 2016 where the courts denied attempts by environmental groups to force the EPA to create additional federal regulations involving Total Maximum Daily Loads (TMDLs). The states are to establish total maximum daily TMDLs for watercourses that fail to meet water quality standards after the application of controls on point sources. A TMDL establishes the maximum amount of a pollutant that can be discharged or “loaded” into the water at issue from all combined sources on a daily basis and still permit that water to meet water quality standards. A TMDL must be set “at a level necessary to implement water quality standards.” The purpose of a TMDL is to limit the amount of pollutants in a watercourse on any particular date. Two federal court opinions in 2016 reaffirmed the principle that regulation of nonpoint source pollution is left to the states and not the federal government.
In Conservation Law Foundation v. United States Environmental Protection Agency, No. 15-165-ML, 2016 U.S. Dist. LEXIS 172117 (D. R.I. Dec. 13, 2016), the plaintiff claimed that the EPA’s approval of the state TMDL for a waterbody constituted a determination that particular stormwater discharges were contributing to the TMDL being exceeded and that federal permits were thus necessary. The court, however, determined that the EPA’s approval of the TMDL did not mean that EPA had concluded that stormwater discharges required permits. The court noted that there was nothing in the EPA’s approval of the TMDL indicating that the EPA had done its own fact finding or that EPA had independently determined that stormwater discharges contributed to a violation of state water quality standards. The regulations simply do not require an NPDES permit for stormwater discharges to waters of the United States for which a TMDL has been established. A permit is only required when, after a TMDL is established, the EPA makes a determination that further controls on stormwater are needed.
In the other case, Gulf Restoration Network v. Jackson, No. 12-677 Section: “A” (3), 2016 U.S. Dist. LEXIS 173459 (E.D. La. Dec. 15, 2016), numerous environmental groups sued the EPA to force them to impose limits on fertilizer runoff from farm fields. The groups claimed that many states hadn’t done enough to control nitrogen and phosphorous pollution from agricultural runoff, and that the EPA was required to mandate federal limits under the Administrative Procedure Act – in particular, 5 U.S.C. §553(e) via §303(c)(4) of the CWA. Initially, the groups told the EPA that they would sue if the EPA did not write the rules setting the limits as requested. The EPA essentially ignored the groups’ petition by declining to make a “necessity determination. The groups sued and the trial court determined that the EPA had to make the determination based on a 2007 U.S. Supreme Court decision involving the Clean Air Act (CAA). That decision was reversed on appeal on the basis that the EPA has discretion under §303(c)(4)(B) of the CWA to decide not to make a necessity determination as long as the EPA gave a “reasonable explanation” based on the statute why it chose not to make any determination. The appellate court noted that the CWA differed from the CAA on this point. On remand, the trial court noted upheld the EPA’s decision not to make a necessity determination. The court noted that the CWA gives the EPA “great discretion” when it comes to regulating nutrients, and that the Congressional policy was to leave regulation of diffused surface runoff up to the states. The court gave deference to the EPA’s “comprehensive strategy of bringing the states along without the use of federal rule making…”.
Also, in 2016 the U.S. Supreme Court declined to review a decision of the U.S. Court of Appeals for the Third Circuit which had determined in 2015 that the EPA had acted within its authority under 33 U.S.C. §1251(d) in developing a TMDL for the discharge of nonpoint sources pollutants into the Chesapeake Bay watershed. American Farm Bureau, et al. v. United States Environmental Protection Agency, et al., 792 F.3d 281 (3d Cir. 2015), cert. den., 136 S. Ct. 1246 (2016).
(1) The Election of Donald Trump as President and the Potential Impact on Agricultural and Tax Policy. Rural America voted overwhelmingly for President-elect Trump, and he will be the President largely because of the sea of red all across the country in the non-urban areas. So, what can farmers, ranchers and agribusinesses anticipate the big issues to be in the coming months and next few years and the policy responses? It’s probably reasonable to expect that same approach will be applied to regulations impacting agriculture. Those with minimal benefit and high cost could be eliminated or retooled such that they are cost effective. Overall, the pace of the generation of additional regulation will be slowed. Indeed, the President-elect has stated that for every new regulation, two existing regulations have to be eliminated.
