Monday, December 31, 2018

The "Almost Top Ten" Ag Law and Tax Developments of 2018

Overview

2018 was a big year for developments in law and tax that impact farmers, ranchers, agribusinesses and the professionals that provide professional services to them.  It was also a big year in other key areas which are important to agricultural production and the provision of food and energy to the public.  For example, carbon emissions in the U.S. fell to the lowest point since WWII while they rose in the European Union.  Poverty in the U.S. dropped to the lowest point in the past decade, and the unemployment rate became the lowest since 1969 with some sectors reporting the lowest unemployment rate ever.  The Tax Cuts and Jobs Act (TCJA) doubles the standard deduction in 2018 compared to 2017, which will result additional persons having no federal income tax liability and other taxpayers (those without a Schedule C or F business, in particular) having a simplified return.  Wages continued to rise through 2018, increasing over three percent during the third quarter of 2018.  This all bodes well for the ability of more people to buy food products and, in turn, increase demand for agricultural crop and livestock products.  That’s good  news to U.S. agriculture after another difficult year for many commodity prices.

On the worldwide front, China made trade concessions and pledged to eliminate its “Made in China 2025” program that was intended to put China in a position of dominating world economic production.  The North-Korea/South Korea relationship also appears to be improving, and during 2018 the U.S. became a net exporter of oil for the first time since WWII.  While trade issues with China remain, they did appear to improve as 2018 progressed, and the USDA issued market facilitation payments (yes, they are taxed in the year of receipt and, no, they are not deferable as is crop insurance) to producers to provide relief from commodity price drops as a result of the tariff battle. 

So, on an economic and policy front, 2019 appears to bode well for agriculture.  But, looking back on 2018, of the many ag law and tax developments of 2018, which ones were important to the ag sector but just not quite of big enough significance nationally to make the “Top Ten”?  The almost Top Ten – that’s the topic of today’s post.

The “Almost Top Ten” - No Particular Order

Syngenta litigation settles.  Of importance to many corn farmers, during 2018 the class action litigation that had been filed a few years ago against Syngenta settled.  The litigation generally related to Syngenta's commercialization of genetically-modified corn seed products known as Viptera and Duracade (containing the trait MIR 162) without approval of such corn by China, an export market. The farmer plaintiffs (corn producers), who did not use Syngenta's products, claimed that Syngenta's commercialization of its products caused the genetically-modified corn to be commingled throughout the corn supply in the United States; that China rejected imports of all corn from the United States because of the presence of MIR 162; that the rejection caused corn prices to drop in the United States; and that corn farmers were harmed by that market effect.  In April of 2018, the Kansas federal judge handling the multi-district litigation preliminarily approved a nationwide settlement of claims for farmers, grain elevators and ethanol plants.  The proposed settlement involved Syngenta paying $1.5 billion to the class.  The class included, in addition to corn farmers selling corn between September of 2013 and April of 2018, grain elevators and ethanol plants that met certain definition requirements.  Those not opting out of the class at that point are barred from filing any future claims against Syngenta arising from the presence of the MIR 162 trait in the corn supply.  Parties opting out of the class can't receive any settlement proceeds, but can still file private actions against Syngenta.  Parties remaining in the class had to file claim forms by October of 2018.   The court approved the settlement in December of 2018, and payments to the class members could begin as early as April of 2019. 

Checkoff programs.  In 2018, legal challenges to ag “checkoff” programs continued.  In 2017, a federal court in Montana enjoined the Montana Beef Checkoff.  In that case, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, No. CV-16-41-GF-BMM, 2017 U.S. Dist. LEXIS 95861 (D. Mont. Jun. 21, 2017), the plaintiff claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was unconstitutional.  The Beef Checkoff imposes a $1.00/head fee at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board. The plaintiff claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision was finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. On further review by the federal trial court, the court adopted the magistrate judge’s decision in full. The trial court determined that the plaintiff had standing on the basis that the plaintiff would have a viable First Amendment claim if the Montana Beef Council’s advertising involves private speech, and the plaintiff did not have the ability to influence the advertising of the Montana Beef Council. The trial court rejected the defendant’s motion to dismiss for failure to state a claim on the basis that the court could not conclude, as a matter of law, that the Montana Beef Council’s advertisements qualify as government speech. The trial court also determined that the plaintiff satisfied its burden to show that a preliminary injunction would be appropriate. 

The USDA appealed the trial court’s decision, but the U.S. Court of Appeals for the Ninth Circuit affirmed the trial court in 2018.  Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, 718 Fed. Appx. 541 (9th Cir. 2018).  Later in 2018, as part of the 2018 Farm Bill debate, a provision was proposed that would have changed the structure of federal ag checkoff programs.  It did not pass, but did receive forty percent favorable votes.    

GIPSA rules withdrawn.  In the fall of 2016, the USDA sent to the Office of Management and Budget (OMB) an interim final rule and two proposed regulations setting forth the agency’s interpretation of certain aspects of the Packers and Stockyards Act (PSA) involving the buying and selling of livestock and poultry. The proposals generated thousands of comments, with ag groups and producers split in their support. The proposals concern Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) which makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. The “effect” language of the statute would seem to eliminate any requirement that the producer show that the packer acted with the intent to control or manipulate prices. However, the federal courts have largely interpreted the provision to require a plaintiff to show an anti-competitive effect in order to have an actionable claim. 

The interim final rule and the two proposed regulations stemmed from 2010.  In that year, the Obama administration’s USDA issued proposed regulations providing guidance on the handling of antitrust-related issues under the PSA. 75 Fed. Reg. No. 119, 75 FR 35338 (Jun. 22, 2010).  Under the proposed regulations, "likelihood of competitive injury" was defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.” It included, but was not limited to, situations in which a packer, swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers. It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace." According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace. The scope of PSA §202(a) and (b) was stated to depend on the nature and circumstances of the challenged conduct. The proposed regulations specifically noted that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases. The proposed regulations also specified that a PSA violation could occur without a finding of harm or likely harm to competition, contrary to numerous court opinions on the issue.

On April 11, 2017, the USDA announced that it was delaying the effective date of the interim final rule for 180 days, until October 19, 2017, with the due date for public comment set at June 12, 2017.  However, on October 17, 2017, the USDA withdrew the interim rule.  The withdrawal of the interim final rule and two proposed regulations was challenged in court.  On December 21, 2018, the U.S. Court of Appeals for the Eighth Circuit denied review of the USDA decision.  In Organization for Competitive Markets v. United States Department of Agriculture, No. 17-3723, 2018 U.S. App. LEXIS 36093 (8th Cir. Dec. 21, 2018), the court noted that the USDA had declined to withdraw the rule and regulations because the proposal would have generated protracted litigation, adopted vague and ambiguous terms, and potentially bar innovation and stimulate vertical integration in the livestock industry that would disincentivize market entrants.  Those concerns, the court determined, were legitimate and substantive.  The court also rejected the plaintiff’s argument that the court had to compel agency action.  The matter, the court concluded, was not an extraordinary situation.  Thus, the USDA did not unlawfully withhold action. 

No ”clawback.”   In a notice of proposed rulemaking, the U.S Treasury Department eliminated concerns about the imposition of an increase in federal estate tax for decedents dying in the future at a time when the unified credit applicable exclusion amount is lower than its present level and some (or all) of the higher exclusion amount had been previously used. The Treasury addressed four primary questions. On the question of whether pre-2018 gifts on which gift tax was paid will absorb some or all of the 2018-2025 increase in the applicable exclusion amount (and thereby decrease the amount of the credit available for offsetting gift taxes on 2018-2025 gifts), the Treasury indicated that it does not. As such, the Treasury indicated that no regulations were necessary to address the issue. Similarly, the Treasury said that pre-2018 gift taxes will not reduce the applicable exclusion amount for estates of decedents dying in years 2018-2025.

The Treasury also stated that federal gift tax on gifts made after 2025 will not be increased by inclusion in the tax computation a tax on gifts made between 2018 and 2015 that were sheltered from tax by the increased applicable exclusion amount under the TCJA.  The Treasury concluded that this is the outcome under current law and needed no regulatory “fix.” As for gifts that are made between 2018-2025 that are sheltered by the applicable exclusion amount, the Treasury said that those amounts will not be subject to federal estate tax in estates of decedents dying in 2026 and later if the applicable exclusion amount is lower than the level it was at when the gifts were made. To accomplish this result, the Treasury will amend Treas. Reg. §20.2010-1 to allow for a basic exclusion amount at death that can be applied against the hypothetical gift tax portion of the estate tax computation that is equal to the higher of the otherwise applicable basic exclusion amount and the basic exclusion amount applied against prior gifts.

The Treasury stated that it had the authority to draft regulations governing these questions based on I.R.C. §2001(g)(2). The Treasury, in the Notice, did not address the generation-skipping tax exemption and its temporary increase under the TCJA through 2025 and whether there would be any adverse consequences from a possible small exemption post-2025. Written and electronic comments must be received by February 21, 2019. A public hearing on the proposed regulations is scheduled for March 13, 2019. IRS Notice of Proposed Rulemaking, REG-106706-18, 83 FR 59343 (Nov. 23, 2018).

Conclusion

These were significant developments in the ag law and tax arena in 2018, but just not quite big enough in terms of their impact sector-wide to make the “Top Ten” list.  Wednesday’s post this week will examine the “bottom five” of the “Top Ten” developments for 2018. 

December 31, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Friday, November 9, 2018

Developments in Ag Law and Tax

Overview

Legal developments impacting rural landowners, producers and agribusinesses continue to occur.  The same can be said for tax developments that impact practitioners and their client base.  It’s a never-ending stream.

In today’s post, I examine just a few of the recent developments from the courts of relevance.

