Thursday, May 30, 2019

Can Foreign Persons/Entities Own U.S. Agricultural Land?

Overview

During the significant economic downturn of early 2008 that continued through mid-2009 and then turned into an anemic recovery until 2017, foreign investors sought U.S. farmland as an alternative to stocks.  This has caused concern in some corners of ag. It’s an issue of national security – potentially disloyal parties should not be owning the U.S. real estate food base.  As of the end of 2016, the USDA reported that foreign individuals and entities held interests in 28.3 million acres of U.S. agricultural land.  That amounts to 2.2 percent of all privately held U.S. ag land and about one percent of all U.S. land.  This has also raised questions about whether there are laws are on the books that might protect American soil from being owned by foreign persons and interests.

Foreign ownership of agricultural land – that’s the topic of today’s post.

Historically

Under the English common law, aliens could not acquire title to land except with the King's approval.  The common law rule existed in England until it was abolished by statute in 1870.  However, by that time, the notion of limiting alien ownership of agricultural land was well imbedded in United States jurisprudence.  In the 1970s, the issue of foreign investment in and ownership of agricultural land received additional attention because of several large purchases by foreigners and the suspicion that the build-up in liquidity in the oil exporting countries would likely lead to more land purchases by nonresident aliens.  The lack of data concerning the number of acres actually owned by foreigners contributed to fears that foreign ownership was an important and rapidly spreading phenomenon.

Federal Law

In 1978, the Congress enacted the Agricultural Foreign Investment Disclosure Act (AFIDA).  7 U.S.C. 3501 et seq.  Under AFIDA, the USDA obtains information on U.S. agricultural holdings of foreign individuals and businesses.  In essence, AFIDA is a reporting statute rather than a regulatory statute.  The information provided in reports by the AFIDA helps serve as the basis for any future action Congress may take in establishing direct controls or limits on foreign investment in agricultural land and provides useful information to states considering limitations on foreign investment. The Act requires that foreign persons report to the Secretary of Agriculture their agricultural land holdings or acquisitions.  The Secretary assembles and analyzes the information contained in the report, passes it on the respective states for their action and reports periodically to the Congress and the President.

AFIDA requires reports in four situations:  (1) when a foreign person “acquires or transfers any interest, other than a security” in agricultural land; (2) when any interest in agricultural land, except a security interest, is held by any foreign person on the day before the effective date of the Act; (3) when a nonforeign owner of agricultural land subsequently becomes a foreign person; and (4) when nonagricultural land owned by a foreign person subsequently becomes agricultural land.

AFIDA defines “agricultural land” as “any land located in one or more states and used for agricultural, forestry, or timber production purposes...”.  7 U.S.C. § 3508(1).  The regulations define agricultural land as “land in the United States which is currently used for, or if currently idle, land last used within the past five years, for farming, ranching, or timber production, except land not exceeding ten acres in the aggregate, if the annual gross receipts from the sale of the farm, ranch, or timber products produced thereon do not exceed $1,000.  7 C.F.R. § 781.2(b).

The reporting provisions of the AFIDA require the disclosure of considerable information regarding both the land and the reporting party.  Individuals who are not U.S. citizens, and have purchased or sold agricultural land must report the transaction to the USDA’s FSA with 90 days of the closing.   The information must be reported on Form FSA-153, and failure to do so can result in civil penalties of up to 25 percent of the fair market value of the property.  The information to be disclosed includes: (1) the legal name and address of the foreign person; (2) the citizenship of the foreign person, if an individual; (3) if the foreign person is not an individual or government, the nature of the legal entity holding the interest, the country in which the foreign person is created or organized, and the principal place of business; (4) the type of interest in agricultural land that the person acquired or transferred; (5) the legal description and acreage of the agricultural land; (6) the purchase price paid, or other consideration given, for such interest; (7) the agricultural purposes for which the agricultural land is being used and for which the foreign person intends to use the agricultural property; and (8) such other information as the Secretary of Agriculture may require by regulation.  7 U.S.C. § 3501(a)(9) 

State Restrictions

While federal law requires informational reporting, some states have enacted statutes designed to restrict alien ownership of real property.  The state laws are generally of three types: (1) outright restrictions on the acquisition of certain types of property; (2) limitations on the total amount of land that can be acquired; and (3) limitations on the length of time property can be held.  Acquisition restrictions are common in the agricultural context, with the restriction generally applying only to the acquisition of farmland, as defined by the law.  Exceptions are common for the acquisition of land for conversion to non-agricultural purposes, land acquired by devise or descent, and land acquired through collection of debts or enforcement of liens or mortgages.  Acreage restrictions allow foreign investment, but place a premium on having an effective method of discovering and preventing multiple acquisition by the same individuals through the use of various investment vehicles.  Time restrictions generally do not apply to voluntary acquisition of the land by foreign investors, but are associated with involuntary acquisitions.  Some states require the disclosure of information concerning the land acquired and the investors.

Currently, thirty states restrict agricultural land acquisition by aliens.  Consider the following three states as examples of states that have more restrictive provisions:

 

  • Iowa - Presently, Iowa has the most restrictive limitation on nonresident alien ownership of any state in the United States. Iowa Code §9I.  The Iowa restriction provides that a “nonresident alien, foreign business, or foreign government, or an agent, trustee or fiduciary thereof, shall not purchase or otherwise acquire agricultural land in this state.” A major exception exists that allows restricted parties to acquire up to 320 acres of agricultural land for “an immediate or pending use other than farming” if the conversion is completed within five years, and annual reports on the progress of the conversion are made.  In addition, during the five-year period, the land can only be farmed on lease to a family farm, a family farm corporation, or an authorized farm corporation. The Iowa law also provides that agricultural land acquired by nonresident aliens by devise or descent must be divested within two years.  However, if the land is acquired by devise or descent from another nonresident alien, it need not be divested, unless the nonresident alien originally acquired the land in the six months preceding enactment of the law. 

 

  • Under the Minnesota law, no natural person (unless a United States citizen or a permanent resident alien of the United States) can acquire, directly or indirectly, any interest in agricultural land, including leaseholds. Minn. Stat. Ann. § 500.221.1.  Foreign corporations cannot, either directly or indirectly, acquire or obtain any interest in title to agricultural land unless at least 80 percent of each class of stock issued and outstanding or 80 percent of the ultimate beneficial interest of the entity is held, directly or indirectly, by United States citizens or permanent resident aliens.  Land can be acquired by devise, inheritance, as security for indebtedness, by process of law in the collection of debts, or by enforcement of a lien, but land acquired in these fashions must be divested within three years of acquisition.  Similarly, land or interests acquired in connection with mining and mineral processing operations are permissible but, pending development for mining purposes, the land can only be used for farming on lease to a family farm, family farm corporation or authorized farm corporation. Another exception exists for agricultural land operated for research or experimental purpose if the total acreage does not exceed that held on May 27, 1977.

 

  • Missouri law prohibits aliens and foreign businesses from acquiring by grant, purchase, devise or descent, agricultural land in the state. Mo. Rev. Stat. §§ 442.560-442.592.  Under the legislation, “alien” is defined as any person who is not a citizen of the United States and who is not a resident of the United States or its holdings.  Mo. Rev. Stat. § 442.566(2).  A “foreign business” is defined as “any business entity whether or not incorporated, including but not limited to corporations, partnerships, limited partnerships, and associations in which a controlling interest is owned by aliens.” Mo. Rev. Stat. § 442.566(4). Agricultural land is defined as any tract consisting of more than five acres whether inside or outside the corporate limits of any municipality, which is capable of supporting an agricultural enterprise including production of agricultural crops, livestock, poultry and dairy products. Farm leasehold interests of ten years or longer or a lease renewable at the lessee's option for greater than ten years are treated as the acquisition of agricultural land.  An exception exists for agricultural land acquired for immediate or potential use in non-farming purposes, but the exception is limited to that amount of land necessary for the nonfarm business operation.  While the nonfarm activity is being developed, the land may only be farmed under lease to a family farm unit, family farm corporation, or a registered alien or foreign business.  The Missouri legislation also contains a reporting requirement requiring any foreign person holding any interest (other than a security interest) in agricultural land to submit a detailed report to the Director of Agriculture within 60 days, except for land used for the production of energy-related minerals.  The information required to be submitted includes the name and address of the foreign person, the citizenship of foreign individuals, the type of interest in acquired land held or transferred, a legal description of the land, the purchase price or consideration paid or received, information concerning transferees, and the declaration of the type of agricultural activity engaged in or the nonfarm purpose for which the land was acquired.  Failure to file a required report is subject to civil fine.

Other states that restrict foreign interests in ag land in one form or another (some restrictions are very minor) are:  Alabama, Alaska, Arkansas, California, Georgia, Hawaii, Idaho, Illinois, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Mississippi, Nebraska, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Tennessee, Virginia, Washington, Wisconsin and Wyoming.

Conclusion

While there is no bar on foreign ownership of agricultural land at the federal level, a majority of states have some sort of restriction.  In many of these states, those restrictions are minor.  The states with the most extensive restrictions tend to be in the center of the country.  Other states have no restrictions at all or place the same restrictions on foreign individuals or entities as they do domestic ones.

May 30, 2019 in Regulatory Law | Permalink | Comments (0)

Tuesday, May 28, 2019

Market Facilitation Program Payments Pledged As Collateral – What Are the Rights of a Lender?

Overview

Last week the USDA announced a second round of Market Facilitation Program (MFP) payments would be forthcoming.  This is a support program in a long line of federal government support programs for farmers going back decades.  Some farmers will pledge these payments to lenders as collateral for loans.  That raises important questions – how are MFP payments classified from a secured transactions perspective?  Are they “proceeds” of crops?  In ag, “proceeds” can take many forms.  Where do MFP payments fit, and what must a lender do to secure its interest in the payments?

Lenders’ rights in MFP payments – that’s the topic of today’s post.

MFP Payments – In General

The MFP is a USDA federal farm program that the Farm Service Agency (FSA) administers.  The MFP provides “payments to farmers with commodities that have been significantly impacted by actions of foreign governments resulting in the loss of traditional exports.”  83 Fed. Reg. 169, p. 44173 (Aug. 20, 2018).  In 2018, the first round of MFP payments was authorized.  Those payments were paid for various crops as an advance payment of 50 percent of a producer’s final production times a rate for each crop or commodity.  The MFP payment rate was $1.65/bu. for certified 2018 soybean production; $.86/bu. for sorghum; $.14/bu. for wheat; $.12/hundredweight for dairy; and $8/head for pork – just to name a few of the commodities that were covered by the program.  There was a separate $125,000 payment limit that applied for the 2018 MFP payments, but they were subject to the $900,000 AGI limitation.   

Now, the USDA has announced a 2019 MFP payment.  This payment will be based on a per-acre payment tied to the county where the producer’s particular farm is located.  But, to be eligible for an MFP payment, a producer must actually plant crops.  Another form of payments – prevented planting payments – will be available under the rules applicable to that program for producers that aren’t able to plant due to weather-related conditions.  Whether there will be a separate $125,000 payment limitation for the 2019 MFP payment remains to be determined.  If not, larger farming operations where the operating entity limits liability will be subject to a single $125,000 payment limit for all payments, including the MFP payment.  In addition, the $900,000 AGI limitation is waived for producers with at least 75 percent of their AGI from farming. 

MFP payments are not deferable for income tax purposes as are crop insurance payments that are paid for actual physical destruction to the taxpayer’s crops.  Instead, MFP payments are for lost profit rather than to compensate a producer for physical damage or destruction to crop, or the inability to plant (the requirement for deferability under I.R.C. §451(f)).    Because they are intended to compensate a farmer for lost profits, they are included in gross income in accordance with I.R.C. §61(a)See also Rev. Rul. 73-408, 1973-2 C.B. 15; Rev. Rul. 68-44, 1968-1 C.B. 191.  They are also similar to counter-cyclical and price-loss payments authorized under prior Farm Bills which a farmer/recipient had to include in gross income.  MFP payments must included in net earnings from self-employment and, thus, subject to self-employment tax because they are tied to earnings derived by a farmer from the farming business.  See, e.g., Ray v. Comr., T.C. Memo. 1996-436; IRS Legal Advice to Program Managers, PMTA-2018-21 (Dec. 10, 2018).