Ag policy. As for trade, it is likely that trade agreements will be negotiated on a much more bi-lateral basis – the U.S. negotiating with one other country at a time rather than numerous countries. The President-elect is largely against government hand-outs and is big on economic efficiency. That bodes well for the oil and gas industry (and perhaps nuclear energy). But, what about less efficient forms of energy that are heavily reliant on taxpayer support? Numerous agricultural states are heavily into subsidized forms of energy with their state budgets littered with numerous tax “goodies” for “renewable” energy.” However, the President-elect won those states. So, does that mean that the federal subsidies for ethanol and biodiesel will continue. Probably. The Renewable Fuels Standard will be debated in 2017, but will anything significant happen? Doubtful. It will continue to be supported, but I expect it to be reviewed to make sure that it fits the market. Indeed, one of the reasons that bio-mass ethanol was reduced so dramatically in the EPA rules was that it couldn’t be produced in adequate supplies. What about the wind energy production tax credit? What about the various energy credits in the tax code? Time will tell, but agricultural interests should pay close attention.
The head of the Senate Ag Committee will be Sen. Roberts from Kansas. As chair, he will influence the tone of the debate of the next farm bill. I suspect that means that the farm bill will have provisions dealing with livestock disease and biosecurity issues. Also, I suspect that it will contain significant provisions crop insurance programs and reforms of existing programs. The House Ag Committee head will be Rep. Conaway from Texas. That could mean that cottonseed will become an eligible commodity for Agricultural Risk Coverage (ARC) and Price Loss Coverage (PLC). It may also be safe to assume that for the significant Midwest crops (and maybe some additional crops) their reference prices will go up. Also, it now looks as if the I.R.C. §179 issue involving the income limitation for qualification for farm program payments (i.e., the discrepancy of the treatment between S corporations and C corporations) will be straightened out. Other federal agencies that impact agriculture (EPA, Interior, FDA, Energy, OSHA) can be expected to be more friendly to agriculture in a Trump Administration.
Tax policy. As for income taxes, it looks at this time that the Alternative Minimum Tax might be eliminated, as will the net investment income tax that is contained in Obamacare. Individual tax rates will likely drop, and it might be possible that depreciable assets will be fully deductible in the year of their purchase. Also, it looks like the corporate tax rate will be cut as will the rate applicable to pass-through income. As for transfer taxes, President-elect Trump has proposed a full repeal of the federal estate tax as well as the federal gift tax. Perhaps repeal will be effective January 1, 2017, or perhaps it will be put off until the beginning of 2018. Or, it could be phased-in over a certain period of time. Also, while it appears at the present time that any repeal would be “permanent,” that’s not necessarily a certainty. Similarly, it’s not known whether the current basis “step-up” rule would be retained if the estate tax is repealed. That’s particularly a big issue for farmers and ranchers. It will probably come down to a cost analysis as to whether step-up basis is allowed. The President-elect has already proposed a capital gains tax at death applicable to transfers that exceed $10 million (with certain exemptions for farms and other family businesses). Repeal of gift tax along with repeal of estate tax has important planning implications. There are numerous scenarios that could play out. Stay tuned, and be ready to modify existing plans based on what happens. Any repeal bill would require 60 votes in the Senate to avoid a filibuster unless repeal is done as part of a reconciliation bill. Also, without being part of a reconciliation bill, any repeal of the federal estate tax would have to “sunset” in ten years.
January 6, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, January 4, 2017
This week we are looking at the biggest developments in agricultural law and taxation for 2016. On Monday, we highlighted the important developments that just missed being in the top ten. Today we take a look at developments 10 through six. On Friday, we will look at the top five.