Debtor Can Convert Chapter 12 Case to Chapter 11 

Can a Chapter 12 bankruptcy case be converted to Chapter 11?  That was the issue in In re Cardwell, No. 17-50307-rlj12, 2018 Bankr. LEXIS 3089 (Bankr. N.D. Tex. Oct. 3, 2018).  The debtor, an elderly widowed woman, owned three tracts of farmland that she leased out for farming purposes.  The tracts served as collateral for loans taken out by her children and grandchildren. The debtor sued a bank and the spouse of a granddaughter for “improprieties on the loans and liens.” The debtor filed Chapter 12, but the bank moved to dismiss the case on the basis that the debtor was not a ‘family farmer.” The debtor then moved to convert the case to Chapter 11. The bank objected, claiming that a Chapter 12 case cannot be converted to a Chapter 11.

While the court noted that there is some authority for that proposition, the court also noted that there is no explicit statutory language that bars a Chapter 12 from being converted to a Chapter 11 and that the courts are split on the issue. Ultimately, the court concluded that 11 U.S.C. §1208(e) allowed for conversion if the proceeding was in good faith and conversion would not be inequitable or prejudicial to creditors. The court also noted that if it dismissed the debtor’s Chapter 12 case, the debtor could simply refile the matter as a Chapter 11 case. The court saw no point in requiring that procedural step as there was no explicit statutory language requiring dismissal and refiling. The court also noted that upon conversion the automatic stay would remain in place, and that the debtor would actually have a more difficult time getting her reorganization plan confirmed as part of a Chapter 11 case as compared to a Chapter 12 case. 

Federal Law Preempts Kansas Train Roadway Blockage Law

Burlington Northern Santa Fe Railway (BNSF) operates trains through the town of Bazaar in Chase County, Kansas. At issue State of Kansas v. Burlington Northern Santa Fe Railway Company, No. 118,095, 2018 Kan. App. LEXIS 63 (Kan. Ct. App. Nov. 2, 2018), were two railroad crossings where the main line and the side tracks crossed county and town roads. The side track is used to change crews or let other trains by on the main line. Early one morning, the Chase County Sheriff received a call that a train was blocking both intersections. The Sheriff arrived on scene two hours later and spoke with a BNSF employee. This employee said that he was checking the train but did not state when the train would move. The Sheriff then called BNSF three times. The train remained stopped on both crossings for approximately four hours. The Sheriff issued two citations (one for each engine) under K.S.A. 66-273 for blocking the crossings for four hours and six minutes. K.S.A. 66-273 prohibits railroad companies and corporations operating a railroad in Kansas from allowing trains to stand upon any public roadway near any incorporated or unincorporated city or town in excess of 10 minutes at any one time without leaving an opening on the roadway of at least 30 feet in width. BNSF moved to dismiss the citation, but the trial court rejected the motion.

During the trial, many citizens presented evidence that they could not get to work that day, and a service technician could not reach a home that did not have hot water and was having heating problems. BNSF presented train logs for one of the engines. These logs showed that one engine was stopped in Bazaar for only 8 minutes to change crews and was not in Bazaar at 9:54 a.m. The Sheriff later conceded that he might have been mistaken about the numbers on the engines for the citations. There were no train logs for the other engine. BNSF also stated there could be other alternatives from blocking the crossings but uncoupling the middle of the train would be time consuming and unsafe.

The trial court ruled against BNSF and entered a fine of $4,200 plus court costs. On appeal, BNSF claimed that the Interstate Commerce Commission Termination Act (ICCTA) and Federal Railroad Safety Act (FRSA) preempted Kansas law, and that the evidence presented was not sufficient to prove a violation of Kansas law. The appellate court agreed, holding that the ICCTA, by its express terms contained in 49 U.S.C. 10501(b), preempted Kansas law. While the appellate court noted that the Kansas statute served an “admirable purpose,” it was too specific in that it applied only to railroad companies rather than the public at large. Also, the statute had more than a remote or incidental effect on railway transportation. As a result, the Kansas law infringed on the Surface Transportation Board’s exclusive jurisdiction to regulate the railways in the United States. The appellate court noted that the Surface Transportation Board was created by the ICCTA and given exclusive jurisdiction over the construction, acquisition, operation, abandonment, or discontinuance of railroad tracks and facilities. In addition, the appellate court noted that the Congress expressly stated that the remedies with respect to regulation of rail transportation set forth in the ICCTA are exclusive and preempt other remedies provided under federal or state law. The appellate court did not consider BNSF’s other arguments. 

Groundwater Is Not a “Point Source” of Pollution Under the CWA

The defendant in Tennessee Clean Water Network v. Tennessee Valley Authority, No. 17-6155, 2018 U.S. App. LEXIS 27237 (6th Cir. Sept. 24, 2018), is a utility that burns coal to produce energy.  It also produces coal ash as a byproduct. The coal ash is discharged into man-made ponds. The plaintiffs, environmental activist groups, claimed that the chemicals from the coal ash in the ponds leaked into surrounding groundwater where it was then carried to a nearby lake that was subject to regulation under the Clean Water Act (CWA). The plaintiffs claimed that the contamination of the lake without a discharge permit violated the CWA and the Resource Conservation and Recovery Act (RCRA).

The trial court had dismissed the RCRA claim, but the appellate court reversed that determination and remanded the case on that issue. On the CWA claim, the trial court ruled as a matter of law that the CWA applies to discharges of pollutants from a point source through hydrologically connected groundwater to navigable waters where the connection is "direct, immediate, and can generally be traced." The trial court held that the defendant’s facility was a point source because it "channel[s] the flow of pollutants . . . by forming a discrete, unlined concentration of coal ash," and that the Complex is also a point source because it is "a series of discernible, confined, and discrete ponds that receive wastewater, treat that wastewater, and ultimately convey it to the Cumberland River." The trial court also determined that the defendant’s facility and the ponds were hydrologically connected to the Cumberland River by groundwater. As for the defendant’s facility, the trial court held that "[f]aced with an impoundment that has leaked in the past and no evidence of any reason that it would have stopped leaking, the Court has no choice but to conclude that the [defendant’s facility] has continued to and will continue to leak coal ash waste into the Cumberland River, through rainwater vertically penetrating the Site, groundwater laterally penetrating the Site, or both." The trial court determined that the physical properties of the terrain made the area “prone to the continued development of ever newer sinkholes or other karst features." Thus, based on the contaminants flowing from the ponds, the court found defendant to be in violation of the CWA. The trial court also determined that the leakage was in violation of the defendant “removed-substances” and “sanitary-sewer” overflow provisions. The trial court ordered the defendant to "fully excavate" the coal ash in the ponds (13.8 million cubic yards in total) and relocate it to a lined facility.

On further review, the appellate court reversed. The appellate court held that the CWA does not apply to point source pollution that reaches surface water by means of groundwater movement. The appellate court rejected the plaintiffs’ assertion that mere groundwater is equivalent to a discernable point source through which pollutants travel to a CWA-regulated body of water. The appellate court noted that, to constitute a “conveyance” of groundwater governed by the CWA, the conveyance must be discernible, confined and discrete. While groundwater may constitute a conveyance, the appellate court reasoned that it is neither discernible, confined, nor discrete. Rather, the court noted that groundwater is a “diffuse” medium that “travels in all directions, guided only by the general pull of gravity.” In addition, the appellate court noted that the CWA regulates only “the discharge of pollutants ‘to navigable waters from any point source.’” In so holding, the court rejected the holdings in Hawai’i Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018) and Upstate Forever, et al. v. Kinder Morgan Energy Partners, LP, et al., 887 F.3d 637 (4th Cir. 2018). 

Cash Gifts to Pastor Constituted Taxable Income

In Felton v. Comr., T.C. Memo. 2018-168, the petitioner was the pastor of a church and the head of various church related ministries in the U.S. and abroad, got behind on his tax filings and IRS audited years 2008 and 2009. While most issues were resolved, the IRS took the position that cash and checks that parishioners put in blue envelopes were taxable income to the petitioner rather than gifts. The amounts the petitioner received in blue envelopes were $258,001 in 2008 and $234,826 in 2009. There was no question that the church was run in a businesslike manner. While the church board served in a mere advisory role, the petitioner did follow church bylaws and never overrode the board on business matters. As for contributions to the church, donated funds were allocated based on an envelope system with white envelopes used for tithes and offerings for the church. The white envelopes also included a line marked “pastoral” which would be given directly to the petitioner. The amounts in white envelopes were tracked and annual giving statements provided for those amounts.

The petitioner reported as income the amounts provided in white envelopes that were designated as “pastoral.” Amount in gold envelopes were used for special programs and retreats, and were included in a donor’s annual giving statement. Amounts in blue envelopes (which were given out when asked for) were treated as pastoral gifts and the amounts given in blue envelopes were not included in the donor’s annual giving statement and the donor did not receive any tax deduction for the gifted amounts. Likewise, the petitioner did not include the amounts given in blue envelopes in income. The IRS took the position that the amounts given by means of the blue envelopes were taxable income to the petitioner. The Tax Court agreed, noting that the petitioner was not retiring or disabled. The court also noted that the petitioner received a non-taxable parsonage allowance of $78,000 and received only $40,000 in white envelope donations. The court also upheld the imposition of a penalty because the petitioner, who self-prepared his returns, made no attempt to determine the proper tax reporting of the donations. 

Conclusion

The developments keep rolling in.  There will be more to write about in a subsequent post.

November 9, 2018 in Bankruptcy, Civil Liabilities, Environmental Law, Income Tax | Permalink | Comments (0)

Monday, November 5, 2018

Chapter 12 Bankruptcy and the Tools-Of-The-Trade Exemption

Overview

During the farm debt crisis of the 1980s, Chapter 12 bankruptcy was enacted to provide a means for “family farmers” to receive debt relief in the context of more favorable bankruptcy reorganization rules than would otherwise apply.  Now that the farm sector has been going through several down economic years, the use of Chapter 12 has increased again. 

Requirements must be satisfied to qualify for Chapter 12 relief.  Once that occurs, the farmer- debtor can take advantage of numerous favorable provisions.  One of those is the “tools-of-the-trade” exemption.  A farm debtor can keep assets exempt from creditors that are needed continue the farming operation.