MFP Payments As Loan Collateral

The security interest created by a security agreement is a relatively durable lien. The collateral may change form as the production process unfolds. Fertilizer and seed become growing crops, animals are fattened and sold, and equipment is replaced. The lien follows the changing collateral, and in the end, may attach to the proceeds from the sales of products (at least up to ten days after the debtor receives the proceeds).

The “proceeds” issue.  What are “proceeds” of crops or livestock?  In ag, “proceeds” can take the form of crop insurance payments, prevented planting payments, storage payments, disaster relief payments, and other types of government payments.  State law interpretations of Article 9 of the Uniform Commercial Code (UCC) can differ, but Article 9 provides an extensive and careful coverage for security interests in proceeds. Proceeds are generally defined as whatever is received upon the sale, trade-in or other disposition of the collateral covered by the security agreement. Revised UCC § 9-102(a)(64)(A).  “Proceeds” also includes whatever is distributed or collected on account of collateral.  But, a disposition is not necessarily required.  See, e.g., Western Farm Service v. Olsen, 90 P.3d 1053 (Wash. 2004), rev’g, 59 P.3d 93 (Wash. Ct. App. 2003). 

The general intent of Article 9 is to give the secured party with a security interest in collateral a similar security in anything which the debtor received from third parties in exchange for that collateral. No specific reference to proceeds is required in the security agreement.  UCC §9-203.  Indeed, the attachment of a security interest in collateral automatically gives the secured party an interest in the proceeds if they are identifiable.  UCC § 9-203(f).

As noted above, in ag settings, “proceeds” of crops or livestock can take several forms. These can include federal farm program deficiency payments, storage payments, diversion payments, disaster relief payments, insurance payments for destroyed crops, Conservation Reserve Program payments and dairy herd termination program payments, among other forms.  See, e.g., FMB-First Michigan Bank v. Van Rhee, 681 F. Supp. 1264 (W.D. Mich. 1987).  This is significant in agriculture because of the magnitude of the payments. In fact, in debt enforcement or liquidation settings, the federal payments are often the primary or only form of money remaining for creditors to reach.  However, it should be noted that at least two courts have held that the Federal Crop Insurance Act (FCIA) preempts UCC Article 9. Thus, according to these courts, the exclusive method for a creditor to obtain a lien in undisclosed proceeds is through the FCIA authorized assignment process.  In re Duckworth, No. 10-83603, 2012 Bankr. LEXIS 1219 (C.D. Ill. Mar. 22, 2012); In re Cook, 169 F.3d 271 (5th Cir. 1999).

In general, for governmental agricultural payments to qualify as proceeds, three conditions must be met:  (1) the crop must have been planted; (2) the crop must have been lost or destroyed; and (3) the government payment being claimed must have been received by the producer for the lost or destroyed crop. See, e.g., In re Schmaling, 783 F.2d 680 (7th Cir. 1986); ConAgra, Inc. v. Farmers State Bank, 602 N.W. 2d 390 (Mich. Ct. App. 1999).  Thus, the majority of courts hold that if deficiency payments are made to supplement a planted crop's depressed market price, they are proceeds. Other courts have held that deficiency payments are not proceeds primarily because the payments are made regardless of whether the farmer harvests or sells a crop.  See, e.g., In re Hunerdosse, 85 B.R. 999 (Bankr. S.D. Iowa 1988); In re Kruger, 78 B.R. 538 (Bankr. N.D. Ill. 1987); In re Kingsley, 865 F.2d 975 (8th Cir. 1989).    Similarly, government payments received for the inability to produce crops have been determined to not be proceeds.  See, e.g., In re Schmitz, 270 F.3d 1254 (9th Cir. 2001).  The courts seem to distinguish between payments that replace lost crops (or their markets) and payments that are paid in substitution of a crop.  The former constitutes “proceeds” of crops and the later are general intangibles.  See, e.g., In re Mattick, 45 B.R. 615 (Bankr. Minn. 1985).     

What about MFP payments?  Given the regulatory definition of MFP payments noted above, they are supplemental payments to farmers based (at least for 2018) on certified crop production.  Presently, there aren’t any reported court decisions on the issue of what the method is to properly perfect an interest in MFP payments.  But, logic indicates that MFP payments are intended to serve as a substitute for what would have been crop proceeds if it were not for conduct by foreign governments.  Thus, perhaps a strong argument can be made that MFP payments are like disaster relief payments.  Disaster relief payments have been held to be “proceeds” of crops (or livestock).  See, e.g., In re Nivens, 22 B.R. 287 (Bankr. N.D. Tex. 1982).  Thus, if a lender holds a perfected security in the crops (or farm products) “and proceeds thereof” of a farm debtor, the perfected security interest would include the MFP payments.  But, is a mere reference in a security agreement/financing statement to “government payments or programs” of the farm debtor enough to cause the security interest to attach and become enforceable in MFP payments?  Without a specific reference to the debtor’s crops or farm products, maybe not.      

Does a statutory lien extend to MFP payments?  Probably not.  Lien statutes are typically tied to a specific crop that crop inputs and related services benefitted.  Thus, a properly perfected secured creditor in proceeds of crops would beat out a lien creditor with respect to MFP payments.  However, the precise answer to this issue is dependent on the particular state lien statute at issue and court opinions in that particular state construing the reach of the lien.  Also, it’s important to note that rules for the 2018 MFP payment allowed a landlord operating under a crop-share lease to submit a separate MFP application for the landlord’s share of the crop irrespective of whether the landlord has a landlord’s lien that would beat out a secured creditor.

The FSA is also not subject to state central filing rules or direct notice provisions.  Those rules provide relief to a lender in the event a buyer of a crop that serves as loan collateral fails to issue a jointly payable check to the farmer and the lender.  This is an important point for lenders to understand.  With respect to the 2018 MFP payments, the FSA was encouraging the amounts to be direct deposited into the farmer’s operating account.  If the lender is other than the depository bank, the payments could become subject to a prior perfected security interest of the bank upon deposit.  The banks interest will beat out the lender holding an interest in the debtor’s farm products and proceeds thereof. 

Conclusion

MFP payments raise some important questions from a lending standpoint.  Regardless of the classification of farm program payments that a jurisdiction adopts, a creditor must always comply with applicable UCC requirements for the creation, attachment, and perfection of a security interest in the payments. In any event, however, the most effective manner for a creditor to perfect a claim against a farmer's federal farm program payments is to include specific references to federal farm program benefits (and comparable benefits such as the MFP program payments) in the lender’s blanket security agreement.   A lender should also closely pay attention to the status of a borrower’s MFP application and require that any payments be direct deposited into the debtor’s account with the lender (if there is such an account).  But, the advice remains for lenders drafting documents designed to take an interest in farm program benefits:  1) the security agreement must “reasonably identify” the collateral and; 2) the collateral must be sufficiently identified in the financing statement. 

Another good question is whether the differences in the MFP program between 2018 and 2019 make a material difference on the “proceeds” issue.  While the 2019 payment is tied to the county where the producer’s farm is located, the rule appears to require the producer to actually plant crops to receive a payment.  From a lending and security perspective, that could be a key point.

May 28, 2019 in Secured Transactions | Permalink | Comments (0)

Friday, May 24, 2019

Where Does Life Insurance Fit In An Estate Plan For A Farmer or Rancher?

Overview

During life, many farmers and ranchers are focused on building their asset base, making sure that the business transitions successfully to the next generation, and preserving enough assets for the next generation’s success.  Historically, farm and ranch families haven’t widely used life insurance, but it can play an important role in estate, business and succession planning.  It can also help protect a spouse (and dependents, if any) against a substantial drop in income upon the death of the farm operator.  It can also provide post-death liquidity and fund the buy-out of non-farm heirs.

Planning with life insurance for farmers and ranchers – that’s the topic of today’s post.

During Life

A primary purpose of life insurance during the life of the insured farm operator is to provide for the family in the event of death.  In that sense, life insurance can provide the necessary capital to build an estate.  But, it can also protect income and capital of the farming or ranching business which could be threatened by the operator’s death.  Selling off farm assets, including land, to pay debts after the operator’s death will threaten continuity of the business.  Life insurance is a means of providing the necessary liquidity to protect against the liquidation of operating assets.

Unfortunately, my experience has been that many legal and tax professionals often overlook the usefulness of insurance as part of the overall plan.  This can leave a gaping hole in the estate and business plan that otherwise need not be there.  The result is that many farm and ranch families may feel that “the land is my life insurance.”  But, what if funds are needed to be unexpected expenses at death?  What about debt levels that have increased in recent years?  Is it really good to have to liquidate a tract or tracts of land to pay off expenses associated with death and retire burdensome debt?

So how can life insurance be utilized effectively during life?  That depends on the economic position of the operator, the asset value of the operation and the legal and tax rules surrounding the ownership of life insurance.  Of course, the cost of life insurance must be weighed against options for accumulating funds for use post-death.  Also, consideration must be given to the amount of insurance needed, the type of life insurance that will fit the particular situation, and who the insured(s) will be. 

From an economic standpoint, life insurance tends to provide a lower return on investment than other alternative capital investments for a farmer or rancher.  It’s also susceptible to inflation (not much of an issue in recent years) because of the potentially long time before there is a payout under the policy.  But, also from an economic standpoint, life insurance proceeds are generally not included in the beneficiary’s gross income.  I.R.C. §101(a)(1).

For younger farmers and ranchers, premium payments can be reduced by putting a term policy in place to cover the beneficiary’s premature death.  The term policy can later be converted to a permanent policy.  That’s a key point.  The use of and plan for life insurance is not static.  Life insurance wanes in importance as a mechanism to help build wealth as the farm operation matures and becomes more financially successful and stable.  The usage and type of life insurance will change over the life cycle of the farm or ranch business.   

After Death

From a tax standpoint, life insurance proceeds are included in the insured’s gross estate if the proceeds are received by or for the benefit of the estate.  As such, they are potentially subject to federal estate tax.  However, the current $11.4 million exemption equivalent of the unified credit (per person) takes federal estate tax off the table for the vast majority of farming and ranching estates.  In addition, if the proceeds are payable to the estate, they also become subject to creditors’ claims as well as probate and estate administration costs.  If the beneficiary is legally obligated to use the proceeds for the benefit of the estate, the proceeds are included in the estate regardless of whether the estate is the named beneficiary.  It makes no difference who took the policy out or who paid the premiums.  But, the proceeds are included in the decedent’s gross estate only to the extent they are actually used to discharge claims.  See, e.g., Hooper v. Comr., 41 B.T.A. 114 (1940); Estate of Rohnert v. Comr., 40 B.T.A. 1319 (1939); Prichard v. United States, 255 F. Supp. 552 (5th Cir. 1966)

But, there is a possible way to have the funds available to cover the obligations of the decedent’s estate without having the insurance proceeds being included in the estate.  That can be accomplished by authorizing the beneficiary to pay charges against the estate or by authorizing the trustee of a life insurance trust to use the proceeds to pay the estate’s obligations, buy the assets of the estate at their fair market value, or make loans to the estate.  Treas. Reg. §20.2042-1(b)(1).  In that situation, the proceeds aren’t included in the decedent’s estate because there is no legal obligation (i.e., duty) of the beneficiary (or trustee if the policy is held in trust) to use the proceeds to pay the claims of the decedent’s estate.  See, e.g., Estate of Wade v. Comr., 47 B.T.A. 21 (1942).  However, achieving this result requires careful drafting of policy ownership language along with the description of how the policy proceeds can be used to avoid an IRS claim that the decedent retained “incidents of ownership” over the policy at the time of death.  I.R.C. §2042.  In addition, the policy holder’s death within three years of transferring the policy can cause inclusion of the policy proceeds in the decedent’s estate.  I.R.C. §2035

Other Uses of Life Insurance

Loan security.  Life insurance can be pledged as security for a loan.  This means that a farmer or rancher can use it as collateral for buying additional assets to be used in the business.  In this event, the full amount of the policy proceeds will be included in the decedent’s gross estate, but the estate can deduct any outstanding amount that is owed to the creditor, including accrued interest.  It makes no difference whether the creditor actually uses the insurance proceeds to pay the outstanding debt. 