- Court Obscures Rational Basis Test To Eliminate Ag Exemption From Workers' Compensation Law. While this is a state Supreme Court decision, its implications are significant. Most, if not all, states have a statutory exemption from workers’ compensation for employers that are engaged in agriculture. The statutory exemption varies in scope from state to state and, of course, an employer that is otherwise exempt can choose to be covered by the statute and offer workers’ compensation benefits to employees. In this case, the plaintiffs claimed that their on-the-job injuries should be covered under the state (NM) workers' compensation law. One plaintiff tripped while picking chile and fractured her left wrist. The other plaintiff was injured while working in a dairy when he was head-butted by a cow and pushed up against a metal door causing him to fall face-first into a concrete floor and sustain neurological damage. The plaintiffs' claims for workers' compensation benefits were dismissed via the exclusion from the workers' compensation system for employers. On appeal, the appellate court reversed. Using rational basis review (the standard most deferential to the constitutionality of the provision at issue), the court interpreted Sec. 52-1-6(A) of the New Mexico Code as applying to the primary job duties of the employees (as opposed to the business of the employer and the predominant type of employees hired), and concluded the distinction was irrational and lacked any rational purpose. The appellate court noted that the purpose of the law was to provide "quick and efficient delivery" of medical benefits to injured and disabled workers. Thus, the court determined that the exclusion violated the constitutional equal protection guarantee. The court further believed that the exclusion for workers that cultivate and harvest (pick) crops, but the inclusion of workers that perform tasks associated with the processing of crops was a distinction without a difference. The appellate court made no mention that the highest court in numerous other states had upheld a similar exclusion for agriculture from an equal protection constitutional challenge. On further review, the state Supreme Court affirmed. The Court determined that there was nothing to distinguish farm and ranch laborers from other ag employees and that the government interest of cost savings, administrative convenience and similar interests unique to agriculture were not rationally related to a legitimate government interest. The court determined that the exclusion that it construed as applying to ag laborers was arbitrary discrimination. A dissenting judge pointed out that the legislature’s decision to allow employers of farm and ranch laborers to decide for themselves whether to be subject to workers’ compensation or opt out and face tort liability did not violate any constitutionally-protected right. The dissent noted that such ability to opt out was a legitimate statutory scheme that rationally controlled costs for New Mexico farms and ranches, and that 29 percent of state farms and ranches had elected to be covered by workers’ compensation. The dissent also noted that the majority’s opinion would have a detrimental economic impact on small, economically fragile farms in New Mexico by imposing an additional economic cost of $10.5 million annually (as projected by the state Workers’ Compensation Administration). On this point, the dissent further pointed out that the average cost of a claim was $16,876 while the average net farm income for the same year studied was $19,373. The dissent further concluded that the exemption for farming operations was legitimately related to insulating New Mexico farm and ranches from additional costs. In addition, the dissent reasoned that the majority misapplied the rational basis analysis to hold the act unconstitutional as many other state courts and the U.S. Supreme Court had held comparable state statutes to satisfy the rational basis test. The dissent pointed out forcefully that the exclusion applied to employers and that the choice to be covered or not resided with employers who predominately hired ag employees. As such there was no disparate treatment between ag laborers and other agricultural workers. Rodriguez, et al. v. Brand West Dairy, et al., 378 P.3d 13 (N.M. Sup. Ct. 2016), aff’g., 356 P.3d 546 (N.M. Ct. App. 2015).