The tools-of-the-trade exemption in the context of Chapter 12 bankruptcy.  That’s the topic of today’s post.

Chapter 12 Eligibility

To be eligible for Chapter 12 bankruptcy, a debtor must be a “family farmer” or a “family fisherman” with “regular annual income.”  The term “farming operation” includes farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, or livestock, and production of poultry or livestock products in an unmanufactured state.  11 U.S.C. §101(21).  A “family farmer” is defined as an individual or individual and spouse who earned more than 50 percent of their gross income from farming either for the taxable year preceding the year of filing or during the second and third tax years preceding filing, and whose aggregate debts do not exceed $4,153,150 (as of April, 2016).  In addition, more than 80 percent of the debt must be debt from a farming operation that the debtor owns or operates.

Exempt Property

The U.S. legal system has a long history of allowing debtors to hold specified items of property exempt from creditors (unless the exemption is waived).  This, in effect, gives debtors a “head start” in becoming reestablished after suffering economic reverses. Typically, one of the largest and most important exemptions is for the homestead.

Initially even the exempt property is included in the debtor's estate in bankruptcy but the exempt assets are soon returned to the debtor.  Only nonexempt property is used to pay the creditors.

In agricultural bankruptcies, one of the more important exemptions listed above is for “tools-of-the-trade.” 11 U.S.C. §522(f) permits the avoidance of non-possessory, non-PMSIs in “implements, professional books, or tools of the trade of the debtor or the trade of a dependent of the debtor” when the security interest impairs an exemption to which the debtor would have been entitled but for the security interest. 

Conceivably, many farm assets could qualify as a tool-of-the-trade.  For example, some courts have held that livestock held for breeding purposes (In re Heape, 886 F.2d 280 (10th Cir. 1989). large items of farm equipment (In re LaFond, 791 F.2d 623 (8th Cir. 1986), and draft horses (In re Stewart, 110 B.R. 11 (Bankr. D. Idaho 1989) are tools of the debtor's trade. Generally, courts focus on the functional use of an asset in the debtor's business in determining whether the asset is a tool of the debtor's trade.

The debtor must be actively engaged in a farming business to exempt farm assets as tools of the trade. For example, in In re Johnson, 230 B.R. 608 (Bankr. 8th Cir. 1999), the debtor owned a 73-acre rural residence, but had not farmed in past two years and was employed full-time off of the farm.  The court held that the farm machinery was not tools of debtor’s trade because the debtor not actively engaged in farming.  In any event, to be considered as an exempt tool of the debtor’s trade, the debtor must have a reasonable prospect of continuing in or returning to the farming business.  For instance, in In re Henke, 294 B.R. 105 (Bankr. D. N.D. 2003), farm equipment was not exempt as a tool of the trade where the debtor had no reasonable prospect of returning to the farming business.

Recent Case

A recent Kansas Chapter 12 case is a good illustration of how courts analyze the applicability of the tools-of-the-trade exemption.  In In re Rudolph, No. 18-40423, 2018 Bankr. LEXIS 3328 (Bankr. D. Kan. Oct. 30, 2018), the debtors (a married couple) significantly reduced the scale of their farming operation before filing Chapter 12. Upon filing Chapter 12, the debtors claimed the Kansas exemption for tools of the trade contained in Kan. Stat. Ann. §60-2304(e). The debtors’ lender (a bank) objected to the exemption on the basis that the debtors had so significantly reduced their farming operations that they were no longer “farmers” as their primary occupation, or that the debtors were only entitled to a percentage of the exemption.

The husband debtor had farmed since 1948 and his wife began working exclusively on the farm in 2007. The bank agreed that if the husband was entitled to the exemption his wife was also. The debtors’ homestead consisted of 17 acres, and the debtors used a portion of it to raise a forage crop for livestock and another portion was used as a hay meadow for livestock grazing. The husband debtor was also the beneficiary of three tracts of land held in trusts established by his parents consisting of almost 500 acres that were a mixture of row crop, hay meadow, pasture and CRP ground. The debtor, via the trust instrument, was responsible for managing those properties.

The bank financed the debtors’ farming operations and when the loans matured in late 2017 the bank sought payment. The debtors’ proposed to pay the loan by retiring from row crop farming and generating funds from the sale of certain farm equipment. At the time of filing, the debtors were no longer row crop farming but were continuing to care for cattle on the trust properties and were managing the CRP acres. Some of the trust properties were rented out, with the debtors maintaining fences and providing nutrients and care for the tenants’ cattle. The debtors also planted fall crops to feed to their own cattle and horses. The debtors inspected the trust lands twice weekly and controlled weeds on the CRP ground and maintained brush control. Their proposed reorganization plan estimated their monthly net farm income as $978.98 and they projected their annual gross farm income to be $21,364 with $20,800 consisting of farm rental income. The debtors testified to the value of the items of personal property that they were claiming as tools of the trade, and the total claimed value did not exceed the statutorily allowed amount.

The court noted that the debtors retained only those farming assets that were necessary to the continuation of their reduced-scale farming operation and turned over other assets to the bank. The debtors also proposed to retain four non-exempt tractors by paying the bank their value in ten semi-annual installments, with interest. The court noted that eligibility for the exemption was to be determined as of the date of filing. As the court pointed out, that’s different than a debtor being eligible for Chapter 12 – which is based on debt and income in the year preceding filing (or the second and third years back). The court also pointed out that the only issues for consideration as to eligibility for the exemption was whether the debtors were engaged in the farming business, and whether the claimed exempt items were regularly and reasonably necessary in carrying on that business.

While the court pointed out that the debtors were no longer engaged in planting and harvesting crops, as of the date the Chapter 12 petition was filed, the court determined that the debtors were engaged in ranching and other farming activities such as cattle grazing, harvesting hay and planting forage crops to feed cattle and horses. The court noted that the debtors also maintained the farmland in the trusts and managed the 3-5 acres of CRP ground. The court specifically determined that while the debtors did not have most of their income come from farming, the tools of the trade exemption does not require that farming be the exclusive or sole means generating income. The court also concluded that the exemption does not require the tools to be used on land the debtor farms for himself (crop/livestock share leases are permissible as is managing CRP ground) or produce something for sale.

The court also rejected the bank’s argument that the debtors couldn’t claim the exemption because they had quit farming as of the time they filed for Chapter 12 as contrary to the evidence. The evidence showed that the debtors had at least temporarily retired from crop farming, but not from ranching and caring for agricultural land as indicated by the retention of some equipment essential to continuing the ranching and ag land maintenance activities. In addition, the debtors’ proposed budget that showed only social security benefits and retirement benefits along with land rent was consistent with the debtors’ testimony that they were reducing their farming activities. The court determined that the debtors were still engaged in the trade or business of farming as of the petition date and were entitled to claim the tools-of-the-trade exemption.  However, the court determined that five of the claimed horses were not eligible for the exemption as nonessential to the continuation of the debtors’ farming activities. The court also stated that the bank’s objection to the valuation of the exempt assets would be determined in a separate proceeding unless the parties came to an agreement. 

Conclusion

Presently, times are difficult for many agricultural producers.  However, Chapter 12 bankruptcy has several very helpful provisions to ease the pain of restructuring the family farming business so that it can continue.  The tools-of-the-trade exemption is one of those provisions that can be of assistance.

November 5, 2018 in Bankruptcy | Permalink | Comments (0)

Thursday, October 18, 2018

Agricultural Law Online!

Overview

For the Spring 2019 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of next spring’s online Ag Law course – that’s the topic of today’s post.

Course Coverage

The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?

Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.

Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.

Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate. A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.

Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.

Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.

Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.

Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.

Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.

Further Information and How to Register

Information about the course is available here:
https://eis.global.ksu.edu/CreditReg/CourseSearch/Course.do?open=true&sectionId=127126

You can also find information about the text for the course at the following link (including the Table of Contents and the Index):
https://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html

If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution.  Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.

If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.

I hope to see you in January!

Checkout the postcard (401 KB PDF) containing more information about the course and instructor.

KStateAgriculturalLawandEconomicsPostcard

October 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Friday, August 31, 2018

Can A Bankrupt Farm Debtor Make Plan Payments Directly To Creditors?

Overview

Economic and financial conditions remain tough in much of agriculture.  Bankruptcy filings have seen an increase, and that includes the number of Chapter 12 filings.  In a Chapter 12 the debtor must file a reorganization plan under which the debtor proposes a plan for paying off creditors.  Plan payments generally must pass through the hands of the bankruptcy trustee.  The trustee is compensated out of a portion of the plan payments.

But, what if a debtor proposes to make payments directly to the creditors?  Doing so would bypass the trustee, and would also bypass the trustee’s fee.  It would also mean that all of the payments made under the bankruptcy plan would go to the creditors instead of some of it syphoned off to pay the trustee. 

That’s the focus of today’s post – whether a debtor in reorganization bankruptcy can make direct payments to creditors under the debtor’s reorganization plan.

The Reorganization Plan

A Chapter 12 debtor has an exclusive 90-day period after filing for Chapter 12 bankruptcy to file a plan for reorganization unless the court grants an extension.  A court may grant additional time only if circumstances are present for which the debtor should not fairly be held accountable.  11 U.S.C. §1221See e.g., In re Davis, No. CC-16-1390-KuLTa, 2017 Bankr. LEXIS 2169 (B.A.P. 9th Cir. Aug. 2, 2017).  If the court determines that the debtor will be unable to make all payments as required by the plan, the court may require the debtor to modify the plan, convert the case to a Chapter 7, or request the court to dismiss the case.  In other words, the plan must be feasible.  It must also be proposed in good faith.  Good faith can be viewed as practically synonymous the requirement that the plan be feasible.  See, e.g., In re Lockard, 234 B.R. 484 (Bankr. W.D. Mo. 1999).