Funding a buy-sell agreement.  For those farming and ranching operations where the desire is that the business continue into subsequent generations as a viable economic unit, ensuring that sufficient liquid funds are available to pay costs associated with death is vitally important to help ease the transition from one generation to the next.  Having liquid funds can also be key to buying out non-farm heirs so that they do not acquire ownership interests in the daily operational aspects of the business.  Few things can destroy a successful generational transition of a farming or ranching business more effectively than a sharing of managerial control of the business between the on-farm and off-farm heirs.  Life insurance proceeds can be used fund a buy-out of the off-farm heirs.  How is this accomplished?  For example, an on-farm heir of the farm operator could buy a life insurance policy on the life of the operator.  The policy could name the on-farm heir as the beneficiary such that when the operator dies the proceeds would be payable to the on-farm heir.  The on-farm can then use the proceeds to buy-out the interests of the off-farm heirs.  In addition, the policy proceeds would be excluded from the operator’s estate. 

There are other approaches to the addressing the transition of the farming/ranching business.  Of course, one way to approach the on-farm/off-farm heir situation is for the parents’ estate plans to favor the on-farm heirs as the successor-operators.  But, this can lead to family conflict if the younger generation perceives the parents’ estate plans as unfair.  Whether this point matters to the parents is up to them to decide.  Another approach is to leave property equally to the on-farm and the off-farm heirs.  But, this approach splits farm ownership between multiple children and their families and can result in none of the families being able to derive sufficient income from their particular ownership interest.  This causes the ownership interest to be viewed as a “dead” asset.  Remember, off-farm heirs often prefer cash as their inheritance.  Sentimental ownership of part of the family farming or ranching operation may last for a while, but it tends to not to be a long-term feeling for various reasons.  Sooner or later a sale of the interest will be desired, real estate will be partitioned and the future of the family farming operation will be destroyed.  A life insurance funded buy-out can be a means to avoiding these problems. 

Conclusion

Today’s post merely introduced the concept of integrating life insurance in the estate/business plan of a farmer or rancher.  Other considerations involving life insurance include a determination of the appropriate type of life insurance to be purchased, the provisions to be included in a life insurance contract, and the estate tax treatment of life insurance.  Ownership planning is also necessary.  As you can see, it gets complex rather quickly.  However, the use of life insurance as part of an estate plan can be quite beneficial. 

May 24, 2019 in Business Planning, Estate Planning | Permalink | Comments (2)

Wednesday, May 22, 2019

What’s the Best Entity Structure For the Farm or Ranch Business?

Overview

The question often arises with farm and ranch clients that engage in estate, business or succession planning as to what the optimal entity structure is for the business?  There’s no easy, one-size-fits-all answer to that question.  It simply depends on numerous factors.  In fact, the question is best answered by asking a question in return – what do you want the farming or ranching business to look like after you and your spouse are gone?  What are your goals and objectives.  If planning starts from that standpoint, then it is often much easier to get set on a path for creating an “optimal” entity structure.

Some thoughts on structuring the farming or ranching business – that’s the topic of today’s post

Food For Thought

In many planning scenarios it is useful to create a checklist of points to consider that are relevant in the entity selection decisionmaking process.  The next step would then be to apply those points to the goals and objectives of the parties.  For starters, consider the following:

C corporations.  The following are relevant to C corporations:

  • A C corporation can be formed tax free if property is exchanged for stock; the transferors (as a group) hold 80 percent or more of the stock immediately after the exchange of property for stock; and the formation is for a business purpose.
  • C corporate income is subject to tax at a flat rate of 21 percent.
  • A C corporation is not eligible for the 20 percent qualified business income deduction of I.R.C. §199A that is available to a sole proprietor or the member of a pass-through entity (such as a partnership or S corporation).
  • While gain that is realized on the sale of stock of a farming corporation can’t be excluded under the special rules that apply to qualified small business stock (I.R.C. §1202), if the stock is that of a corporation engaged in processing activities, the gain can be excluded. There are other rules that can limit (or eliminate) this capital gain exclusion.
  • When a C corporation converts to S corporation status, the built-in gains (BIG) tax applies to the built-in gains on income items.  I.R.C. §1374(a). The Tax Cuts and Jobs Act (TCJA) didn’t eliminate the BIG tax, but it did lower it to 21 percent. 
  • A C corporation has good flexibility in establishing its capitalization structure as well as how it allocates income, losses, deductions and credits.
  • A C corporation is potentially subject to additional penalty taxes if too much earnings are accumulated without legitimate, well documented business reasons, or If too much income is passive.
  • The alternative minimum tax presently doesn’t apply to C corporate income.
  • A corporation for the farming operating entity will limit farm program payment limitations to a single $125,000 limit at the entity level.  That amount will then be divided by the number of shareholders.  If a pass-through entity is the operating entity, the number of payment limits will be determined by the number of members of the entity.  
  • A C corporation can deduct state income tax. This should be contrasted with the TCJA limitation on the deduction of such taxes for individuals that is pegged at $10,000 (including real property taxes on property that is not used in the conduct of the taxpayer’s trade or business).  I.R.C. §164(b)(6).   
  • A C corporation can provide employees with the tax-free fringe benefits of meals (limited to 50 percent by I.R.C. §274(n)) and lodging that are supported by legitimate business reasons (and satisfy other conditions). This benefit is not available to sole proprietors and partners in a partnership. See, e.g., Rev. Rul. 69-184, 1969-1 C.B. 256.  That is also the result for S corporation employees who own, directly or indirectly, more than 2% of the outstanding stock of the S corporation may not receive certain otherwise tax-free fringe benefits (including meals and lodging).  See I.R.C. §1372. Attribution rules apply for determining who is considered to be an S corporation shareholder.  I.R.C. §318.
  • A farming or ranching C corporation can generally use the cash method of accounting.
  • In some states, a C corporation cannot own or operate agricultural land unless members of the same family own a majority of the corporate stock. State laws differ on the specific rules barring C corporations from being involved in agriculture, and some states don’t have such rules.
  • A C corporation faces the potential of a double layer of tax upon liquidation.
  • The C corporation generally does provide good estate planning opportunities. In other words, it tends to be a good organizational vehicle for transitioning ownership from one generation to the next.

What About Income Tax Basis?

Given the currently high level of the federal estate tax exemption equivalent of the unified credit (11.4 million per decedent for deaths in 2019), income tax basis planning is high on the priority list.  Thus, when federal estate tax is not a potential concern, planning generally focuses on making sure that property is included in a decedent’s estate.  This raises some basic planning rules that must be considered:

  • For property that is included in a decedent’s estate for purposes of federal estate tax, the basis of that property in the hands of the person inherits the property is generally the fair market value (FMV) as of the date of the decedent’s death.  I.R.C. §Sec. 1014(a)(1)). 
  • But, the “stepped-up” basis rule (to the date-of-death value) doesn’t apply to property that is income in respect of a decedent (IRD) under §691. R.C. §1014(c).  An item is IRD something that decedent was entitled to as gross income but wasn’t’ included in income due to death in accordance with the decedent’s method of accounting.  See Treas. Reg. §1.691(a)-1(b).  Farmers and ranchers have some common occurrences of IRD such as…
    • Deferred gain to be reported from installment sales and deferred sales of crops and livestock;
    • The portion (on a pro rata) basis or crop-share rentals due at the time of death;
    • Receivables for a cash basis farmer;
    • Unpaid wages;
    • The value of commodities stored at an elevator (cooperative). Reg. §1.691(a)-2(b), Example 5 (canning factory and processing cooperative).
    • Accrued interest income on Series E/EE bonds;
  • When a decedent’s estate makes an election under I.R.C. §2032A to value ag land in the estate at its value as ag property (known as the “special use” value) rather than at its fair market value, the basis of the land in the hands of the heir is the special use value. There is no basis “step-up” to fair market value at the time of death.  Treas. Reg. §§1014(a)(3); 1.1014-3(a).
  • While the income of a pass-through entity is taxed only at the owner level, and the pass-through income increases the owner’s tax basis in the owner’s interest in the pass-through entity, a C corporation pays tax at the corporate level and then tax is also paid at the shareholder level on dividends or proceeds of liquidation. In addition, C corporate income does not increase the shareholder’s stock basis.

Just Starting Out – Creating a New Entity

If an organizational structure is initially being put into place, again there are numerous factors to consider in determining whether the farming or ranching business should operate as a C corporation or a pass-through entity.  In addition, to those factors pointed out above, the following factors should also be considered:

  • Is it anticipated that the primary or sole shareholder will hold the corporate stock until death?
  • Where will the business be incorporated and do business? If the business will be a C corporation, does the state of incorporation or other states in which the corporation will do business have a state income tax?
  • What tax bracket(s) will apply to the shareholders?
  • If the underlying business of the corporation would qualify for the 20 percent qualified business income deduction of I.R.C. §199A, what’s the differential between the corporate tax rate of 21 percent and the individual rate less the 20 percent deduction? Will that full 20 percent deduction be available if the entity weren’t a C corporation?  This can involve a rather complex analysis.
  • What type of assets are involved? Will they appreciate in value?  If so, the corporate tax rate of 21 percent plus the second layer of tax on gain of the appreciated asset value at the shareholder level upon liquidation (or on a qualified dividend) will exceed the maximum 23.8 percent capital gain rate that applies to an individual (20 percent rate plus an additional 3.8 percent on passive gain under Obamacare.  I.R.C. §1411
  • Is it anticipated that the business will retain earnings or pay it out in the form of compensation, rents or other expenses? Growing businesses tend to retain earnings.  Paid-out earnings of a C corporation are taxed again at the shareholder level.
  • Is income expected to fluctuate widely? If so, remember that the C corporate tax rate is a flat 21 percent. 
  • Will there be sufficient funds to pay consistent income to the owners of the business? If so, that can mean that (if a C corporation structure is utilized) shareholder-employees can receive tax benefits at the individual level.  If a corporate-level loss is incurred in doing so, that loss can be used to offset future taxable income. 
    • Under the TCJA, losses can offset up to 80 percent of pre-NOL taxable income.
    • The loss (for a farming corporation) can be carried back two years.  I.R.C. §172(b)(1)(B). 
  • From an accounting and tax planning standpoint, is a fiscal year desired? A C corporation can have a fiscal year-end and the individual shareholders can have a calendar year-end.

Conclusion

So, what is the best entity structure for your farming or ranching operation?  The discussion above merely scratches the surface of a very complex matter.  However, if you clearly articulate your goals and objectives for the future of your business to your planners, and provide complete information on assets, liabilities, land ownership, current arrangements, family data and dynamics, cropping and livestock history and tax history, then a good plan can be put in place that can, at least in the short-term satisfy your objectives.  Then, there must be a commitment to routinely review and update the plan as necessary.  There is no “one-size-fits-all” business plan, and plans aren’t static.  There is cost involved, of course, but the successful operations realize that the cost is a small compared to the benefits.

May 22, 2019 in Business Planning, Estate Planning | Permalink | Comments (0)

Monday, May 20, 2019

Legal Issues Associated With Abandoned Railways

Overview

For farmers and ranchers (and other rural landowners) owning agricultural land adjacent to railroads, the abandonment of an active rail line presents a number of real property issues.  What is the legal effect of the abandonment?  Does state or federal law apply?  What about fencing?  These (and others) are all important questions when a railroad abandons a line.