- 9. COE Jurisdictional Determination Subject to Court Review. The plaintiff, a peat moss mining company, sought the approval of the Corps of Engineers (COE) to harvest a swamp (wetland) for peat moss to use in landscaping projects. The COE issued a jurisdictional determination that the swamp was a wetland subject to the permit requirements of the Clean Water Act (CWA). The plaintiff sought to challenge the COE determination, but the trial court ruled for the COE, holding that the plaintiff had three options: (1) abandon the project; (2) seek a federal permit costing over $270,000; or (3) proceed with the project and risk fines of up to $75,000 daily and/or criminal sanctions including imprisonment. On appeal, the court unanimously reversed, strongly criticizing the trial court's opinion. Based on Sackett v. Environmental Protection Agency, 132 S. Ct. 1367 (2012), the court held that COE Jurisdictional Determinations constitute final agency actions that are immediately appealable in court. The court noted that to hold elsewise would allow the COE to effectively kill the project without any determination of whether it's position as to jurisdiction over the wetland at issue was correct in light of Rapanos v. United States, 547 U.S. 715 (U.S. 2006). The court noted that the COE had deliberately left vague the "definitions used to make jurisdictional determinations" so as to expand its regulatory reach. While the COE claimed that the jurisdictional determination was merely advisory and that the plaintiff had adequate ways to contest the determination, the court determined that such alternatives were cost prohibitive and futile. The court stated that the COE's assertion that the jurisdictional determination (and the trial court's opinion) was merely advisory ignored reality and had a powerful coercive effect. The court held that the Fifth Circuit, which reached the opposition conclusion with respect to a COE Jurisdictional Determination in Belle Co., LLC v. United States Army Corps. of Engineers, 761 F.3d 383 (5th Cir. 2014), cert. den., 83 U.S.L.W. 3291 (U.S. Mar. 23, 2015), misapplied the Supreme Court's decision in Sackett. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, 782 F.3d 984 (8th Cir. 2015), rev'g., 963 F. Supp. 2d 868 (D. Minn. 2013). In a later decision, the court denied a petition to rehear the case en banc and by the panel. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, No. 13-3067, 2015 U.S. App. LEXIS 11697 (8th Cir. Jul. 7, 2015). In December of 2015, the U.S. Supreme Court agreed to hear the case and affirmed the Eighth Circuit on May 31, 2016. The Court, in a unanimous opinion, noted that the memorandum of agreement between the EPA and the Corps established that jurisdictional determinations are “final actions” that represent the Government’s position, are binding on the Government in any subsequent Federal action or litigation involving the position taken in the jurisdictional determination. When the landowners received an “approved determination” that meant that the Government had determined that jurisdictional waters were present on the property due to a “nexus” with the Red River of the North, located 120 miles away. As such, the landowners had the right to appeal in Court after exhausting administrative remedies and the Government’s position take in the jurisdictional determination was judicially reviewable. Not only did the jurisdictional determination constitute final agency action under the Administrative Procedure Act, it also determined rights or obligations from which legal consequences would flow. That made the determination judicially reviewable. United States Army Corps of Engineers v. Hawkes Company, 136 S. Ct. 1807 (2016).
- 8. Proposed Regulations Under I.R.C. §2704. In early August, the IRS issued new I.R.C. §2704 regulations that could seriously impact the ability to generate minority interest discounts for the transfer of family-owned entities. Prop. Reg. – 163113-02 (Aug. 2, 2016). The proposed regulations, if adopted in their present form, will impose significant restrictions on the availability of valuation discounts for gift and estate tax purposes in a family-controlled environment. Prop. Treas. Regs. §§25.2704-1; 25.2704-4; REG- 163113-02 (Aug. 2, 2016). They also redefine via regulation and thereby overturn decades of court decisions honoring the well-established willing-buyer/willing-seller approach to determining fair market value (FMV) of entity interests at death or via gift of closely-held entities, including farms and ranches. The proposed regulations would have a significant impact on estate, business and succession planning in the agricultural context for many agricultural producers across the country and will make it more difficult for family farm and ranch businesses to survive when a family business partner dies. Specifically, the proposed regulations treat transfer within three years of death as death-bed transfers, create new “disregarded restrictions” and move entirely away from examining only those restrictions that are more restrictive than state law. As such, the proposed regulations appear to exceed the authority granted to the Treasury by Congress to promulgate regulations under I.R.C. §2704 and should be withdrawn. A hearing on the regulations was held in early December.
- 7. Capitalization Required For Interest and Real Property Taxes Associated with Crops Having More Than Two-Year Preproductive Period. The petitioner (three partnerships) bought land that they planned to use for growing almonds. They financed the purchase by borrowing money and paying interest on the debt. They then began planting almond trees. They deducted the interest and property taxes on their returns. The IRS objected to the deduction on the basis that the interest and taxes were indirect costs of the “production of real property” (i.e., the almonds trees that were growing on the land. The Tax Court agreed with the IRS noting that I.R.C. §263A requires the capitalization of certain costs and that those costs include the interest paid to buy the land and the property taxes paid on the land attributable to growing crops and plants where the preproductive period of the crop or plant exceeds two years. I.R.C. §263A(f)(1) states that “interest is capitalized where (1) the interest is paid during the production period and (2) the interest is allocable to real property that the taxpayer produced and that has a long useful life, an estimated production period exceeding two years, or an estimated production period exceeding one year and a cost exceeding $1 million.” The corresponding regulation, the court noted, requires that the interest be capitalized under the avoided cost method. The court also noted that the definition of “real property produced by the taxpayer for the taxpayer’s use in a trade or business or in an activity conducted for profit” included “land” and “unsevered natural products of the land” and that “unsevered natural products of the land” general includes growing crops and plants where the preproductive period of the crop or plant exceeds two years. Because almond trees have a preproductive period exceeding two years in accordance with IRS Notice 2000-45, and because the land was “necessarily intertwined” with the growing of the almond trees, the interest and tax cost of the land is a necessary and indispensable part of the growing of the almond trees and must be capitalized. Wasco Real Properties I, LLC, et al. v. Comr., T.C. Memo. 2016-224.