The Bankruptcy Trustee

Duties.  A trustee is appointed in every Chapter 12 case.  A Chapter 12 trustee’s duties are similar to those under Chapter 13.  Specifically, a trustee under Chapter 12, is directed to:

*          be accountable for all property received;

*          ensure that the debtor performs in accordance with intention;

*          object to the allowance of claims which would be improper;

*          if advisable, oppose the discharge of the debtor;

*          furnish requested information to a party in interest unless the court orders otherwise;

*          make a final report;

*          for cause and upon request, investigate the financial affairs of the debtor, the

    operation of the debtor’s business and the desirability of the continuance of the business;

*          participate in hearings concerning the value of property of the bankruptcy estate; and

*          ensure that the debtor commences making timely payments required by confirmed plan.

In specifying the duties of trustees, Chapter 12 modifies the duty applicable to trustees under other chapters of the Bankruptcy Code to “investigate the financial affairs of the debtor.”  Chapter 12 authorizes an investigative role for trustees, as noted above, “for cause and on request of a party in interest....”  Thus, it would appear, in a routine case where there is no fraud, dishonesty, incompetence or gross mismanagement, the debtor should be allowed to reorganize without significant interference from the trustee.

Compensation.  The compensation of trustees is not to exceed 10 percent of payments made under the debtor’s plan for the first $450,000 of payments.  The fee is then not to exceed three percent of aggregate plan payments above that amount.  28 U.S.C. §586(e)(1).  The trustee collects the fee from payments received under the plan.  28 U.S.C. § 586(e)(2).  That’s an important point - the fee is based on all payments the debtor makes under the plan to the trustee rather than on amounts the trustee disperses to creditors. See, e.g., Pelofsky v. Wallace, 102 F.3d 350 (8th Cir. 1996). 

Plan Payments

Except as provided in the plan or in order confirming the plan, it is the trustee that is to make payments to creditors under the plan. Courts have generally recognized that payments on fully secured claims that the bankruptcy plan does not modify can be paid directly to the creditor, as can claims not impaired by the plan.  However, for claims that are impaired, courts are divided as to whether a court may approve direct payments to creditors. 

The issue of who actually disburses the debtor’s payments is important to the trustee because, as noted above, the trustee is entitled to a statutory commission only on funds actually received from the debtor pursuant to the reorganization plan.  But, the bankruptcy code does not prevent a debtor from making payments directly to creditors.   

So, how does a court decide whether a debtor can make payments directly to creditors and bypass the trustee (and the trustee fee)?  Historically, the courts have utilized three approaches for deciding whether a debtor can make direct payment under a Chapter 12 reorganization plan (and thereby bypass the trustee fee).  One approach utilizes a blanket rule barring the direct payment of impaired secured creditors.  See, e.g., In re Fulkrod, 973 F.2d 801 (9th Cir. 1992).  Another approach is, essentially, the direct opposite.  Under this approach, debtors can pay secured creditors directly, regardless of their impaired status.  See, e.g., In re Wagner, 36 F.3d 723 (8th Cir. 1994).   But, the majority approach is to weigh a number of factors in the balance on a case-by-case basis to determine whether direct payments can be made.  See, e.g., In re Beard, 45 F.3d 113 (6th Cir. 1995)

The issue came up again in a recent case.

Recent Case

In In re Speir, No. 16-11947-JDW, 2018 Bankr. LEXIS 2359 (Bankr. N.D. Miss. Aug. 8, 2018), the debtor filed Chapter 12 in mid-2016 and a reorganization plan later that year.  The plan called for direct payments to the secured creditors but payments to the unsecured creditors would be made to the trustee for distribution.  The trustee objected, but the court upheld the direct payments except as applied to one secured creditor based on the application of a 13-factor test.   Those factors are: 

  • The debtor’s past history;
  • The debtor’s business acumen;
  • Whether the debtor has complied post-filing statutory and court-imposed duties;
  • Whether the debtor is acting in good-faith;
  • The debtor’s ability to achieve meaningful reorganization absent direct payments;
  • How the reorganization plan treats each creditor to which a direct payment is proposed to be made;
  • The consent, or non-consent, of the affected creditor to the proposed plan treatment;
  • How sophisticated a creditor is, and whether the creditor has the ability and incentive, to monitor compliance;
  • The ability of the trustee and the court to monitor future direct payments;
  • The potential burden on the trustee;
  • The possible effect on the trustee’s salary or funding of the U.S. Trustee system;
  • The potential for abuse of the bankruptcy system; and
  • The existence of other unique or special circumstances

In balancing the factors, the In re Speir court noted that each factor may be considered, but it is not necessary that equal weight be given to each factor or even to different claims in the same case. Ultimately, what the analysis came down to in In re Speir was a weighing of the necessary compensation for the Trustee against a feasible plan for the debtor. The court noted that the debtor had used the bankruptcy process to substantially modify one secured creditor’s claim and, as a result, had to pay that creditor’s claim through the Trustee.  The other secured creditors, the court noted, remained mostly unaffected by the debtor’s bankruptcy and could be paid directly. 

Conclusion

While times remain tough in agriculture for some ag producers, Chapter 12 bankruptcy was created specifically to assist farm debtors in distress.  The ability to pay creditors directly and bypass the Trustee (and the Trustee’s fee) might be possible.  For those in Chapter 12, the issue should be evaluated. 

August 31, 2018 in Bankruptcy | Permalink | Comments (0)

Wednesday, July 18, 2018

Agricultural Law and Economics Conference

Overview

Next month, Washburn Law School and Kansas State University (KSU) will team up for its annual symposium on agricultural law and the business of agriculture.  The event will be held in Manhattan at the Kansas Farm Bureau headquarters.  The symposium will be the first day of three days of continuing education on matters involving agricultural law and economics.  The other two days will be the annual Risk and Profit Conference conducted by the KSU Department of Agricultural Economics.  That event will be on the KSU campus in Manhattan.  The three days provide an excellent opportunity for lawyers, CPAs, farmers and ranchers, agribusiness professionals and rural landowners to obtain continuing education on matters regarding agricultural law and economics.  

Symposium

This year’s symposium on August 15 will feature discussion and analysis of the new tax law, the Tax Cuts and Jobs Act, and its impact on individuals and businesses engaged in agriculture; farm and ranch financial distress legal issues and the procedures involved in resolving debtor/creditor disputes, including the use of mediation and Chapter 12 bankruptcy; farm policy issues at the state and federal level (including a discussion of the status of the 2018 Farm Bill); the leasing of water rights; an update on significant legal (and tax) developments in agricultural law (both federal and state); and an hour of ethics that will test participant’s negotiation skills. 

The symposium can also be attended online.  For a complete description of the sessions and how to register for either in-person or online attendance, click here:  http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html

Risk and Profit Conference

On August 16 and 17, the KSU Department of Agricultural Economics will conduct its annual Risk and Profit campus.  The event will be held at the alumni center on the KSU campus, and will involve a day and a half of discussion of various topics related to the economics of the business of agriculture.  One of the keynote speakers at the conference will be Ambassador Richard T. Crowder, an ag negotiator on a worldwide basis.  The conference includes 22 breakout sessions on a wide range of topics, including two separate breakout sessions that I will be doing with Mark Dikeman of the KSU Farm Management Association on the new tax law.  For a complete run down of the conference, click here:  https://www.agmanager.info/risk-and-profit-conference

Conclusion

The two and one-half days of instruction is an opportunity is a great chance to gain insight into making your ag-related business more profitable from various aspects – legal, tax and economic.  If you are a producer, agribusiness professional, or a professional in a service business (lawyer; tax professional; financial planner; or other related service business) you won’t want to miss these events in Manhattan.  See you there, or online for Day 1.

July 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Tuesday, May 29, 2018

Farm Bankruptcy and the Preferential Payment Rule

Overview

Economic times continue to be difficult in much of agriculture. Many crop prices have declined from their peak a few years ago. The same is true for much of livestock agriculture. What’s more, great yields rarely if ever make up for low prices. As a result, farm bankruptcy filings are occurring at an increased rate, particularly in areas that have both crops and dairy operations.

An important issue that can come up in a farm bankruptcy is known as the “preferential payment rule.” It can be a surprise not only to farmers in financial distress, but also to creditors who receive payment or buy agricultural goods shortly before the debtor files bankruptcy. It’s an issue that can arise in the normal course of doing business before bankruptcy is filed when nothing “unusual” appears to be happening.

Today’s post takes a look at this unique bankruptcy provision – the preferential payment rule.

In General

11 U.S.C. §547 provides in general that when a debtor makes a payment to a creditor and the debtor files bankruptcy within 90 days of making the payment, the bankruptcy trustee can “avoid” the payment by making the creditor pay the amount received to the bankruptcy estate where it will be distributed to the general creditors of the debtor. The timeframe expands from 90 days to one year is the creditor is an “insider.” The rule can come as a shock to a creditor that has received payment, paid their own creditors from the funds received from the debtor, and now has no funds to pay the bankruptcy estate to satisfy the bankruptcy trustee’s avoidance claim.

Exceptions

The preferential payment rule does come with some exceptions. The exceptions basically comport with usual business operations. In other words, if the transaction between the debtor and the creditor occurred in the normal course of the parties doing business with each other, then the trustee’s “avoidance” claim will likely fail. So, if the payment was made as part of a contemporaneous exchange for new value given, the trustee’s avoidance claim will be rejected. Also, if the payment was made in the “ordinary course of business” between the debtor and the creditor where invoices are paid in the time period required on the invoice, or payment is made in accordance with industry custom or past dealings, the trustee’s claim will likely fail. Likewise, if the transfer creates a security interest in property that the debtor acquires that secures new value given in accordance with a security agreement, the trustee’s claim will also likely not be granted.