Abandoned rail lines and legal issues – that’s the topic of today’s post.

Legal Effect of Abandonment

During the nineteenth century, many railroad companies acquired easements from adjoining landowners to operate rail lines.  In some instances, railroads acquired a fee simple interest in rights-of-way and in those situations, can sell or otherwise dispose of the property.  In most situations, however, a railroad was granted an easement for railroad purposes, usually acquired from adjacent property owners.  The general rule is that a right-of-way for a railroad is classified as a limited fee with a right of reverter if received from Congress on or before 1871, but is classified as an exclusive use easement if the right of way is received after 1871.

If the railroad held an easement, the abandonment of the line automatically terminates the railroad's easement interest, and the interest generally reverts to the owners of the adjacent land owning the fee simple interest from which the easement was granted. See, e.g., Penn. Central Corp. v. United States Railroad Vest Corp., 955 F.2d 1158 (7th Cir. 1992).

After abandonment, state law controls the property interests involved.  Once abandonment occurs, federal law does not control the property law questions involved. The only exception is if the United States retained a right of reverter in the abandoned railway.  Under the Abandoned Railroad Right of Way Act (43 U.S.C. § 912), land given by the United States for use as a railroad right-of-way in which the United States retained a right of reverter had to be turned into a public highway within one year of the railroad company’s abandonment or be given to adjacent landowners.  Later, the Congress enacted the National Trails System Improvement Act of 1988 under which those lands not converted to public highways within one year of abandonment would revert back to the United States, not adjacent private landowners.

What About Recreational Trails? 

In 1976, the Congress passed the Railroad Revitalization and Regulatory Reform Act in an effort to promote the conversion of abandoned lines to trails.  Under the Act, the Secretary of Transportation is authorized to prepare a report on alternate uses for abandoned right-of-ways.  The Secretary of the Interior can offer financial, educational and technical assistance to local, state and federal agencies.  In addition, the Interstate Commerce Commission (ICC) was authorized to delay disposition of railroad property for up to 180 days after an order of abandonment, unless the property was first offered for sale on reasonable terms for public purposes including recreational use.  The National Trails System Act amendments of 1983 authorized the ICC to preserve for possible future railroad use, rights-of-way not currently in service and to allow interim use of land by a qualified organization as recreational trails.  Effective January 1, 1996, the Congress replaced the ICC with the Surface Transportation Board (STB), and gave the STB authority to address rail abandonment and trail conversion issues.  The organizations operating the corridors as trails assume all legal and financial responsibility for the corridors.  This is known as railbanking.

Under the 1983 amendments, a railroad must follow a certain procedure if it desires to abandon a line.  A potential trail operator must agree to manage the trail, take legal responsibility for the trail and pay any taxes on the trail.  The STB engages in a three-stage process for railroad abandonment.  First, a railroad must file an application with the STB and notify certain persons of its planned abandonment.  The application must state whether the right-of-way is suitable for recreational use.  In addition, the application must notify government agencies and must be posted in train stations and newspapers giving the public a right to comment.  Second,the STB then determines whether “present or future public convenience and necessity” permit the railroad to abandon.  A trail organization then must submit a map and agreement to assume financial responsibility and the STB will then determine whether the railroad intends to negotiate a trail agreement.  Third, if such a determination is made, the STB will issue a “certificate of interim trail use” or a certificate of abandonment.  The parties have 180 days to reach this agreement.  If no agreement is reached, the line is abandoned.  Abandonment of a railroad right-of-way cannot occur without the prior authorization of the STB.  See, e.g., Phillips Company v. Southern Pacific Rail Corp., 902 F. Supp. 1310 (D. Colo. 1995).  But, once abandonment occurs, the STB no longer has any jurisdiction over the issue.  See, e.g., Preseault v. Interstate Commerce Commission, 494 U.S. 1 (1990).

Before passage of the 1983 amendments, it was clear that when a railroad ceased line operation and abandoned the railway, the easement interest of the railroad in the line reverted to the adjacent landowners of the fee simple.  See, e.g., Consolidated Rail Corp. Inc. v. Lewellen, 682 N.E.2d 779 (Ind. 1997)However, as noted, the 1983 amendments established a more detailed process for railroad abandonment and gave trail organizations the ability to operate an abandoned line.  While most railroads hold a right-of-way to operate their lines by easement specifying that the easement reverts to the landowner upon abandonment, after passage of the 1983 amendments, a significant question is when, if ever, abandonment occurs. One court has held that the public use condition on abandonment does not prevent the abandonment from being consummated, at which time STB jurisdiction ends, federal law no longer pre-empts state law, and state property law may cause the extinguishment of the railroad's rights and interests.  See, e.g., Fritsch v. Interstate Commerce Commission, 59 F.3d 248 (D.C. Cir. 1995), cert. denied sub. nom. CSX Transportation v. Fritsch, 516 U.S. 1171 (1996).  

A more fundamental issue is whether a preclusion of reversion to the owner of the adjacent fee simple is an unconstitutional taking of private property. I will analyze the constitutional takings issue is a subsequent post.  Suffice it to say, however, in 1990 the U.S. Supreme Court upheld the 1983 amendments as constitutional.  Preseault v. Interstate Commerce Commission, 494 U.S. 1 (1990). But see Swisher v. United States, 176 F. Supp.2d 1100 (D. Kan. 2001).  

Recent Case

Numerous issues (including issues associated with fencing) involving the abandonment of a rail line were front and center in a recent court decision from Kansas.  In, Central Kansas Conservancy, Inc., v. Sides, No.119,605, 2019 Kan. App. LEXIS 29 (Kan. Ct. App. May 17, 2019), the Union Pacific Railroad acquired a right-of-way over a railroad corridor that it abandoned in the mid-1990s.  At issue in the case was a 12.6-mile length of the abandoned line between the towns of McPherson and Lindsborg in central Kansas. A Notice of Interim Trail Use (NITU) was issued in the fall of 1995.  The corridor was converted into a trail use easement under the National Trails System Act. 

In 1997, Union Pacific gave the plaintiff a "Donative Quitclaim Deed" to the railroad’s easement rights over the corridor, with three-quarters of a mile of it running through the defendant’s property at a width of 66 feet.  Pursuant to a separate agreement, the plaintiff agreed to quitclaim deed its rights back to the railroad if the railroad needed to operate the line in the future.   By virtue of the easement, the plaintiff intended to develop the corridor into a public trail.  In 2013, the plaintiff contacted the defendant about developing the trail through the defendant’s land.  The defendant had placed machinery and equipment and fencing in and across the corridor which they refused to remove. 

In 2015, the plaintiff sued to quiet title to the .75-mile corridor strip and sought an injunction concerning the trail use easement over the defendant’s property. The defendant admitted to blocking the railway with fencing and equipment, but claimed the right to do so via adverse possession or by means of a prescriptive easement.  The defendant had farmed, grazed cattle on, and hunted the corridor at issue since the mid-1990s.  The defendant also claimed that the plaintiff had lost its rights to the trail because it had failed to complete development of the trail within two years as the Kansas Recreational Trail Act (KRTA) required. 

In late 2016, the trial court determined that the two-year development provision was inapplicable because the ICC had approved NITU negotiations before the KRTA became effective in 1996.  The trial court also rejected the defendant’s adverse possession/prescriptive easement arguments because trail use easements are easements for public use against which adverse possession or easement by prescription does not apply.  During the summer of 2017 the plaintiff attempted to work on the trail. When volunteers arrived, the defendant had placed equipment and a mobile home on the corridor preventing any work. The plaintiff sought a "permanent prohibitory injunction and permanent mandatory injunction." The defendant argued that he had not violated the prior court order because "[a]ll the Court ha[d] done [was] issue non-final rulings on partial motions for summary judgments, which [were], by their nature, subject to revision until they [were] made final decisions."  Ultimately, the trial court granted the plaintiff’s request for an injunction, and determined that the defendant had violated the prior summary judgment order.  The trial court also held that the plaintiff had not built or maintained fencing in accordance with state law. 

On appeal, the appellate court partially affirmed, partially reversed, and remanded the case.  The appellate court determined that the defendant did not obtain rights over the abandoned line via adverse possession or prescriptive easement because those claims cannot be made against land that is held for public use such as a recreational trail created in accordance with the federal rails-to-trails legislation.  The appellate court also determined that the plaintiff didn’t lose rights to develop the trail for failing to comply with the two-year timeframe for development under the KRTA.  The appellate court held that the KRTA two-year provision was inapplicable because a NITU was issued before the effective date of the KRTA. 

However, the appellate court determined that the plaintiff did not follow state law concerning its duty to maintain fences.  The appellate court held that Kan. Stat. Ann. §58-3212(a) requires the plaintiff to maintain any existing fencing along the corridor and maintain any fence later installed on the corridor.  In addition, any fence that is installed on the corridor must match the fencing maintained on the sides of adjacent property.  If there is no fencing on adjacent sides of a landowner’s tract that abuts the corridor, the plaintiff and landowner are to split the cost of the corridor fence equally.    The appellate court remanded the case for a determination of the type and extent of fencing on the defendant’s property, and that the plaintiff has the right to enter the defendant’s property to build a fence along the corridor.  Any fence along the corridor is to be located where an existing fence is located.  If no existing fence exists along the corridor, the corridor fence is to be located where the plaintiff’s trail easement is separated from the defendant’s property.  The appellate court remanded to the trial court for a reconsideration of its ruling on fence issues. 

Conclusion

Abandoned rail lines create numerous legal issues for adjacent landowners, including a mix of federal and state law.  In addition, fencing issues get involved and those may be handled not under the general fence laws of the particular state, but in accordance with fencing provisions specific to the conversion of abandoned rail lines to trails.  In any event, for those that believe they have been negatively impacted by a rail line abandonment, seeking good legal counsel is a must to protect whatever landowner rights remain. 

May 20, 2019 in Real Property | Permalink | Comments (0)

Thursday, May 16, 2019

Ag Antitrust - Is There a Crack in the Wall of the “Mighty-Mighty” (Illinois) Brick House?

Overview

The markets for the major ag products in the U.S. are highly concentrated.  This is the case in the markets for hogs and poultry as well as food processing and the market for genetic characteristics of corn, soybeans and cottonseed.  The retail sector involving many ag products is also highly concentrated. This raises economic and legal questions as to whether the conduct that such concentration makes possible improperly denies farmers a proper share of the retail food dollar and simultaneously increase prices to consumers.  In other words, does the conduct associated with market concentration at these various levels negatively impact commodity prices, and result in producers receiving less of the retail food dollar while consumers simultaneously pay more for food?  If so, what can a farmer or rancher do about it?  Does antitrust law provide a remedy? Does it matter that a farmer/rancher is not a directly injured party?  The U.S. Supreme Court recently decided a case involving the Apple Co. and IPhone users that involves some of these concepts.  Does it have implications for farmers and ranchers?

That’s the topic of today’s post – the ag implications of the recent Supreme Court decision involving Apple Inc. and IPhone users.  I have asked Peter Carstensen, Professor of Law Emeritus at the University of Wisconsin School of Law to collaborate with me on today’s post.  Peter is a Senior Fellow of the American Antitrust Institute, and formerly worked in the antitrust division of the U.S. Department of Justice.  You will find rather interesting his thoughts on the implications of this week’s Supreme Court decision for agriculture. 