6. No Recapture of Prepaid Expenses Deducted in Prior Year When Surviving Spouse Claims Same Deduction in Later Year. The decedent, a materially participating Nebraska farmer, bought farm inputs in 2010 and deducted their cost on his 2010 Schedule F. He died in the spring of 2011 before using the inputs to put the spring 2011 crop in the ground. Upon his death, the inputs were included in the decedent’s estate at their purchase price value and then passed to a testamentary trust for the benefit of his wife. The surviving spouse took over the farming operation, and in the spring of 2011, took a distribution of the inputs from the trust to plant the 2011 crops. For 2011, two Schedule Fs were filed. A Schedule F was filed for the decedent to report the crop sales deferred to 2011, and a Schedule F was filed for the wife to report the crops sold by her in 2011 and claim the expenses of producing the crop which included the amount of the inputs (at their date-of-death value which equaled their purchase price) that had been previously deducted as prepaid inputs by the husband on the couple’s joint 2010 return. The IRS denied the deduction on the basis that the farming expense deduction by the surviving spouse was inconsistent with the deduction for prepaid inputs taken in the prior year by the decedent and, as a result, the “tax benefit rule” applied. The court disagreed, noting that the basis step-up rule of I.R.C. §1014 allowed the deduction by the surviving spouse which was not inconsistent with the deduction for the same inputs in her deceased husband’s separate farming business. The court also noted that inherited property is not recognized as income by the recipient, which meant that another requisite for application of the tax benefit rule did not apply. Estate of Backemeyer v. Comr., 147 T.C. No. 17 (2016).
Those were developments ten through six, at least as I see it for 2016. On Friday, we will list the five biggest developments for 2016.
January 4, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Monday, January 2, 2017
This week we will be taking a look at what I view as the most significant developments in agricultural law and agricultural taxation during 2016. There were many important happenings in the courts, the IRS and with administrative agencies that have an impact on farm and ranch operations, rural landowners and agribusinesses. What I am writing about this week are those developments that will have the biggest impact nationally. Certainly, there were significant state developments, but they typically will not have the national impact of those that result from federal courts, the IRS and federal agencies.
It’s tough to get it down to the ten biggest developments of the year, and I do spend considerable time going sorting through the cases and rulings get to the final cut. Today we take a quick look at those developments that I felt were close to the top ten, but didn’t quite make the list. Later this week we will look at those that I feel were worthy of the top ten. Again, the measuring stick is the impact that the development has on the ag sector as a whole.
Almost, But Not Quite
Those developments that were the last ones on the chopping block before the final “top ten” are always the most difficult to determine. But, as I see it, here they are (in no particular order):
- HRA Relief for Small Businesses. Late in 2016, the President signed into law H.R. 6, the 21st Century Cures Act. Section 18001 of the legislation repeals the restrictions included in Obamacare that hindered the ability of small businesses (including farming operations) to use health reimbursement arrangements (HRAs). The provision allows a "small employer" (defined as one with less than 50 full-time employees who does not offer a group health plan to any employees) to offer a health reimbursement arrangement (HRA) that the employer funds to reimburse employees for qualified medical expenses, including health insurance premiums. If various technical rules are satisfied, the basic effect of the provision is that, effective for plan years beginning after December 31, 2016, such HRAs will no longer be a violation of Obamacare's market "reforms" that would subject the employer to a penalty of $100/day per affected person). It appears that the relief also applies to any plan year beginning before 2017, but that is less clear. Of course, all of this becomes moot if Obamacare is repealed in its entirety in 2017.