Recent Case

A recent court decision from Arkansas illustrates how the preferential payment rule can apply in an agricultural setting. In Rice v. Prairie Gold Farms, No. 2:17CV126 JLH, 2018 U.S. Dist. LEXIS 51678 (E.D. Ark. Mar. 28, 2018), the debtor was a partnership engaged in wheat farming activities. The debtor entered into two contracts for the sale of wheat with a grain broker. The contracts called for a total of 10,000 bushels of wheat to be delivered to the broker anytime between June 1, 2014 and July 31, 2014. In return, the debtor was to be paid $6.78/bushel for 5,000 bushels and $7.09/bushel for the other 5,000 bushels for a total price of $69,350. The debtor delivered the wheat in fulfillment of the contracts on July 21, 2014 and August 4, 2014 and received $71,957.10 later in August, in return for a total delivery of 10,813.07 bushels.

The debtor subsequently filed Chapter 11 bankruptcy on October 23, 2014 (which was later converted to Chapter 7). The Chapter 7 trustee sought to avoid the transfer of the debtor’s wheat crop as a preferential transfer under 11 U.S.C. §547(b) and return the wheat crop to the bankruptcy estate for distribution to creditors. The trial court disagreed with the trustee, noting that 11 U.S.C. §547(c)(1) disallowed avoidance of a transfer if it is made in a contemporaneous exchange for new value that the debtor received. The trustee claimed that the transfer of wheat was not contemporaneous because the contract was entered into in May and the wheat was not delivered and payment made until over two months later.

The trial court determined that the transfer was for new value and payment occurred in a substantially contemporaneous manner corresponding to the delivery of the wheat. Thus, the exception of 11 U.S.C. §547(c)(1) applied. The court also noted that the wheat sale contracts were entered into in the ordinary course of the debtor’s business and, thus, also met the exception of 11 U.S.C. §547(c)(2). The debtor and the grain broker had a business history of similar transactions, and the court noted that the trustee failed to establish that the wheat contracts were inconsistent with the parties’ history of business dealings.

Conclusion

The preferential payment rule is important to know about, especially in the context of agricultural bankruptcies. The matter can get complicated in agricultural settings with the use of deferred payment contracts, forward grain contracts and the various types of unique business relationships that farmers often find themselves in. In the Arkansas case, the court noted that the parties had prior dealings that they conducted in the same manner and that nothing was out of the ordinary. There wasn’t any attempt to defraud creditors or shield assets from the reach of creditors. That’s really the point behind the rule. Continue conducting business as usual and the rule won’t likely come into play.

May 29, 2018 in Bankruptcy | Permalink | Comments (0)

Friday, March 16, 2018

Chapter 12 Bankruptcy – Feasibility of the Reorganization Plan

Overview

From an economic standpoint, recent years have not been friendly to many agricultural producers.  Low commodity prices for various grains and milk and increasing debt loads have made it difficult for some farmers to continue.  Chapter 12 bankruptcy filings have been on the rise.  In parts of the Midwest, for instance, filings have been up over 30 percent in the past couple of years compared to prior years. 

There are 94 bankruptcy judicial districts in the U.S.  In 2017, the Western District of Wisconsin led all of them with 28 Chapter 12 cases filed.  Next was Kansas and the Middle District of Georgia with 25 each.  Nebraska was next with 20 Chapter 12 filings.  Minnesota had 19.  Both the Eastern District of Wisconsin and the Eastern District of California had 17.  In the “leader” – the Western District of Wisconsin – filings were up over 30 percent from the prior year for the second year in a row. 

One of the requirements that must be satisfied for a bankruptcy court to get a Chapter 12 reorganization plan confirmed by the bank.  However, it’s becoming a more difficult proposition for some of the Chapter 12 filers. 

The feasibility of a Chapter 12 reorganization plan – that’s the focus of today’s post.   

Chapter 12 Plan Confirmation

Unless the time limit is extended by the court, the confirmation hearing is to be concluded not later than 45 days after the plan is filed. The court is required to confirm a plan if—(1) the plan conforms to all bankruptcy provisions; (2) all required fees have been paid; (3) the plan proposal was made in good faith without violating any law; (4) unsecured creditors receive not less than the amount the unsecured creditors would receive in a Chapter 7 liquidation; (5) each secured creditor either (a) accepts the plan, (b) retains the lien securing the claim (with the value of the property to be distributed for the allowed amount of the claim, as of the effective date of the plan, to equal not less than the allowed amount of the claim), or (c) the creditor receives the property securing the claim; and (6) the debtor will be able to comply with the plan.

Also, under a provision added by The Bankruptcy Act of 2005, an individual Chapter 12 debtor must be current on post-petition domestic support obligations as a condition of plan confirmation.

Feasibility of the Reorganization Plan 

If the court determines that the debtor will be unable to make all payments as required by the plan, the court may require the debtor to modify the plan, convert the case to a Chapter 7, or request the court to dismiss the case.  Over the years, numerous Chapter 12 cases have involved the feasibility issue.  Most recently, a Chapter 12 case from (you guessed it) the Western District of Wisconsin, involved the question of whether a debtor’s reorganization plan was feasible. 

Recent Case

In In re Johnson, No. 17-11448-12, 2018 Bankr. LEXIS 74 (Bankr. W.D. Wisc. Jan. 12, 2018), the debtor was a farmer who primarily raised corn and soybeans. He also was the sole owner of grain farming LLC. The debtor filed a Chapter 12 petition on April 25, 2017, and a Chapter 12 plan on August 22, 2017. On September 25, 2017 a bank objected to plan confirmation. The debtor filed an amended Chapter 12 plan on November 3, 2017 and a second amended Chapter 12 plan on December 14, 2017.

The amended plan proposed payments of $8,150 per month for 12 months, then $11,700 per month for 36 months, and finally $13,700 per month for 12 months. In total the plan proposed payments of $683,400 over 60 months. The debtor claimed that this would pay the creditors in full. However, the court determined that the debtor’s plan was not feasible. At confirmation, the debtor would be required to immediately pay $67,155.70 to cure defaults on leases to be assumed and $40,000 to another creditor. Other than vague testimony that funds were available to satisfy the immediate payments to the other creditor, there was no evidence presented that supported any ability to make the lease cure payments. In addition, the evidence to which the debtor pointed supporting his ability to make payments were his tax returns for the years 2012 through 2015. However, those returns also included crop insurance payments which the debtor was no longer eligible to receive. Yet, according to the debtor’s estimates, he would do better in each of the next three years than he did at any time between 2012 and 2015. The bankruptcy court determined that, based on the picture presented by the debtor’s tax returns and testimony, the debtor’s projections were unpersuasive and lacked credibility.

The debtor also estimated that his gross income from crop sale would swell over the next three years and that his expenses would be less than any of the last four years. Yet, the debtor offered no explanation for how he arrived at these estimates. The debtor claimed that his expenses would decrease because he was no longer paying for crop insurance. However, that would only lower his expenses by approximately $30,000 and there was no reserve for crop loss in the projections, which had ranged from $39,210 to $274,933 in the past. For these reasons, the court determined that the debtor failed to meet his burden in showing that the plan was feasible.

In addition, the debtor’s plan proposed paying the bank’s various secured claims at a 5.5 percent interest rate. The court determined that under Till v. SCS Credit Corp., 541 U.S. 465 (2004), the bank was entitled to a “prime-plus” interest rate. Moreover, in the context of chapter 12 cases, the court noted that risk is often heightened due to the unpredictable nature of the agricultural economy. The court found that the interest rate proposed for the bank in the debtor’s plan was inadequate under Till. The court noted that the current national interest rate was 4.5 percent and the debtor proposed the minimum risk adjustment of 1 percent. The fact that the debtor’s tax returns show that he was consistently reporting losses or barely breaking-even in addition to the many other risk factors led the court to hold that the bank would be subject to a significant degree of risk under the plan and that the debtor’s proposed interest rate was insufficient.

Finally, the court held that because the debtor’s projections lacked any credibility or support it would be impossible for the debtor to propose a confirmable plan. As such, the court dismissed the case. 

Conclusion

Chapter 12 bankruptcy is a difficult experience for a farm debtor to experience.  But, putting a feasible reorganization plan together is essential for getting a plan confirmed.  In the current economic environment, that’s becoming more difficult for many farmers.

March 16, 2018 in Bankruptcy | Permalink | Comments (0)

Wednesday, January 3, 2018

Top Ten Agricultural Law and Tax Developments of 2017 (Ten Through Six)

Overview

This week we are looking at the biggest developments in agricultural law and taxation for 2017.  On Monday, I discussed those developments that were important but just not quite significant enough based on their national significance to make the top ten.  Today I start a two-day series on the top ten developments of 2017 with a discussion of developments 10 through six.  On Friday, developments five through one will be covered. To make my list, the development from the courts, IRS and federal agencies must have a major impact nationally on agricultural producers, agribusiness and rural landowners in general. 

Without further delay, here we go - the top developments for 2017 (numbers 10 through six).

  • 10 – South Dakota Enacts Unconstitutional Tax Legislation. In 2017, the South Dakota Supreme Court gave the South Dakota legislature and Governor what it wanted – a ruling that a recently enacted South Dakota law was unconstitutional.  South Dakota’s thirst for additional revenue led it to enact a law imposing sales tax on businesses that have no physical presence in the state.  That’s something that the U.S. Supreme Court first said 50 years ago that a state cannot do.  Accordingly, the South Dakota Supreme Court struck the law down as an unconstitutional violation of the Commerce Clause.  The legislature deliberately enacted the law so that it would be challenged as unconstitutional in order to set up a case in hopes that the U.S. Supreme Court would review it and reverse its longstanding position on the issue.  See, e.g., National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967) and Quill Corporation v. North Dakota, 504 U.S. 298 (1992).  If that happens, or the Congress takes action to allow states to impose sales (and/or use) tax on businesses with no physical presence in the state, the impact would be largely borne by small businesses, including home-based business and small agricultural businesses all across the country.  It would also raise serious questions about how strong the principle of federalism remains.  State v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. Sup. Ct. 2017), pet. for cert. filed, Oct. 2, 2017.