Antitrust and Indirect Purchasers

The 1977 U.S. Supreme Court decision.  The questions posed above are interesting.  From a legal standpoint, what can a farmer or rancher do if they believe that they have been improperly harmed by anticompetitive conduct?  In 1977, the U.S. Supreme Court held in Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977), that a plaintiff cannot claim damages when the plaintiff is not the party that was directly injured.  In other words, even if an antitrust violation can be established that results, for example, in ag product prices being lower than a competitive market would produce, Illinois Brick bars the farmer/rancher from suing for damages due to lack of standing because they haven’t been directly injured – there is a processor in-between. For example, assume manufacturers or food retailers operate in a concentrated market and agree to fix the prices of their products and then sell those products to wholesalers or retailers (their direct customers).  The wholesalers and retailers then resell the goods either to other entities down the supply chain or to end consumers (i.e., indirect purchasers).  It’s those indirect purchasers that the 1977 Supreme Court decision bars from seeking damages because the court feared that defendants would be exposed to multiple claims for recovery and there would be complications in apportioning damages among the plaintiffs in the supply chain. The same reasoning has been applied to farmer claims where the alleged source of harm is a downstream conspiracy by retailers. Indirectly injured parties can still seek injunctive relief, but private lawyers are unlikely to take such cases despite the statutory right to a reasonable attorney’s fee if they succeed.  Since 1977, most states have enacted laws or have judicial opinions that reject the Illinois Brick decision (which are not preempted by federal law – see California v. ARC America, 490 U.S. 93 (1989)).  In these states, indirect purchasers can seek recovery under state antitrust laws. 

Recent Supreme Court opinion.  In Apple Inc. v. Pepper, et al., No. 17-204, 2019 U.S. LEXIS 3397 (U.S. Sup. Ct. May 13, 2019), IPhone users sued Apple Inc. over its operations of the App Store.  The trial court held that the consumers in the case were indirect purchasers that lacked standing due to Illinois Brick.  The Ninth Circuit reversed (Pepper v. Apple Inc., 846 F.3d 313 (9th Cir. 2017)) and the U.S. Supreme Court agreed to hear the case (Apple Inc. v. Pepper, 138 S. Ct. 2647 (2018)On May 13, the Supreme Court affirmed the Ninth Circuit decision by a 5 to 4 vote.  Thus, the plaintiffs could pursue their claims against Apple for allegedly monopolizing access to apps for Apple’s iPhones and imposing monopoly prices.  Apple had constructed its arrangement with the app developers so that formally the developers set the prices charged to buyers and Apple took a 30 percent commission from that price before remitting the remainder to the developer.  Thus, as a formal contract matter, Apple was only the agent of the developer although the customers could only deal with Apple to get apps.

The majority took the view that Apple was a retailer of apps with an alleged monopoly over the supply.  In this view the formal contract relationship between the developer and Apple was irrelevant to the question of whether the buyers were the first victim to Apple’s alleged monopoly.  The opinion acknowledged that there could be some difficult issues as to damages because if Apple took a lower commission (mark-up) on the apps, the app seller might have raised its prices.  Hence, the actual damages to the buyers might be difficult to calculate.  Moreover, the opinion pointed out that the developers could have a claim for damages as a result of lost sales resulting from the excessive commission charge if they would have kept a lower retail price. 

The dissent argued that the better interpretation of Illinois Brick was to focus on the party setting the price, here the developers.  Hence, they alone should have standing to claim that any Apple monopoly had harmed them as the first victim.  The dissent stressed the problems of determining damages for both upstream and downstream victims given that the majority had held that both could sue.

Thus, the court was unanimous that the Illinois Brick rule should remain.  It rejected the argument of a group of 30 states set forth  in an Amicus Brief urging the Court to reverse Illinois Brick and allow indirect purchasers with damage claims to have access to the federal courts. However, the majority decision appears to reject the use of formal contracts to determine who is the first buyer.  This is consistent with historic practice in antitrust where courts have looked to the substance and not the form of the conduct.  However, to determine who is the first seller, the majority focused on transactional characteristics that seem very formal. But it repeatedly characterized Apple as a classic retailer that selected the goods it would sell, and generally controlled the marketing of the goods.  In contrast, there are real “agents” who function as independent contractors to deliver goods for others and remit the payments.  The decision does not make this distinction explicitly but its repeated characterization of Apple as a retailer suggests that the majority was taking a realistic, functional view of the relationship. A more nuanced analysis of this point would have been very helpful.

Implications for Agriculture

The following are Prof. Carstensen’s thoughts on the ag implications of the Pepper decision:

Because the decision leaves the Illinois Brick rule in place, it fails to give farmers any direct expansion of their right to damages under federal law.  Of greater significance for agriculture where the concern is exploitation of monopsony or oligopsony power, the majority opinion is clear that both downstream customers and upstream suppliers (e.g., farmers) can sue the buyer/seller engaged in anticompetitive conduct causing harm.  This is helpful with respect to poultry and (potentially) hog cases brought on behalf of farmers providing growing services. It confirms their independent right to claim damages.  This declaration is also relevant to the continuing disputes over the interpretation of the Packers and Stockyards Act (PSA) condemnation of unfair and discriminatory conduct. 7 U.S.C. §§182 et seq. The courts have imposed an interpretation that holds that the PSA is an antitrust statute which requires competitive injury before there can be a violation.  In addition, the decisions have required that there be an adverse effect on consumers and not just producers.  The Pepper decision re-emphasizes the well-established antitrust principle that both upstream and downstream harms are independent antitrust injuries.  In future PSA cases proof of harm to producers should establish “harm to competition.”  Of course, a better understanding of the PSA, consistent with its application in various contexts such as buyer defaults and false weighing, is that its purpose is to protect individual farmers from unfair and discriminatory conduct.  But that issue must await a court willing to interpret the PSA’s provisions correctly.

Another implicit but important underlying assumption of the case is that Illinois Brick applies to exploitive conduct (i.e., either excessive prices imposed on buyers, or under payment to sellers).  The implication is that this rule has no bearing on cases involving exclusion or predation where the illegal conduct harms the victims but does not create a direct gain to the wrongdoer.  Unlike the exploitation cases, the predatory wrongdoer is not sitting on a “pot of money” resulting from its illegal deeds; rather it has expended resources to exclude rivals or entrench its market position in some way.  In such cases the measure of harm is the loss to the victim and not the gain to the wrongdoer.  This is important because usually the harm results from some market manipulation or exclusionary practice in which the wrongdoer causes the harms without directly dealing with the victim. Where farmers are victims of such exclusionary practices even if the harm is inflicted indirectly, they would still have standing to seek damages as well as injunctions in federal court.

Conclusion

In Pepper, the Supreme Court reaffirmed the Illinois Brick rule.  However, it employs a functional analysis to identify the first buyer (seller).  This may improve slightly the chances of farmers getting damages in federal court when buyers engaged in unlawful exploitation have used agents or other specious means to avoid direct dealings.  But the rule remains a major barrier to getting damages for farmers harmed indirectly by exploitive practices by downstream buyers.  Where the farmers’ harm stems from exclusionary or predatory conduct, the decision reinforces the position that the rule does not apply to such damages.  But, it also provides a further correction to the misinterpretations of competitive harm invoked in PSA cases.

The Pepper decision is not much of a crack in the (Illinois) brick house.  A small dent perhaps, but not a foundational crack.  “Ow…a brick house.”…

May 16, 2019 in Regulatory Law | Permalink | Comments (0)

Tuesday, May 14, 2019

2019 National Ag Tax/Estate and Business Planning Conference in Steamboat Springs!

Overview

This summer Washburn Law School is sponsoring its summer national ag tax and estate and business planning conference in Steamboat Springs, Colorado on August 13-14.  The event will be held at the beautiful Steamboat Grand Hotel, and is co-sponsored by the Department of Agricultural Economics at Kansas State University and WealthCounsel.  Registration is now open for the two-day event, and onsite seating is limited to the first 100 registrants.  However, the event will be live streamed over the web for those who can’t make it to Steamboat. 

Key Ag Tax and Planning Topics

The QBID.  As we historically have done at this summer event, we devote an entire day to ag income tax topics and an entire second day to planning concepts critical to farm and ranch families.  Indeed, on Aug. 13, myself and Paul Neiffer will begin the day with a dive back into the qualified business income deduction (QBID) of I.R.C. §199A and take a look at the experience of the past filing season (that largely continues uninterrupted this year).  For many clients, returns were put on extension in hopes that issues surrounding the QBID, or the DPAD/QBID for patrons of cooperatives would get resolved.  Plus, software issues abounded, and the IRS issued conflicting (and some incorrect) information concerning the QBID.  In addition, the season began with errors in Pub. 225, the Farmers’ Tax Guide.  Some states even piggy-backed the IRS errors for state income tax purposes and coupling.  That made matters very frustrating.

On the QBID discussion, we will take a close look at the rental issue.  That seems to be a rather confusing matter for many practitioners.  Is there an easy way to separate rental situations so that they can be easily analyzed?  We will break it down as simply as possible and explain when to use the safe-harbor – it’s probably not nearly as often as you think.  What is an I.R.C. §162 trade or business activity?  How do the passive loss rules interact with the QBID? 

For farmers that are patrons of ag cooperatives, how is the DPAD/QBID to be calculated?  What information is needed to properly complete the return?  Where does what get reported?  My experience so far this tax season in seminars is that it is taking me about three hours just to recap and review the QBID and go through practitioner questions that came in during tax season and share how they were answered.  The discussion has been great, and at the end of the discussion, you will have a better handle on how the QBID works for your clients.  Is it really as complicated as it seems?

Selected ag topics.  After a brief break following the QBID discussion, we will get into various ag-related tax topics and how the changes brought about by the TCJA impact ag returns.  What were the problem areas of applying the new rules during the filing season?  What are the key tax issues that farm and ranch clients are presently facing.  Currently, disaster issues loom large in parts of the Midwest and Plains.  Also, Farm Bill-related issues associated with CCC loans and the impact on the PLC/ARC decision are important.  What about how losses are to be treated and reported?  Those rules have changed.  Depreciation rules have also been modified.  But, is it always in a client’s best interests to maximize the depreciation deduction?  What about trades?  The reporting of personal property trades has changed dramatically.  How do those get reported now?  What are the implications for clients?  

Cases and Rulings

Of course, the day wouldn’t be complete without going through the key rulings and cases from the prior year.  There are always many important developments in the courts and with the IRS.  Some are even amusing!  It’s always insightful to learn from the mistakes of others, and from others that are blazing the trail for others to follow.  We will work through all of the key ag-related cases and rulings from the past 12-18 months.

Other

We will have specific session focusing on depreciation, the passive loss rules (and how to report on the return); ag disasters; and the 2018 Farm Bill.  Day 1 will be a full day. 

Ag Estate and Business Planning

On August 14, we turn our attention to planning concepts for the farm and ranch family.  Joining me on Day 2 will be Stan Miller, the founder of WealthCounsel, LLC.  In addition to providing estate and business planning education, WealthCounsel, LLC also provides drafting software.  In addition, Timothy O’Sullivan joins the Day 2 teaching team.  Tim has a longstanding practice in Wichita, Kansas, where he focuses on estate planning and the administration of trusts and estates.

Recent developments.  Day 2 begins with a rapid summary of the development that impact estate and business planning.  For most clients, the issue is not tax avoidance given the presently high levels of the applicable exclusion.  Rather, the issue is including property in the estate to achieve a stepped-up basis.  I will go through recent developments impacting the basis planning issue and other developments impacting charitable giving as well as retirement planning. 

Other issues.  Tim O’Sullivan will devote a session to dealing with family disharmony and how to keep it from cratering a good estate plan. Tim will also have a separate session on incorporating good long-term care planning into the overall family estate and business plan.  This is a very important topic for many farm and ranch families – particularly those that want to keep the family business in tact for future generations.  I will have separate sessions on charitable giving; planning for second (and subsequent) marriages; and common estate planning mistakes.  To round out Day 2, Stan Miller will devote a session to techniques that can professionals can implement to preserve family held farms and ranches for future generations.  This will be a timely topic given the many variables that farmers and ranchers must handle to help their operations continue to be successful.

Registration

 For more information about the event and to register, click here:  http://washburnlaw.edu/employers/cle/farmandranchtax.html

A room block for the conference is available at the Steamboat Grand Hotel and is accessible from the page at the link provide above or here:  https://group.steamboatgrand.com/v2/lodging-offers/promo-code?package=49164&code=WASH19_BLK

If you can’t attend, the conference is live streamed.  Information about signing up for the live streaming is also available on the first link provided above.