- More Obamacare litigation. In a somewhat related development, in May the U.S. District Court for the District of Columbia ruled in United States House of Representatives v. Burwell, No. 14-1967 (RMC), 2016 U.S. Dist. LEXIS 62646 (D. D.C. May, 12, 2016), that the Obama Administration did not have the power under the Constitution to spend taxpayer dollars on "cost sharing reduction payments" to insurers without a congressional appropriation. The Obama Administration had argued that congressional approval was unnecessary because the funds were guaranteed by the same section of Obamacare that provides for the premium assistance tax credit that is designed to help offset the higher cost of health insurance as a result of the law. However, the court rejected that argument and enjoined the use of unappropriated funds due insurers under the law. The court ruled that the section at issue only appropriated funds for tax credits and that the insurer payments required a separate congressional appropriation. The court stayed its opinion pending appeal. A decision on appeal is expected in early 2017, but would, of course, be mooted by a repeal of Obamacare.
- Veterinary Feed Directive Rule. The Food and Drug Administration revised existing regulations involving the animal use of antibiotics that are also provided to humans. The new rules arose out of a belief of bacterial resistance in humans to antibiotics even though there is no scientific proof that antibiotic resistant bacterial infections in humans are related to antibiotic use in livestock. As a result, at the beginning of 2017, veterinarians will be required to provide a “directive” to livestock owners seeking to use or obtain animal feed products containing medically important antimicrobials as additives. A “directive” is the functional equivalent of receiving a veterinarian’s prescription to use antibiotics that are injected in animals. 21 C.F.R. Part 558.
- Final Drone Rules. The Federal Aviation Administration (FAA) issued a Final Rule on UASs (“drones”) on June 21, 2016. The Final Rule largely follows the Notice of Proposed Rulemaking issued in early 2015 (80 Fed. Reg. 9544 (Feb. 23, 2015)) and allows for greater commercial operation of drones in the National Airspace System. At its core, the Final Rule allows for increased routine commercial operation of drones which prior regulations required commercial users of drones to make application to the FAA for permission to use drones - applications the FAA would review on a case-by-case basis. The Final Rule (FAA-2015-0150 at 10 (2016)) adds Part 107 to Title 14 of the Code of Federal Regulations and applies to unmanned “aircraft” that weigh less than 55 pounds (that are not model aircraft and weigh more than 0.5 pounds). The Final Rule became effective on August 29, 2016.
- County Bans on GMO Crops Struck Down. A federal appellate court struck down county ordinances in Hawaii that banned the cultivation and testing of genetically modified (engineered) organisms. The court decisions note that either the state (HI) had regulated the matter sufficiently to remove the ability of counties to enact their own rules, or that federal law preempted the county rules. Shaka Movement v. County of Maui, 842 F.3d 688 (9th Cir. 2016) and Syngenta Seeds, Inc. v. County of Kauai, No. 14-16833, 2016 U.S. App. LEXIS 20689 (9th Cir. Nov. 18, 2016).
- Insecticide-Coated Seeds Exempt from EPA Regulation Under FIFRA. A federal court held that an existing exemption for registered pesticides applied to exempt insecticide-coated seeds from separate regulation under the Federal Insecticide, Rodenticide Act which would require their separate registration before usage. Anderson v. McCarthy, No. C16-00068, WHA, 2016 U.S. Dist. LEXIS 162124 (N.D. Cal. Nov. 21, 2016).
- Appellate Court to Decide Fate of EPA’s “Waters of the United States” Final Rule. The U.S. Court of Appeals for the Sixth Circuit ruled that it had jurisdiction to hear a challenge to the EPA’s final rule involving the scope and effect of the rule defining what waters the federal government can regulate under the Clean Water Act. Murray Energy Corp. v. United States Department of Defense, 817 F.3d 261 (6th Cir. 2016).