  • 9 - Amendment to Bankruptcy Law Gives Expands Non-Priority Treatment of Governmental Claims. H.R. 2266, signed into law on October 26, 2017, contains the Family Farmer Bankruptcy Act (Act). The Act adds 11 U.S.C. §1232 which specifies that, “Any unsecured claim of a governmental unit against the debtor or the estate that arises before the filing of the petition, or that arises after the filing of the petition and before the debtor's discharge under section 1228, as a result of the sale, transfer, exchange, or other disposition of any property used in the debtor's farming operation”… is to be treated as an unsecured claim that arises before the bankruptcy petition was filed that is not entitled to priority under 11 U.S.C. §507 and is deemed to be provided for under a plan, and discharged in accordance with 11 U.S.C. §1228. The provision amends 11 U.S.C. §1222(a)(2)(A) to effectively override Hall v. United States, 132 Sup. Ct. 1882 (2012) where the U.S. Supreme Court held that tax triggered by the post-petition sale of farm assets was not discharged under 11 U.S.C. §1222(a)(2)(A). The Court held that because a Chapter 12 bankruptcy estate cannot incur taxes by virtue of 11 U.S.C. §1399, taxes were not “incurred by the estate” under 11 U.S.C. §503(b) which barred post-petition taxes from being treated as non-priority. The provision is effective for all pending Chapter 12 cases with unconfirmed plans and all new Chapter 12 cases as of October 26, 2017. H.R. 2266, Division B, Sec. 1005, signed into law on October 26, 2017.

  • 8 – “Hobby Loss” Tax Developments. 2017 saw two significant developments concerning farm and ranching activities that the IRS believes are not conducting with a business purpose and are, thus, subject to the limitation on deductibility of losses.     Early in 2017, the IRS issued interim guidance on a pilot program for Schedule F expenses for small business/self-employed taxpayer examinations.  It set the program to begin on April 1, 2017 and run for one year.  The focus will be on “hobby” farmers, and will involve the examination of 50 tax returns from tax year 2015.  The program could be an indication that the IRS is looking to increase the audit rate of returns with a Schedule F, and it may be more likely to impact the relatively smaller farming operations.  The interim guidance points out that the IRS believes that compliance issues may exist with respect to the deduction of expenses on the wrong form, or expenses that actually belonged to another taxpayer, or that should be subject to the hobby loss rules of I.R.C. §183.  Indeed, the IRS notes that a filter for the project will be designed to identify those taxpayers who have W-2s with large income and who also file a Schedule F “and may not have time to farm.”  In addition, the guidance informs IRS personnel that the examined returns could have start-up costs or be a hobby activity which would lead to non-deductible losses. The interim guidance also directs examiners to look for deductions that “appear to be excessive for the income reported.”  The implication is that such expenses won’t be deemed to be ordinary and necessary business expenses.  How that might impact the practice of pre-paying farm expenses remains to be seen.  The guidance also instructs examiners to pick through gas, oil, fuel, repairs, etc., to determine the “business and non-business parts” of the expense without any mention of the $2,500 safe harbor of the repair regulations.  The interim guidance would appear to be targeted toward taxpayers that either farm or crop share some acres where the income ends up on Schedule F, but where other non-farm sources of income predominate (e.g., W-2 income, income from leases for hunting, bed and breakfast, conservation reserve program payments, organic farming, etc.).  In those situations, it is likely that the Schedule F expenses will exceed the Schedule F income.  That’s particularly the case when depreciation is claimed on items associated with the “farm” - a small tractor, all-terrain vehicle, pickup truck, etc.  That’s the typical hobby loss scenario that IRS is apparently looking for.

    The second development on the hobby loss issue was a Tax Court opinion issued by Judge Paris in late 2017.  The case involved a diversified ranching operation that, for the tax years at issue, had about $15 million in losses and gross income of $7 million.  For those years, the petitioner’s primary expense was  depreciation. The IRS claimed that the ranching activity was not engaged in for profit and the expenses were deductible only to the extent of income. The Tax Court determined that all of the petitioner’s activities were economically intertwined and constituted a single ranching activity. On the profit issue, the court determined that none of the factors in the Treasury Regulations §1.183-2(b) favored the IRS. Accordingly, the petitioner’s ranching activity was held to be conducted for-profit and the losses were fully deductible. The court specifically rejected the IRS argument that a profit motive could not be present when millions of dollars of losses were generated.  That’s a very important holding for agriculture.  Depreciation is often the largest deduction on a farm or ranch operation’s return.  Welch, et al. v. Comr., T.C. Memo. 2017-229.

  • 7 - Beneficial Use Doctrine Established Water Right That Feds Had Taken.  In late 2017, the U.S. Court of Federal Claims issued a very significant opinion involving vested water rights in the Western United States.  The court ruled that the federal government had taken the vested water rights of the plaintiff, a New Mexico cattle ranching operation, which required compensation under the Fifth Amendment.  The court determined that the plaintiff had property rights by virtue of having “made continuous beneficial use of stock water sources” predating federal ownership.  Those water rights pre-dated 1905, and the U.S. Forest Service (USFS) had allowed that usage from 1910 to 1989.  The court also agreed with the plaintiff’s claim the water was “physically taken” when the United States Forest Service (USFS) blocked the plaintiff’s livestock from accessing the water that had long been used by the plaintiff and its predecessors to graze cattle so as to preserve endangered species.

    More specifically, the plaintiff held all “cattle, water rights, range rights, access rights, and range improvements on the base property, as well as the appurtenant federally-administered grazing allotment known as the Sacramento Allotment” in New Mexico. The plaintiff obtained a permit in 1989 from the USFS to graze cattle on an allotment of USFS land which allowed for the grazing of 553 cows for a 10-year period. At the time the permit was obtained, certain areas of the allotment were fenced off, but the USFS allowed the plaintiff’s cattle access to water inside the fenced areas. However, in 1996, the USFS notified the plaintiff that cattle were not permitted to graze inside the fenced areas, but then later allowed temporary grazing due to existing drought conditions. In 1998, the USFS barred the plaintiff from grazing cattle inside the fenced areas, but then reissued the permit in 1999 allowing 553 cattle to graze the allotment for 10 years subject to cancellation or modification as necessary. The permit also stated that “livestock use” was not permitted inside the fenced area. In 2001, the USFS denied the plaintiff’s request to pipe water from the fenced area for cattle watering and, in 2002, the USFS ordered the plaintiff to remove cattle that were grazing within the fenced area. Again in 2006, the plaintiff sought to pipe water from a part of the fenced area, but was denied. A U.S. Fish and Wildlife Service Biological Opinion in 2004 recommended the permanent exclusion of livestock from the allotment, and the plaintiff sued for a taking of its water rights which required just compensation. While the parties were able to identify and develop some alternative sources of water, that did not solve the plaintiff’s water claims and the plaintiff sued.

    The court determined that the plaintiff’s claim was not barred by the six-year statute of limitations because the plaintiff’s claim accrued in 1998 when the USFS took the first “official” action barring the grazing of cattle in the fenced area. The court also determined that under state (NM) law, the right to the beneficial use of water is a property interest that is a distinct and severable interest from the right to use land, with the extent of the right dependent on the beneficial use. The court held that the “federal appropriation of water does not, per se constitute a taking….Instead, a plaintiff must show that any water taken could have been put to beneficial use.” The court noted that NM law recognizes two types of appropriative water rights – common law rights in existence through 1907 and those based on state statutory law from 1907 forward. The plaintiff provided a Declaration of Ownership that had been filed with the New Mexico State Engineer between 1999 and 2003 for each of the areas that had been fenced-in. Those Declarations allow a holder of a pre-1907 water right to specify the use to which the water is applied, the date of first appropriation and where the water is located. Once certified, the Declaration of Ownership is prima facie evidence of ownership. The court also noted that witnesses testified that before 1907, the plaintiff’s predecessor’s in interest grazed cattle on the allotment and made beneficial use of the water in the fenced areas. Thus, the court held that the plaintiff had carried its burden to establish a vested water right. The plaintiff’s livestock watering also constituted a “diversion” required by state law.   Thus, the USFS action constituted a taking of the plaintiff’s water right.  Importantly, the court noted that a permanent physical occupation does not require in every instance that the occupation be exclusive, or continuous and uninterrupted.  The key, the court noted, was that the effects of the government’s action was so complete to deprive the plaintiff of all or most of its interest.  The court directed the parties to try to determine whether alternative water sources could be made available to the plaintiff to allow the ranching operation to continue on a viable basis.  If not, the court will later determine the value of the water rights taken for just compensation purposes. Sacramento Grazing Association v. United States, No. 04-786 L. 2017 U.S. Claims LEXIS 1381 (Fed. Cl. Nov. 3, 2017).

  • 6 – Department of Labor Overtime Rules Struck Down. In 2017, a federal court in Texas invalidated particular Department of Labor (DOL) rules under the Fair Labor Standards Act (FLSA).  The invalidation will have a significant impact on agricultural employers.  The FLSA exempts certain agricultural employers and employees from its rules.  However, one aspect of the FLSA that does apply to agriculture are the wage requirements of the law, both in terms of the minimum wage that must be paid to ag employment and overtime wages.  But, an exemption denies persons employed in agriculture the benefit of mandatory overtime payment. 29 U.S.C. § 213(b)(12)The agricultural exemption is broad, defining “agriculture” to include “farming in all its branches [including] the raising of livestock, bees, fur-bearing animals, or poultry,…and the production, cultivation, growing, and harvesting of...horticultural commodities and any practices performed by a farmer or on a farm as an incident to or in conjunction with farming operations.”   In addition, exempt are “executive” workers whose primary duties are supervisory and the worker supervises 2 or more employees.  Also exempt are workers that fall in the “administrative” category who provide non-manual work related to the management of the business, and workers defined as “professional” whose job is education-based and requires advanced knowledge.  Many larger farming and ranching operations have employees that will fit in at least one of these three categories.  For ag employees that are exempt from the overtime wage payment rate because they occupy an “executive” position, they must be paid a minimum amount of wages per week.