Conservation Easement Seminar

I will also be presenting at another CLE/CPE event in Steamboat on Monday, August 12 immediately preceding our two-day conference.  That event is sponsored by the Colorado Cattlemen’s Agricultural Land Trust, the Eagle Valley Land Trust, and the Yampa Valley Land Trust, and focuses on the legal, real estate and tax issues associated with conservation easement donations.  I will provide more information about that event as it becomes available.

Conclusion

This two-day seminar is a high-quality event this summer in a beautiful location.  If you are in need of training on ag tax and planning related issues, this is the event for you.  In addition, the full day on conservation easements preceding the two-day conference is an excellent opportunity to dig into a topic that IRS is looking at closely.  It’s important to complete these transactions properly and this conference will lay out the details as to how to do it properly. 

I hope to see you either in-person in Steamboat Springs later this summer or via the web.  It will be a great event for your practice!

May 14, 2019 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Friday, May 10, 2019

More Ag Law and Tax Developments

Overview

It’s been a while since I have devoted a post to recent developments, so that’s what today’s post is devoted to.  There are always many significant developments in ag law and tax.  I was pleased recently when one of my law students, near the conclusion of the course, commented on how many areas of the law that agricultural law touches and how often the rules as applied to farmers and ranchers are different.  That is so true.  Ag law is daily life for a farmer, rancher, rural landowner, and agribusiness in action.

Recent development in ag law and tax – that’s the topic of today’s post.

Chapter 12 Plan Not Feasible

As I have written in other posts, when a farmer files Chapter 12 bankruptcy, the reorganization plan that is proposed must be feasible.  That means that the farmer must estimate reasonable crop yields and revenue based on historical data, and also provide reasonable estimates of expenses.  Courts also examine other factors to determine whether a reorganization plan is feasible.

In, In re Jubilee Farms, 595 B.R. 546, 2018 Bankr. LEXIS 4080 (Bankr. E.D. Ky. Dec. 28, 2018), the debtor, a farm partnership operated by two brothers, farmed primarily corn and soybeans. The Debtors filed Chapter 12 bankruptcy in early 2018. In May of 2018, the Debtors filed a joint Chapter 12 plan, but the secured creditors, FCMA and FCS, objected. The debtors filed an amended Chapter 12 plan providing FCMA with a fully secured claim of roughly $2.7 million and FCS with a fully secured claim of roughly $180,000. The plan provided for periodic payments funded primarily by the debtor’s farming income and supplemented by custom trucking and combining revenue. Additional funding in the first year would come from crop insurance and anticipated federal aid for farmers affected by political activity upsetting foreign crop sales.

The creditors and the Trustee objected to the confirmation of the amended plan on various grounds, but the main argument raised was that the amended plan was not feasible, because the debtor’s one-year income and expense projections were limited and unrealistic compared to the debtor’s historical income and expenses. An evidentiary hearing was held to present projected revenue and expenses for the farm and thus determine the feasibility (whether the debtor could make all plan payments and comply with the plan) of the amended plan.

The court analyzed the projected revenues and expenses for the coming year, and the concluded that the plan was not feasible because the debtors had failed to prove that the plan was feasible beyond March 2019. The court stated that if the debtors only had to prove they could make the payments required up to March 2019, the debtors would prevail because the testimony created a reasonable belief that the receipts necessary to make payments up to that time either had or would soon occur. However, beyond March 2019 that was not the case. The court compared the debtors’ projections to calculations using the yield and price per acre that was supported by the record. The record showed that the debtors could only pay anticipated operating expenses and plan payments after March 2019 if the debtor’s unsupported projections were used. The projections using the bushels per acre and price per bushel only showed revenue of $592,000 to $736,000 with expenses of $872,000. Given this lack of ability to pay combined with the debtor’s projections overstating revenue from soybean production during the 2019 crop year the court found that the debtors anticipated receipts simply did not cover the debtors’ obligations to pay operating expenses and plan payments beyond March 2019. Thus, the plan was not feasible and the court denied confirmation of the amended plan.

Grazing Scam Results in Fraud Convictions

There are various scams that one can get caught up in, but they don’t often involve cattle grazing.  However, a recent case did involve a cattle grazing scam.  In United States v. Hagen, No. 17-3279, 2019 U.S. App. LEXIS 6109 (8th Cir. Feb. 28, 2019), the defendant and his ex-wife set up a company to provide custom grazing in 2004. The ex-wife obtained grazing leases on tribal land from the Bureau of Indian Affairs ("BIA"). The defendant worked with ranchers to set up custom grazing contracts. In 2011, the BIA issued letters to the defendants for non-compliance with leasing procedures. In 2012, the defendants had leased enough pasture to sustain 57.92 cow-calf pairs but contracted to graze with three cattle producers for the lease of 100 cow-calf pairs and 200 heifers. That summer, 70 pairs were grazed for the full term of the grazing contract, and 33 pairs belonging to another rancher were grazed for a day. A third rancher was forced to find other pasture for his heifers. In 2013, the defendants had leased pasture for 91.26 pairs and had contracted with six different producers to graze a total of 380 pairs. A total of $126,500 was paid upfront by the producers. Not a single pair was grazed that summer and no rancher was reimbursed.

In 2014, the defendants had leased pasture for 6.67 pairs and again over-contracted with three ranchers for 300 pairs, who paid $102,500 up front. No pairs grazed during the summer of 2014 and the ranchers were not reimbursed. The defendants were charged with three counts of wire fraud, four counts of mail fraud, and one count of conspiracy to commit mail and wire fraud for their fraudulent contracting/leasing practices. The ex-wife plead guilty to the conspiracy count and testified against the her ex-spouse at trial. He was convicted by a jury on all eight counts. Sentencing included 46 months imprisonment and 3 years of supervised release on each count, restitution in the amount of $236,000, and a $100 special assessment on each count. The defendant appealed on the basis that the evidence was insufficient to prove he had the requisite intent to defraud, and that the two mailings were not in furtherance of any fraud.

The appellate court affirmed the defendant’s conviction of conspiracy to commit mail and wire fraud, but vacated the conviction and special assessments on the other five substantive counts. The appellate court determined that sufficient evidence supported the jury verdict that the ex-husband had conspired to commit fraud by contracting with twelve different cattle producers to graze cattle. Only one of those contracts had been filled, and the defendants failed to issue refunds on the other contracts for the the 2012-2014 grazing seasons. The appellate court also found sufficient evidence to support the jury’s verdict of use of mail and wire to defraud. One of the ranchers had mailed the defendant a $35,000 check, as full payment for the grazing contract and the defendant had cashed the check using a wire transmission a week later. There was a pasture visit where a rancher was assured that the pasture could support 200 pairs. Another contract was signed by the rancher’s son, and another $35,000 check was written to the defendant. This second contract brought the total contracted to graze with the defendant to 200 pairs for $70,000. It later became evident that the defendant only had 40 acres leased, enough to sustain 6.67 pairs. When it came time for delivery, the defendant did not return any calls. The ranch did not graze any cattle that season nor issued refunds for their payments. The appellate court determined that the evidence was sufficient for the jury to conclude that the defendant knowingly only had enough pasture to graze 6 pairs but nonetheless contracted to graze 200 pairs with this rancher. However, the appellate court vacated the convictions and special assessments tied to specific instance of fraud against different ranchers. The dry conditions that limited the length of the grazing season likely lead to a breach of contract for early termination, rather than an intent to defraud. Other mailings by the defendants containing offers to graze cattle were not in furtherance of fraud, and the convictions and special assessments related to these mailings were vacated.

Fences, Boundary Lines and Adverse Possession

Fences and boundary issues present many court cases.  It is certainly true that good fences make good neighbors.  Bad fences and boundary disputes tend to bring out the worst in neighbors.  A recent Alabama case illustrates the issues that can arise when fences and boundary issues are involved.  In Littleton v. Wells, No. 2170948, 2019 Ala. Civ. App. LEXIS 20 (Civ. App. Feb. 22, 2019), a predecessor sold 82 acers to the defendants in 2015. This land had been in the same family for generations, however the seller had only been on the property “maybe twice” since 1989. The plaintiffs received title to their property from their parents, who had been there since 1964. There were three fences between the party’s properties. The defendant relied on a 1964 survey when making his purchase, thinking the property line was the middle fence.  No survey was completed at that time.

In 2000, the mapping office notified the parties of a “conflict.” The office determined the actual boundary to be closer to the fence on the defendant’s property rather than the middle fence. However, this determination was for tax purposes and was not a substitute for a survey. The plaintiffs also treated the third fence line, like the map office, as the boundary line.

The plaintiffs grazed cattle up to the furthest fence and maintained all the ground between the fences as their own. The plaintiff also testified as to working on the furthest fence as a child in the 1960’s. The plaintiffs also showed that they held annual gatherings and the kids would play in the creek on the disputed ground. There was also evidence that the plaintiffs leased the disputed ground to others. The plaintiffs did not present all the witnesses as to the family’s use of the property up to the furthest fence. Nor was the employee of the map office testimony heard in court.

The trial court determined that the property line was to be the closer center fence, not the third fence as the plaintiffs claimed. The court ordered an official survey to their findings and entered that survey as the final order. The plaintiffs appealed. The appellate court reversed and remanded. The plaintiffs’ challenged the trial court’s denial of their adverse possession claim and determination of the location of the boundary line. The court looked at all the evidence on record from trial, when analyzing the plaintiff’s adverse possession claim. The appellate court held that the record showed that the plaintiffs had been in actual, hostile, open, notorious, exclusive, and continuous possession of the disputed property for more than ten years (the statutory timeframe). The plaintiffs had presented evidence to support every one of those elements and the defendants have not rebutted any element. The only evidence the defendant presented to rebut the plaintiffs’ evidence was a “belief” that he owned up to the second fence. Since the lower court was erroneous in determining the adverse possession claim, the appellate court did not need to analyze the boundary line determination. The court remanded to create a new boundary line that included the property that the plaintiffs had adversely possessed.

Conclusion

There’s never a dull moment in agricultural law.  It’s everyday reality in the life of a farmer, rancher, rural landowner and agribusiness.

May 10, 2019 in Bankruptcy, Civil Liabilities, Criminal Liabilities | Permalink | Comments (0)

Wednesday, May 8, 2019

Heirs Liable For Unpaid Federal Estate Tax 28 Years After Death

Overview

In recent months, several court decisions have involved the issues of executors and beneficiaries of an estate being held personally liable for the unpaid taxes of the estate.  Sometimes a statute of limitations defense can be raised to fend off personal liability.  Sometimes it cannot be raised.  The matter can also be complicated when the estate makes an election to pay the estate tax in installment over (essentially) 15 years rather than filing the return and paying the federal estate tax nine months after the decedent’s death.

Personal liability of heirs for unpaid federal estate tax – that’s the topic of today’s post

Recent Case

Family trust.  In United States v. Johnson, No. 17-4083, 2019 U.S. App. LEXIS 9317 (10th Cir. Mar. 29, 2019), the decedent died in 1991, survived by her four children.  Before death, the decedent had established a trust that named two of her children as the successor trustees of her trust and the personal representatives of her estate. The decedent funded the trust with stock in a closely-held corporation that operated a hotel with a Nevada gambling license.  Her will directed that the residue of her estate after payment of expenses and claims be transferred to the trust and administered in accordance with the trust’s terms.  The children were also the beneficiaries of the decedent’s life insurance policies value at approximately $370,000.  The decedent died on September 2, 1991.

