Thursday, January 12, 2017
Farm Financial Stress – Debt Restructuring
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: http://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: http://washburnlaw.edu/farmersandrancherscleregister