    Until December 1, 2016, the minimum amount was $455/week ($23,660 annually).  Under the Obama Administration’s DOL proposal, however, the minimum weekly amount was to increase to $913 ($47,476 annually).  Thus, an exempt “executive” employee that is paid a weekly wage exceeding $913 is not entitled to be paid for any hours worked exceeding 40 in a week.  But, if the $913 weekly amount was not met, then the employee would generally be entitled to overtime pay for the hours exceeding 40 in a week.  Thus, the proposal would require farm businesses to track hours for those employees it historically has not tracked hours for – executive employees such as managers and those performing administrative tasks.  But, remember, if the employee is an agricultural worker performing agricultural work, the employee need not be paid for the hours in excess of 40 in a week at the overtime rate.  The proposal also imposes harsh penalties for noncompliance.  Before the new rules went into effect, many states and private businesses sued to block them.  The various lawsuits were consolidated into a single case, and in November of 2016, the court issued a temporary nationwide injunction blocking enforcement of the overtime regulations.  Nevada v. United States Department of Labor, 218 F. Supp. 3d 520 (E.D. Tex. 2016).

    On Aug. 31, 2017, the court entered summary judgment for the plaintiffs in the case thereby invalidating the regulations.   In its ruling, the court focused on the congressional intent behind the overtime exemptions for “white-collar” workers as well as the authority of the DOL to define and implement those exemptions.  The court also concluded that the DOL did not have any authority to categorically exclude workers who perform exempt duties based on salary level alone, which is what the court said that the DOL rules did.  The court noted that the rules more than doubled the required salary threshold and, as a result, “would essentially make an employee’s duties, functions, or tasks irrelevant if the employee’s salary falls below the new minimum salary level.”  The court went on to state that the overtime rules make “overtime status depend predominantly on a minimum salary level, thereby supplanting an analysis of an employee’s job duties.”  The court noted that his was contrary to the clear intent of the Congress and, as a result, the rules were invalid.   The court’s ruling invalidating the overtime rules is an important victory for many agricultural (and other) businesses.  It alleviates an increased burden to maintain records for employees in executive positions (e.g., managers and administrators), and the associated penalties for non-compliance.  The case is Nevada v. United States Department of Labor, No. 4:16-cv-731, 2017 U.S. Dist. LEXIS 140522 (E.D. Tex. Aug. 31, 2017). 

Conclusion

Those are the "bottom five" of the "top 10" developments of 2017.  On Friday I will reveal what I believe to be the top five developments.

January 3, 2018 in Bankruptcy, Regulatory Law, Water Law | Permalink | Comments (0)

Wednesday, December 20, 2017

Christmas Shopping Season Curtailed? - Bankruptcy Venue Shopping, That Is!

Overview

Under current law, a business has options concerning where it can file bankruptcy.  Those places include the state in which the business is organized, the location where the business has significant business assets or conducts business, or (in certain situations) where the parent company or affiliate has filed bankruptcy.  That can create a tough situation for a farmer that has a claim against the bankrupt company if they have to travel far from their farming operation to participate in the bankruptcy.  An example of this was the VeraSun bankruptcy that impacted farmers across parts of the Midwest and the Great Plains a few years ago.

Now, according to Bloomberg News and the Wall Street Journal, it looks like legislation will be introduced into the Congress that would change where a bankrupt company can file bankruptcy.  See, e.g., https://www.wsj.com/articles/lawmakers-to-propose-making-bankrupt-companies-file-for-protection-close-to-home-1513644954?reflink=djemBankruptcyPro&tpl=db;   This is known as “venue” and the bill is known as the “Bankruptcy Venue Reform Act of 2017.”  If introduced this week, the bill may be tucked into the Omnibus spending bill that the Congress will vote on late this week.  It’s a big deal for farmers, employees, retirees of bankrupt debtors (and other creditors).    

Bankruptcy venue reform – today’s blog post topic.

Why Tightening Venue Matters

Several prominent bankruptcy cases filed in recent years illustrate why modifying existing venue rules matters.

VeraSun Energy Corporation (VeraSun).  In early November 2008, Sioux Falls-based VeraSun and twenty-four of its subsidiaries filed for Chapter 11 bankruptcy protection to enhance liquidity while it reorganized.  VeraSun got in financial trouble when it bought corn contracts at a high price and then corn prices dropped by about 50 percent before the specified delivery date in the contracts.  VeraSun had failed to protect itself on the board of trade.  That big price drop caused VeraSun to lose hundreds of millions of dollars. Of course, VeraSun was using the contract to hedge against corn prices going up and the farmer sellers were using them to hedge against a price decline.  The corn farmers guessed right and the contracts worked to their advantage.  However, VeraSun’s bankruptcy meant that  VeraSun could force farmer sellers to hold their grain in a dropping market since it was not required to assume or reject the contracts until its plan of reorganization was to be heard several months down the line.  If the contracting farmer sold his corn to minimize his loss, and the price of corn increased so that it made economic sense for VeraSun to enforce the purchase contract, the farmer would be forced to make up the difference.  Many farmers sought to have the bankruptcy court force VeraSun to make decisions regarding assuming or rejecting the out-of-the money corn contracts quickly, so they would not be faced with a problem if the market rebounded.  The bankruptcy court in Delaware was not willing to force VeraSun to act on a plant-by-plant basis, opting instead to allow each individual farmer to hire counsel in Delaware to press his case involving his contracts.  This was cost prohibitive.  There were over 6,000 midwestern farmers affected by this bankruptcy.

Later in the case, lawyers from Delaware and New York sent threatening letters to the farmers who had been paid for their corn promptly in accordance with state grain elevator laws demanding that they repay all sums they had been paid within 90 days of the case filing claiming that they were preferential transfers.  The farmers organized, and defensive letters were sent back to the threatening lawyers who then opted to not file the threatened preference lawsuits.  If the case had been filed in the Midwest, it would have been more likely that lawyers familiar with agricultural law would not have sent the preference demand letters because they would have known the prompt payment requirements of state grain elevator laws and would have recognized that these payments were in the ordinary course of business of both VeraSun and the farmers it paid. 

In addition, farmers who were unpaid when the bankruptcy was filed became creditors in the VeraSun bankruptcy and had to file claims and participate in the bankruptcy process to have any hope of getting paid.  Those farmers were scattered across the Midwest and Great Plains where Verasun had ethanol and biodiesel plants.  None of them were located in Delaware, where VeraSun filed its bankruptcy petition. 

Why did Verasun file bankruptcy in Delaware when it didn’t have any ethanol plants located in Delaware and wasn’t headquarted there?  Because the an affiliated company organized in Delaware filed Chapter 11 filed bankruptcy in Delaware.  Because of that, all of the affiliated companies could also file in Delaware under the applicable venue rule of the Bankruptcy Code.  That meant that farmers with claims against VeraSun had to participate in Delaware bankruptcy proceedings rather than in the jurisdiction where the contracts were to be performed.  That’s a frustrating, and expensive, proposition for farmers.   Ultimately, VeraSun ended up selling seven of the plants to Valero Energy Corporation, and the rest to other companies in 2009.

A short video about the VeraSun bankruptcy effects on farmers, as told by an Iowa farmer, can be found at: https://www.youtube.com/watch?v=7GdifLvuRdw

Peregrine Financial Group, Inc. (PFG).  PFG was an Iowa-based financial firm that was shut down in 2012 after it was put under investigation for a $200 million shortfall in customer funds.  PFG’s Peregrine’s chief executive office was arrested and charged with making false statements to the Commodity Futures Trading Commission (CFTC).  At the time of PFG filed Chapter 7 it had over $500 million in assets and over $100 million in liabilities.  PFG filed bankruptcy in Illinois even though it was headquartered in Iowa.  Similar to the VeraSun bankruptcy, many Midwest farmers were impacted by PFG’s bankruptcy. 

Solyndra, LLC.  The solar-panel maker Soyndra, LLC, filed Chapter 11 in 2011 in Delaware.  Solyndra had received $535 million in federal financing (under the Obama Administration’s “stimulus” program) and a $25.1 million tax break from the State of California. Upon filing, the California-based company suspended its manufacturing operations and laid-off approximately 1,100 employees triggering both Federal and California Worker Adjustment and Retraining Notification Act issues.  The employees affected by the mass layoffs resided in California.  By filing in Delaware, Solyndra made it more expensive and burdensome for the laid-off employees to pursue their claims.  The result for the employees was an out-of-court settlement of only $3.5 million (less 33% for their attorneys' contingent fee) on their claim of $15 million.  One can only imagine the result if the case had been filed in California and the employees had easy access to the court deciding their fates.

Winn-Dixie Stores, Inc. (WD).  WD was a supermarket chain headquartered in Florida.  In April 2004, Winn-Dixie announced the closure of 156 stores, including all 111 stores located in the Midwest.  On early 2005, WD filed Chapter 11 bankruptcy.  To establish venue in technical compliance with the statute, the WD formed a new entity in New York shortly before the Chapter 11 filing and admitted it did so to establish venue.  The bankruptcy court stated that the current statute contains a loophole allowing companies to file in venues that are not proper even if they have literally complied with the statute.  The court transferred the case to Florida, with the judge stating, “…simply because I don’t believe it just to exploit the loophole in the statute to obtain venue here.” In re Winn-Dixie Stores, Inc., Case No. 05-11063 (RDD) (Bankr. S.D.N.Y. April 12, 2005) Hearing Transcript at 167. 

In re Houghton Mifflin-Harcourt Publishing Co. (HM).  HM was a publishing company that filed its case in the Southern District of New York in 2012.  The United States Trustee filed a Motion to Change Venue.  Unlike the court in WD that transferred venue, the bankruptcy court in HM found there was no statutory basis for venue in the Southern District of New York, but chose to defer transfer of venue until after confirmation of the plan.  The court even chided the United States Trustee for filing the Motion to Change Venue.  In re Houghton Mifflin Harcourt Publishing Co., Case No. 12‐12171 (RFG), Decision on U.S. Trustee Motion to Transfer Venue of these Cases, (June 22, 2012, Bankr. SDNY).