Installment payment election.  As reported on a timely filed federal estate tax return, the gross estate was valued at almost $16 million and the estate tax liability was approximately $6.9 million.  The federal estate tax paid with the estate tax return was $4 million.  An installment payment election was made in accordance with I.R.C. §6166 for the balance of the estate tax liability which allowed that portion of the tax to be paid in 10 annual installments starting in 1997 (after five years of interest-only payments) and ending in 2006.  Upon receiving the filed estate tax return, the IRS took note of the election and assessed the estate for unpaid estate tax on July 13, 1992.  In late 1992, all of the remaining trust assets (primarily hotel stock) were distributed to the children.  The hotel stock was distributed to the trust beneficiaries because Nevada law governing casino ownership via trust required it.  All of the children entered into a distribution agreement (governed by Utah law) acknowledging that they were equally responsible for the unpaid federal estate tax as it became due and equally liable for any additional tax that might result from an audit. 

IRS lien.  In 1995, the IRS took the position that the estate’s gross value had been underreported by approximately $3.5 million.  Ultimately, a settlement was reached whereby the estate agreed to pay additional federal estate tax of $240,381.  In 1997, shortly before the due date of the first estate tax installment, the IRS informed the personal representatives of alternatives to personal liability for unpaid deferred estate tax.  As a result, the personal representatives executed an I.R.C. §6324A lien which all four children signed along with an agreement restricting the sale of stock in a hotel which comprised the largest asset of the decedent’s estate.  That restriction was to be in effect while the lien was in effect.  In 2002, the hotel filed bankruptcy and a sale of all hotel assets was approved.  In 2003, the IRS informed the personal representatives that if they defaulted, the entire balance of estate tax would be immediately due.  Shortly thereafter the estate defaulted on its federal estate tax liability after having paid a total of $5 million of the amount due.  After attempting to collect via levies against the estate, trust and the children, and learned of the distribution agreements in mid-2005.  The IRS filed suit in 2011 naming all of the children as defendants and seeking to recover over $1.5 million in unpaid federal estate tax from them personally.    

Litigation.  The trial court held that the heirs who received trust distributions were not liable as beneficiaries or transferees under I.R.C. §6324(a)(2).  However, the trial court also determined that the personal representatives could be liable under 31 U.S.C. §3713 and I.R.C. §2036(a) as successor trustees up to the value of the trust assets that were included in the decedent’s gross estate via I.R.C. §2034-2042.  The personal representatives claimed that the assets were included in the estate via I.R.C. §2033.  The trial court determined that the assets were included in the estate via I.R.C. §2033 because the decedent never lost the beneficial ownership of them during her lifetime (i.e., the assets had not been transferred as required by I.R.C. §2036).  Thus, the personal representatives were not personally liable for the unpaid estate tax as trustees.  In addition, the court determined that the personal representatives were not liable under 31 U.S.C. §3713 because liability was discharged upon execution of the I.R.C. §6324 lien.  The IRS also claimed it had rights as a third-party beneficiary of the 1992 distribution agreement whereby they agreed to be equally liable for any additional taxes resulting from an audit.  The trial court determined this claim was untimely under Utah law (6-year statute of limitations) and rejected the IRS claim that federal law should apply. 

Tenth Circuit decision.  On appeal, the appellate court held that federal law applied on the contract-based claim and was governed by the 10-year statute of limitations of I.R.C. §6502.  That’s because the court concluded that the government was acting in its sovereign capacity.  Accordingly, the 10-year statute of limitations applied. When the federal government is enforcing its rights, it is not bound by a state’s statute of limitations even with respect to lawsuits that are brought in state courts.  It makes no difference whether the claim at issue arose under federal or state statutes or the common law.

Likewise, the transferee liability claim was timely because the limitations period applicable to the I.R.C. §6324(a) transferees was the same as the limitations period that applied to the estate.  Because the 10-year limitations period that normally applies to the collection of estate tax was suspended by the installment payment election, the government’s claim was timely.  See, e.g., §6503(d); United States v. Botefuhr, 309 F.3d 1263 (10th Cir. 2002).  The appellate court also held that the children were liable for unpaid estate tax to the extent of any life insurance proceeds they received from the estate.  United States v. Johnson, No. 17-4083, 2019 U.S. App. LEXIS 9317 (10th Cir. Mar. 29, 2019).  The appellate court also held, reversing the trial court, that the beneficiaries weren’t entitled to attorney fees and costs because the government’s position was “substantially justified under I.R.C. §7430(c)(4)(B). Indeed, the government received a judgment for the full amount of the estate tax liability asserted.

Conclusion

It’s worth noting that the decedent in Johnson died in 1991.  The Tenth Circuit’s decision was in 2019.  That show’s how long matters can get drawn out if an installment payment election is made and there is unpaid tax liability.  The government is not simply going to go away. 

May 8, 2019 in Estate Planning | Permalink | Comments (0)

Monday, May 6, 2019

Coming-To-The-Nuisance By Staying Put – Or, When 200 Equals 8,000

Overview

Nuisance lawsuits in agriculture are often triggered by offensive odors that migrate to neighboring rural residential landowners.  While there aren’t any common law defenses that an agricultural operation may use to shield itself from liability arising from a nuisance action, courts do consider a variety of factors to determine if the conduct of a particular farm or ranch operation is a nuisance.  See, e.g., Valasek v. Baer, 401 N.W.2d 33 (Iowa 1987); Spur Industries, Inc. v. Del E. Webb Development Co., 108 Ariz. 178, 494 P.2d 700 (1972).  Of primary importance are priority of location and reasonableness of the operation.  Together, these two factors have led courts to develop a “coming to the nuisance” defense.  This means that if people move to an area they know is not suited for their intended use, they should be prohibited from claiming that the existing uses are nuisances.  But, what if the ag nuisance comes to you?  Is the ag operation similarly protected in that situation?

The coming-to-the-nuisance defense in reverse – that’s the topic of today’s post.

Right-To-Farm Laws

In general.  Every state has enacted a right-to-farm law that is designed to protect existing agricultural operations by giving farmers and ranchers who meet the legal requirements a defense in nuisance suits. It may not be only traditional row crop or livestock operations that are protected.  For example, the Washington statute also applies to “forest practices” which has been held to not be limited to logging activity, but include the growing of trees.  Alpental Community Club, Inc., v. Seattle Gymnastics Society, 86 P.3d 784 (Wash. Ct. App. 2004).   

The basic thrust of a particular state's right-to-farm law is that it is unfair for a person to move to an agricultural area knowing the conditions which might be present and then ask a court to declare a neighboring farm a nuisance.  Thus, the basic purpose of a right-to-farm law is to create a legal and economic climate in which farm operations can be continued.  Right-to-farm laws can be an important protection for agricultural operations.  But, to be protected, an agricultural operation must satisfy the law's requirements. To be granted the protection of a statute, the activity at issue must be a farming activity.  For example, in Hood River County v. Mazzara, 89 P.3d 1195 (Or. Ct. App. 2004), the state statute that protected farms against nuisance actions was held to bar a lawsuit against a farmer for noise from barking dogs. The use of dogs to protect livestock was held to be farming practice.

Types.  Right-to-farm laws are of three basic types: (1) nuisance related; (2) restrictions on local regulations of agricultural operations; and (3) zoning related.  While these categories provide a method for identifying and discussing the major features of right-to-farm laws, any particular state's right-to-farm law may contain elements of each category.

The most common type of right-to-farm law is nuisance related.  This type of statute requires that an agricultural operation will be protected only if it has been in existence for a specified period of time (usually at least one year) before the change in the surrounding area that gives rise to a nuisance claim.  See, e.g., Vicwood Meridian Partnership, et al. v. Skagit Sand and Gravel, 98 P. 3d 1277 (Wash. Ct. App. 2004).  This type of statute essentially codifies the “coming to the nuisance defense,” but does not protect agricultural operations which were a nuisance from the beginning or which are negligently or improperly run.  For example, if any state or federal permits are required to properly conduct the agricultural operation, they must be acquired as a prerequisite for protection under the statute.

Subsequent changes – what’s going on in Indiana?  While right-to-farm laws try to assure the continuation of farming operations, they do not protect subsequent changes in a farming operation that constitute a nuisance after local development occurs nearby. See, e.g., Davis, et al. v. Taylor, et al., 132 P.3d 783 (Wash. Ct. App. 2006); Trickett v. Ochs, 838 A.2d 66 (Vt. 2003); Flansburgh v. Coffey, 370 N.W.2d 127 (Neb. 1985)If a nuisance cannot be established, a right-to-farm law can operate to bar an action when the agricultural activity on land changes in nature.  For instance, in Dalzell, et al. v. Country View Family Farms, LLC, No. 1:09-cv-1567-WTL-MJD, 2012 U.S. Dist. LEXIS 130773 (S.D. Ind. Sept. 13, 2012), the land near the plaintiffs changed hands.  The prior owner had conducted a row-crop operation on the property.  The new owner continued to raise row crops, but then got approval for a 2800-head sow confinement facility.  The defendant claimed the state (IN) right-to-farm law as a defense and sought summary judgment.  The court held that state law only allows nuisance claims when “significant change” occurs and that transition from row crops to a hog confinement facility did not meet the test because both are agricultural uses.  The court noted that an exception existed if the plaintiffs could prove that the hog confinement operation was being operated in a negligent manner which causes a nuisance, but the plaintiffs failed to prove that the alleged negligence was the proximate cause of the claimed nuisance.  Thus, the exception did not apply and the defendant’s motion for summary judgment was granted.  The court’s decision was affirmed on appeal.  Dalzell, et al. v. Country View Family Farms, LLC, et al., No. 12-3339, 2013 U.S. App. LEXIS 13621 (7th Cir. Jul. 3, 2013).

Similarly, in Parker v. Obert’s Legacy Dairy, LLC, No. 26A05-1209-PL-450, 2013 Ind. App. LEXIS 203 (Ind. Ct. App. Apr. 30, 2013), the defendant had expanded an existing dairy operation from 100 cows to 760 cows by building a new milking parlor and free-stall barn on a tract adjacent to the farmstead where the plaintiff’s family had farmed since the early 1800s.  The plaintiff sued for nuisance and the defendant asserted the state (IN) right-to-farm statute as a defense.  The court determined that the statute barred the suit.  Importantly, the court determined that the expansion of the farm did not necessarily result in the loss of the statute’s protection.  The expanded farm remained covered under the same Confined Animal Feeding Operation permit as the original farm.  In addition, the conversion of a crop field to a dairy facility was protected by the statute because both uses simply involved different forms of agriculture.  The court also noted that the Indiana statute at issue protected one farmer from suit by another farmer for nuisance if the claim involves odor and loss of property value.  Not all state statutes apply to protect farmers from nuisance suits brought by other farmers.

The coming-to-the-nuisance defense in reverse – recent case.  A recent case again involving the Indiana right-to-farm statute was decided.  In Himsel v. Himsel, No. 18A-PL-645, 2019 Ind. App. LEXIS 181 (Ind. Ct. App. Apr. 22, 2019), the defendants were three individuals, their farming operation and a hog supplier.  In 2013, the individual defendants petitioned the County Area Plan Commission to rezone a 58.42-acre tract from agricultural/residential to agricultural/intense.  The land had been in the family for over 20 years and had been used for ag purposes since at least 1941. From 1994-2013, the property was cropland.  The zoning change would allow for the operation of a Concentrated Animal Feeding Operation (CAFO). The plaintiffs were two married couples, one of whom built their non-farm residence in 1971 and the other who started using their home as a non-farming residence in 2000 after deciding to retire from farming and sell most of the farmland that the husband had grown up on and lived on since the early 1940s.  The plaintiffs attended the hearing and opposed the petition.  The retired farmer plaintiff had raised about 200 head of hogs and 200 head of cattle in an area directly adjacent to his home.  There also was a confinement building about 700 feet from the plaintiff’s home that contained up to 400 hogs that was used for two years until it burnt down.  The area around the plaintiffs’ homes is predominated by agriculture uses, and there are other hog barns near the plaintiff’s property.  The Commission approved the zoning change and the defendant obtained the necessary permits to build an 8,000-head CAFO one quarter of a mile from the retired farmer plaintiff’s home.  The plaintiffs did not appeal.