- California Proposition Involving Egg Production Safe From Challenge. California enacted legislation making it a crime to sell shelled eggs in the state (regardless of where they were produced) that came from a laying hen that was confined in a cage not allowing the hen to “lie down, stand up, fully extend its limbs, and turn around freely.” The law was challenged by other states as an unconstitutional violation of the Commerce Clause by “conditioning the flow of goods across its state lines on the method of their production” and as being preempted by the Federal Egg Products Inspection Act. The trial court determined that the plaintiffs lacked standing and the appellate court affirmed. Missouri v. Harris, 842 F.3d 658 (9th Cir. 2016).
- NRCS Properly Determined Wetland Status of Farmland. The Natural Resource Conservation Service (NRCS) determined that a 0.8-acre area of a farm field was a prairie pothole that was a wetland that could not be farmed without the plaintiffs losing farm program eligibility. The NRCS made its determination based on “color tone” differences in photographs, wetland signatures and a comparison site that was 40 miles away. The court upheld the NRCS determination as satisfying regulatory criteria for identifying a wetland and was not arbitrary, capricious or contrary to the law. Certiorari has been filed with the U.S. Supreme Court asking the court to clear up a conflict between the circuit courts of appeal on the level of deference to be given federal government agency interpretive manuals. Foster v. Vilsack, 820 F.3d 330 (8th Cir. 2016).
- Family Limited Partnerships (FLPs) and the “Business Purpose” Requirement. In 2016, there were two cases involving FLPs and the retained interest section of the Code. That follows one case late in 2015 which was the first one in over two years. In Estate of Holliday v. Comr., T.C. Memo. 2016-51, the court held that the transfers of marketable securities to an FLP two years before the transferor’s death was not a bona fide sale, with the result that the decedent (transferor) was held to have retained an interest under I.R.C. §2036(a) and the FLP interest was included in the estate at no discount. Transferring marketable securities to an FLP always seems to trigger issues with the IRS. In Estate of Beyer v. Comr., T.C. Memo. 2016-183, the court upheld the assessment of gift and estate tax (and gift tax penalties) with respect to transfers to an FLP because the court determined that every benefit allegedly springing from the FLP could have been accomplished by trusts and other arrangements. There needs to be a separate non-tax business purpose to the FLP structure. A deeper dive into the court opinions also points out that the application of the “business purpose” requirement with respect to I.R.C. §2036 is very subjective. It’s important to treat the FLP as a business entity, not put personal assets in the FLP, or at least pay rent for their use, and follow all formalities of state law.
These are the developments that were important, but just not big enough in terms of their overall impact on the ag sector to make the list of the “top ten.” The next post will take a look at developments ten through six.
January 2, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, December 21, 2016
The U.S. legal system has a long history of allowing debtors to hold specified items of property exempt from creditors (unless the exemption is waived). This, in effect, gives debtors a “fresh start” in becoming reestablished after suffering economic reverses. Procedurally, exempt property is included in the debtor's estate in bankruptcy, but any particular exempt asset can be removed from the bankruptcy estate if no objections to the exemption claim is made within 30 days from the meeting of the creditors. In that case, the debtor can then fully utilize the exempt asset. Only nonexempt property is used to pay the unsecured creditors.
Because of the availability of exemptions, debtors may be tempted to convert nonexempt property (such as cash) into exempt assets prior to bankruptcy filing. They may also be tempted to transfer property (either exempt or not) to a spouse or other family member to get the property out of their name. There is no general prohibition on such conversions, but courts closely examine attempted conversions with respect to the adequacy of the purchase price and the bargaining position of the parties involved. If the primary purpose of the move is to hinder, delay or defraud creditors, the conversion can be challenged. In addition, transfers made by insolvent debtors within one year of filing a bankruptcy petition in exchange for less than equivalent value may be avoidable transfers. See 11 U.S.C. § 548(a)(2).
Actual intent to defraud must generally be present, but a court may infer actual intent from the circumstances of the debtor's conduct. In other words, a debtor could engage in actual fraud as defined by 11 U.S.C. §548 (a)(1)(A) or constructive fraud under 11 U.S.C. §548 (a)(1)(B). In addition, the funds used to acquire exempt assets must not be from the sale of collateral or as a result of wrongdoing by the debtor. In addition, some states have enacted limits on acquiring some types of exempt property (notably life insurance policies) within a specified time before bankruptcy filing.