In late 2015, the plaintiff sued the defendant (the retired farmer plaintiff’s cousin and two nephews) for nuisance and negligence and challenged the state’s Right-to-Farm Act (RTFA) as unconstitutional. The plaintiff also claimed that another part of state law (known as the “Agricultural Canon”) which requires state law to be construed to “protect the rights of farmers to choose among all generally accepted farming and livestock production practices, including the use of ever-changing technology,” was unconstitutional. The defendant asserted the RTFA as a defense, and the state joined the suit to defend the constitutionality of the Agricultural Canon. 

The trial court granted the defendant summary judgment.  On appeal, the appellate court affirmed, holding that the plaintiffs’ nuisance, negligence, and trespass claims were barred by the RTFA. The appellate court also determined that the plaintiffs’ various claims that the RTFA was unconstitutional were futile.  As to the RTFA, the appellate court determined that the retired farmer plaintiff essentially “came to the nuisance” when they retired and switched their farming and livestock operation to purely residential with full knowledge of the surrounding ag uses.  This plaintiff came to the nuisance by not moving away before the CAFO was built.

As to the rural residential plaintiff (as well as the retired farmer plaintiff), the court noted that a 2005 amendment to the RTFA meant that the change in the nature of the individual defendants’ farming operation from crops to a large-scale confinement hog operation was not a significant change that would make the RTFA inapplicable. 

The appellate court also determined that the defendant was not operating the confinement facility negligently which would have eliminated the RTFA as a defense.  In addition, the defendant also had obtained all necessary permits to operate the CAFO.  The appellate court also upheld the constitutionality of the RTFA, finding that it was within the legislature's legitimate constitutional authority, and determined that the RTFA had not “taken” the plaintiffs property.  While the plaintiff may have experienced a reduction in value due to the presence of the nearby CAFO, existing caselaw did not indicate that this amounted to a taking.  On this point, the court noted that the plaintiff continued to live in his home and alleged no distinct, investment-backed expectations that the CAFO had frustrated.  The plaintiff also claimed that the RTFA unconstitutionally separated rural dwellers into those engaged in ag operations on land that has been consistently farmed for at least the prior year, and those living in rural areas that don’t farm.  Under the RTFA, farmers can sue either other farmers or non-farmers for nuisance, but non-farmers can only sue other non-farmers for nuisance.  The appellate court determined that the distinction was not unconstitutional because the state had a rational basis for the distinction in terms of conserving, protecting, and encouraging the development and improvement of agricultural land for the production of food and other agricultural products, and that the distinction was applied uniformly.  The appellate court did not rule on the constitutionality of the Agricultural Canon for lack of jurisdiction.  

Several observations about the case can be made.

  • The appellate court in Himsel, determined that the RTFA applied because the change in the nature of the defendant’s hog operation from row crop farming to a CAFO operation involving 8,000 hogs was “not a significant change” that would make the RTFA inapplicable. In other words, 8,000 hogs in a confinement building raised by a contracting party that likely doesn’t make management decisions concerning the hogs, may or may not report the associated contract income as farm income on Schedule F, doesn't report building rent as farm income, and cannot pledge the hogs as loan collateral, was somehow not significantly different from 200 hogs and 200 head of cattle raised by a farmer with associated crop ground who managed the diversified operation.  Just the sheer number of hogs alone stands out in stark contrast.
  • Unlike the Obert’s Legacy Dairy case where the expansion of the dairy farm did not require a new permit, the hog operation in Himsel required a change in the existing zoning of the tract.
  • The plaintiffs in Himsel were found to have essentially come to the nuisance because one of them chose to retire from farming and remain on the land that he had lived on for nearly 80 years, and the other didn’t move from the rural home they built in 1971. In reaching this conclusion the court determined that an 8,000-head hog confinement operation and the presence of 3.9 million gallons of untreated hog manure was comparable to farming in this area in 1941.
  • The Himsel court determined that a “taking” had not occurred because the plaintiff had not sold his home and moved away from the place where he grew up and lived all of his life. The court did not address the implications of whether its opinion essentially granted the CAFO an easement to produce odors across the plaintiffs’ property.

Conclusion

It is possible that the Himsel decision could be transferred to the Indiana Supreme Court for review.  It’s also possible that the Indiana legislature could revisit the RTFA and the 2005 amendment that appears to have resulted in a construction that allows a CAFO of any size to be built in any place with a history of agricultural activity at any time in the past that predates the plaintiff’s use.  While the original idea behind right-to-farm legislation in general was to protect and incentivize multi-generation farming operations that are often significantly tied to the land and the local communities, the Himsel decision is difficult to square with those ideals.  That’s the case even though the court may be right in its construction of the statutory language at issue.  If that’s correct, the policy of the Indiana RTFA and the future of the Hoosier rural countryside is up to the legislature. 

May 6, 2019 in Civil Liabilities | Permalink | Comments (0)

Thursday, May 2, 2019

Product Liability Down on the Farm – Modifications

Overview

If a farmer or rancher buys a product and the product turns out to be defective, can the manufacturer be held liable on a product liability claim for defective product?  In general, the answer is “yes.”  However, there are some exceptions to that general rule.  One of those may involve an acetylene tank and a torch. 

A limitation on the ability to sue a manufacturer on a product liability claim – that’s the topic of today’s post.

Manufacturer’s Liability – In General

Historically, a manufacturer or seller of defective chattels was not liable to persons injured using the product unless a contractual relationship existed.  This rule limited a manufacturer's liability to immediate purchasers if a product turned out to be defective, dangerous or hazardous to health.   This rule, known as the “privity limitation,” dates back to the 1843 English case of Winterbottom v. Wright, 10 M. & W. 109, 152 Eng. Rep. 402 (Ex. 1842). In Winterbottom, the plaintiff purchased a ticket to ride the stage and as the stage was being driven, a wheel with rotten spokes collapsed.  The ensuing crash injured the plaintiff.  The plaintiff sued the defendant who had undertaken to provide a mail coach to carry the mail bags.  The English court ruled that the plaintiff could not sue the defendant because the plaintiff did not have a contract with the defendant.

Winterbottom became a leading case, not only in England, but also in the United States.  The requirement of privity of contract in product liability cases continued in the United States until 1916.  In a 1916 case, MacPherson v. Buick Motor Co., 217 N.Y. 382, 111 N.E. 1050 (1916), the plaintiff bought a Buick from a retail dealer.  The plaintiff was injured while driving the car when the wooden spokes on one of the wheels crumbled into fragments.  The defective wheel had been supplied to Buick Motor Co. by a parts manufacturer.  There was evidence tending to show that a reasonable inspection by Buick would have disclosed the defective wheel, but that Buick failed to make such an inspection.  Buick defended on the basis that the plaintiff purchased the car from a retail dealer and, therefore, did not have privity of contract with Buick.  The New York Court of Appeals upheld the trial court and rejected Winterbottom v. Wright.  The Court held that Buick owed a duty of care to the plaintiff as the ultimate purchaser of the automobile from an independent distributor.   Precedent drawn from the days of stagecoach travel no longer squared with the needs of a modern commercial society.

The MacPherson decision marked the beginning of the consumer movement.  Consumers could now sue manufacturers and hold them accountable for negligence in manufacturing faulty products as well as negligence in design.  For the first several years after MacPherson, the question was limited to negligence in manufacturing.  More recently, the focus has expanded to include negligence in design.  Both come within the rule.  No longer is privity of contract required before a manufacturer can be sued.

MacPherson spawned a great deal of products liability litigation.  Much of the early litigation dealt with food and beverage products.  See, e.g., Pillars v. R.J. Reynolds Tobacco Company, 117 Miss. 490 (1918); Coca-Cola Bottling Company v. Burgess, 195 S.W.2d 392 (Tex. Ct. Civ. App. 1946). 

Since the early 1960s, manufacturer's liability law has changed greatly.  The recent trend is away from a negligence approach and toward strict liability.  In many instances, an injured party is not required to show that the manufacturer was negligent.  While a strict liability approach is not the same as absolute liability, in many instances, manufacturer's liability has become so favorable for plaintiffs that many manufacturers have complained of the inability to afford liability insurance coverage.

Under the modern approach, the injured party is required to prove five elements in order to recover from a manufacturer on a product liability claim. 

  • First, the injured party must show that the defendant sold the product and was engaged in the business of selling the product. This requirement is typically easy to satisfy. 
  • Second, the injured party must show that the product was in a defective condition. See, e.g., Russell v. Deere & Co., 61 P.3d 955 (Or. Ct. App. 2003). This, likewise, is not usually very difficult to establish.
  • Third, the injured party must show that the defective condition was unreasonably dangerous to an ordinary user during normal use. Normal use includes all intended uses and foreseeable misuses of the product. See, e.g., Ellis v. Weasler Engineering, Inc., 258 F.3d 326 (5th Cir. 2001)This requirement is somewhat more difficult to satisfy than the first two, and a few courts do not require this element.  If this element is required, a product may be deemed to be unreasonably dangerous if the manufacturer fails to warn of dangers inherent in the product's normal use that is not obvious to an ordinary user. If the product bears an adequate warning, the product is deemed not to be in defective condition in those states whose product liability act follows Comment j of the Restatement (Second) of Torts § 402A.  However, some states follow Comment i of the Restatement (Third) of Torts § 2, which provides that an adequate warning does not foreclose a finding that a product is defectively designed.  See, e.g., Delaney v. Deere and Company, 268 Kan. 769, 999 P.2d 930 (2000), rev’d, 219 F.3d 1195 (10th Cir. 2000).  In these states, a manufacturer cannot simply warn of open and obvious dangers. The belief in these states is that Comment j allows an adequate warning to absolve the manufacturer of its duty to design against dangers when a reasonably safer design could have been adopted that would have reduced or eliminated the risk remaining after a warning is provided.  But, under either approach, foreseeable misuse of the product remains an issue.  See, e.g., Mallery v. International Harvester Company, 690 So. 2d 765 (La. Ct. App. 1996). 
  • The fourth element that an injured party must prove to recover from a manufacturer on a product liability claim is that the product was expected to reach the user without substantial change in condition and, in fact, did so.
  • The fifth requirement is that the product defect was the proximate cause of the plaintiff's injury or damage. This requirement is the most difficult to show and involves proving one of the elements of negligence.

Preemption Possibilities

There are at least three situations that a particular farmer or rancher may face in which they will be limited in their ability to sue a manufacturer on a product liability claim.  One involves the situation when purchased equipment is altered or when multiple component parts are purchased individually, but are then later combined to make a complete system.  If the component parts are not defective, but when combined produce a defective system, the manufacturers of the component parts do not have a duty to warn or properly instruct about the use of the system. See,e.g., Shaffer v. A.O. Smith Harvestore Products, Inc., 74 F.3d 722 (6th Cir. 1996).  When purchased equipment is altered, the manufacturer is generally released from liability unless the manufacturer could have reasonably foreseen that purchasers would alter the equipment in the manner that resulted in injury.  For example, in Hiner v. Deere & Co., 340 F.3d 1190 (10th Cir. 2003), rev’g, 161 F. Supp. 2d 1279 (D. Kan. 2001), the farmer altered a front-end loader resulting in injury.  The court determined that the farmer’s alterations presented a fact issue for the jury to sort out on the plaintiff’s strict liability claim as to whether the defendant could have reasonably foreseen the alteration.  See, also, Brinkman v. International Truck and Engine Corp., 351 F. Supp. 2d 880 (W.D. Wisc. 2004). 

Conclusion

So, when you buy a product and take it home to the farm or ranch, or have it delivered, sometimes the tendency is to modify the item to fit the specs of the situation.  But, once an alteration is made (perhaps by cutting and welding) and the product fails to operate as expected, that alteration can remove the ability to recover from the manufacturer on a defective product claim. 

Just something else to think about on the farm or ranch from the world of agricultural law.

May 2, 2019 in Civil Liabilities | Permalink | Comments (0)