But, if a bankruptcy trustee objects to a debtor’s transfer as being fraudulent, how soon must the trustee act to avoid the transfer? Does it matter that the IRS also has a claim against the debtor? A recent case from a bankruptcy court in Florida dealt with the issue. The answer that the court provided could serve as a wake-up call to some debtors and their legal counsel.
The Bankruptcy Code’s “Strong-Arm” Provision
The “strong-arm” provision, 11 U.S.C. §544, gives the bankruptcy trustee the authority to “avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title…” So what does that mean? Generally, when a bankruptcy trustee uses the provision, the trustee will rely on a state’s fraudulent transfer statute as the basis for avoiding transfers the debtor makes when the debtor is trying to avoid paying creditors what they are owed. The effect of using the “strong-arm” provision is that the trustee steps into the shoes of an unsecured creditor. That also means that the trustee then becomes subject to the statute of limitations applicable under state law, which is typically four years for fraudulent transfers. But what if the unsecured creditor is the federal government – the IRS?
Recent case. In In re Kipnis, 555 B.R. 877 (Bankr. S.D. Fla. 2016), an individual was a partner with another person in the general contracting business. The business had big losses which passed through proportionately to the individual who then claimed them on his 2000 and 2001 returns. In 2005, the individual transferred via quitclaim deed a condominium to his wife in accordance with a pre-marital agreement that the couple had entered into during the prior month. Later that day, the individual changed the title ownership of his bank account from his name only to include his wife along with himself as tenants by the entirety (a marital form of joint tenancy). The IRS audited the partners’ returns for 2001 and 2001 and disallowed the losses, and in 2012 the Tax Court agreed with the IRS, and little over a year later the individual (now “debtor”) filed for Chapter 11 and then converted it to Chapter 7. The IRS filed a proof of claim for $1,911,787.23. Of that amount, $25,629.51 was unsecured, but prioritized under 11 U.S.C. §507(a)(8). The bankruptcy trustee tried to avoid the transfers under state (FL) law governing fraudulent transfers. The debtor’s wife moved to dismiss on the basis that the four-year statute of limitations that applied under FL law to challenge fraudulent transfers had run and barred the trustee’s claim. She cited In re Vaughan Co., 498 B.R. 297 (Bankr. D.N.M. 2013), where the court determined that the IRS was subject to the state-based statute of limitations. However, the bankruptcy trustee cited cases from numerous other states where the courts in those states determined that the “strong-arm” statute allowed the trustee to step into the shoes of the IRS and take advantage of the 10-year statute of limitations under I.R.C. §6502(a)(1). The court agreed with the trustee, holding that In re Kaiser, 525 B.R. 697 (Bankr. N.D. Ill. 2014) was persuasive and that the court’s rationale should apply to the facts of the case. One of the key aspects of In re Kipnis was the court’s reasoning that the IRS can avoid a state’s statute of limitations because of sovereign immunity, but that a trustee can avoid it via the “strong-arm” statute which provides a derivative form of sovereign immunity.
So, the wife’s attempt to dismiss the trustee’s action was denied, but the court seemed dismayed that the court’s finding could tempt bankruptcy trustees to aggressively go after a debtor’s funds in a bankruptcy proceeding. The court stated, “The Bankruptcy Code’s strong-arm provision (Section 544) provides a bankruptcy trustee the authority to “avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title…”. The court went on to state that, “The IRS is a creditor in a significant percentage of bankruptcy cases,… “The paucity of decisions on the issue may simply be because bankruptcy trustees have not generally realized that this longer reach-back weapon is in their arsenal. If so, widespread use of [Bankruptcy Code Section] 544(b) to avoid state statutes of limitations may occur and this would be a major change in existing practice.”
In re Kipnis illustrates that bankruptcy trustees have a fairly strong weapon in the bag to ultimately effect larger distributions to creditors of a bankruptcy estate. When the IRS is a creditor, that weapon can be powerful and can be used, as in In re Kipnis, to reach transfers that weren’t made to avoid creditors. For bankruptcy lawyers with debtor-clients having facts similar to In re Kipnis, perhaps look into paying outstanding taxes before the debtor files bankruptcy.