Boston Herald.  Last week, provided another example of forum shopping at the expense of retirees, employees and the local community.  The Boston Herald (Herald), a local Boston, MA, newspaper announced plans to sell the newspaper to GateHouse Media after filing Chapter 11 bankruptcy in Delaware.  The only connection that the Herald has to Delaware is that its holding company is incorporated in Delaware.  Eighteen of its 30 largest creditors reside in Massachusetts or New Hampshire and most are individual retirees. 

Changing Venue as an Option?

The WD bankruptcy judge’s transfer of the case is a rarity.  Very few cases are ever transferred.  Indeed, some venue-change proceedings have turned into costly extended proceedings with evidentiary trials and extensive briefing.  For instance, the Patriot Coal Corporation (a St. Louis-based spin-off of Peabody Energy Corporation) filed Chapter 11 bankruptcy in 2015.  On a motion to transfer venue from the Southern District of New York, the bankruptcy court took four months to issue a 61-page decision based on facts that were largely uncontested and involved the manipulation of current venue law.  Venue was determined to be in the Southern District of New York.  Based on a review of the interim fee applications filed in the Patriot Coal case, it can be estimated that the debtor spent approximately $2 million and the creditors spent an additional $1 million to litigate the venue challenge.  The court’s opinion “demonstrates the near impossibility of having venue transferred away from New York.” See Bill Rochelle, Patriot Shows Futility of Moving Cases from NY, Bloomberg (11/29/12).

In In re Enron Corp., 274 B.R. 327 (Bankr. S.D. N.Y. 2002), the court stressed the importance of case administration, and noted the “learning curve” the court acquired in the first month of the case in denying a motion to change venue filed shortly after the filing of the case.  Enron and other cases such as In re Jitney JungleCase No. 99‐3602 (Bankr. D. Del.) and the WD case mentioned above demonstrate that by the time courts consider venue transfer motions, most of the important first day or “second day” motions relating to debtor-in-possession financing, sale procedures, break-up fees and the like would have already been entered and have become final. The reorganization case would have progressed forward so far and taken such a direction that it bears the indelible imprint of the first court. Such was the case with Jitney Jungle. By the time this case was transferred to New Orleans there was little that the New Orleans bankruptcy judge said that he could do because of the actions taken or orders previously entered in Delaware. Similarly, in Winn-Dixie, by the time the Florida judge received the case, so much of substance had already been ordered in the case that there was little the Florida judge could do but administer the orders of the prior judge.

Bankruptcy Venue Reform Act of 2017

The goal of the legislation is to drastically reduce the ability of companies to forum shop bankruptcies by denying access to justice for creditors of companies that choose to file their bankruptcies primarily in the Southern District of New York and Delaware.  The legislation does this will by eliminating place of incorporation as a proper venue as well as eliminating the affiliate rule allowing the companies to file a Delaware affiliate first in Delaware, then file the rest of the cases in Delaware.  Under the bill, venue is appropriate only in the district court for the district where an individual debtor is domiciled, resides, or where their principal assets have been located for the 180-day period immediately preceding the bankruptcy petition, or for a longer portion of the 180-day period than the domicile, residence or principal asset were located anywhere else.  The same 180-day rule applies to a business debtor, but in terms of the debtor’s principal place of business rather than residence or domicile. 

Venue is also proper in jurisdictions where there is already a pending bankruptcy case concerning an affiliate that directly or indirectly owns, controls, is the general partner, or holds 50 percent or more of the outstanding voting securities, of the person or entity that is the subject of the later-filed case if the pending case was properly filed in that district.  The bill also says that changes of ownership or control of a person or entity or assets or principal place of business within a year before bankruptcy filing that is done with the purpose of establishing venue are to be ignored.  A court could still transfer a case in the interest of justice or for the convenience of the parties.

Conclusion

Currently, bankruptcies can be filed in several places, including the state of organization of the company, the district where a company has significant business assets or conducts business, or in the district where a parent or an affiliate has filed bankruptcy.   The proposed legislation will make it difficult for bankruptcies to be filed remotely from the company’s assets or headquarters.  The idea is to increase fair access to justice for the parties affected by a bankruptcy.  The bill is a big deal for bankruptcy reform and fairness to creditors.  While similar legislation was introduced in 2011, it was opposed by the Obama Administration.  Individuals and businesses interested in the matter should contract their Congressional Representatives and Senators immediately and request Senators to Co-sponsor the bill and ask their Representatives to support it. 

December 20, 2017 in Bankruptcy | Permalink | Comments (0)

Wednesday, December 6, 2017

Are Taxes Dischargeable in Bankruptcy?

Overview

For Chapter 7 and 11 filers, there is a possibility that taxes could be dischargeable in bankruptcy.  That’s because under those bankruptcy code provisions, a new tax entity is created at the time of bankruptcy filing.  That’s not the case for individuals that file Chapter 12 (farm) bankruptcy or 13 and for partnerships and corporations under all bankruptcy chapters.  In those situations, the debtor continues to be responsible for the income tax consequences of business operations and disposition of the debtor's property.  Thus, payment of all the tax triggered in bankruptcy is the responsibility of the debtor.  The only exception is that Chapter 12 filers can take advantage of a special rule that makes the taxes a non-priority claim.

A new Tax Court case involving a Chapter 7 filer, illustrates how timing the bankruptcy filing is important for purposes of being able to discharge taxes in a Chapter 7.

Taxes discharged in bankruptcy, that’s the focus of today’s post.

The Bankruptcy Estate as New Taxpayer

The creation of the bankruptcy estate as a new taxpayer, separate from the debtor, highlights the five categories of taxes in a Chapter 7 or 11 case.

  • Category 1 taxes are taxes where the tax return was due more than three years before filing. These taxes are dischargeable unless the debtor failed to file a return or filed a fraudulent return. 
  • Category 2 taxes are the taxes due within the last three years. These taxes are not dischargeable but are entitled to an eighth priority claim in the bankruptcy estate, ahead of the unsecured creditors. 
  • Category 3 taxes are the taxes for the portion of the year of bankruptcy filing up to the day before the day of bankruptcy filing. If the debtor's year is closed as of the date of filing, the taxes for the first year, while not dischargeable, are also entitled to an eighth priority claim in the bankruptcy estate.  If the debtor's year is not closed, the entire amount of taxes for the year of filing are the debtor's responsibility.
  • Category 4 taxes are the taxes triggered on or after the date of filing and are the responsibility of the bankruptcy estate. Taxes due are paid by the bankruptcy estate as an administrative expense.  If the taxes exceed the available funds, the tax obligation remains against the bankruptcy estate but does not return to the debtor.
  • Category 5 taxes are for the portion of the year beginning with the date of bankruptcy filing (or for the entire year if the debtor's year is not closed) and are the responsibility of the debtor.

The Election To Close the Debtor’s Tax Year 

In general, the bankrupt debtor’s tax year does not change upon the filing of bankruptcy.  But, debtors having non-exempt assets may elect to end the debtor’s tax year as of the day before the filing.

Making the election creates two short tax years for the debtor.  The first short year ends the day before bankruptcy filing and the second year begins with the bankruptcy filing date and ends on the bankrupt’s normal year-end date.  If the election is not made, the debtor remains individually liable for income taxes for the year of filing.  But, if the election is made, the debtor’s income tax liability for the first short year is treated as a priority claim against the bankruptcy estate, and can be collected from the estate if there are sufficient assets to pay off the estate’s debts.  If there are not sufficient assets to pay the income tax, the remaining tax liability is not dischargeable, and the tax can be collected from the debtor at a later time.  The income tax owed by the bankrupt for the years ending after the filing is paid by the bankrupt and not by the bankruptcy estate.  Thus, closing the bankrupt’s tax year can be particularly advantageous if the bankrupt has substantial income in the period before the bankruptcy filing.  Conversely, if a net operating loss, unused credits or excess deductions are projected for the first short year, an election should not be made in the interest of preserving the loss for application against the debtor’s income from the rest of the taxable year.  Even if the debtor projects a net operating loss, has unused credits or anticipates excess deductions, the debtor may want to close the tax year as of the day before bankruptcy filing if the debtor will not likely be able to use the amounts, the items could be used by the bankruptcy estate as a carryback to earlier years of the debtor (or as a carryforward) and, the debtor would likely benefit later from the bankruptcy estate’s use of the loss, deduction or credits.

But, in any event, if the debtor does not act to end the tax year, none of the debtor’s income tax liability for the year of bankruptcy filing can be collected from the bankruptcy estate.  Likewise, if the short year is not elected, the tax attributes (including the basis of the debtor’s property) pass to the bankruptcy estate as of the beginning of the debtor’s tax year.  Therefore, for example, no depreciation may be claimed by the debtor for the period before bankruptcy filing.  That could be a significant issue for many agricultural debtors.

Consider the following example:

Sam Tiller, a cash method taxpayer, on January 26, 2016, bought and placed in service in his farming business, a new combine that cost $402,000.  Sam is planning on electing to claim $102,000 of expense method depreciation on the combine and an additional $150,000 (50 percent of the remaining depreciable balance) of first-year bonus depreciation as well as regular depreciation on the combine for 2016. However, during 2016, Sam’s financial condition worsened severely due to a combination of market and weather conditions.  As a result, Sam filed Chapter 7 bankruptcy on December 5, 2016.

If Sam does not elect to close the tax year, the tax attributes (including the basis of his property) will pass to the bankruptcy estate as of the beginning of Sam’s tax year (January 1, 2016).  Therefore, Sam would not be able to claim any of the depreciation for the period before he filed bankruptcy (January 1, 2016, through December 4, 2016).

Recent Tax Court Case

In Ashmore v. Comr., T.C. Memo. 2017-233, the petitioner claimed that his 2009 tax liability, the return for which was due on April 15, 2010, was discharged in bankruptcy.   He filed Chapter 7 on April 8, 2013. That assertion challenged whether the collection action of the IRS was appropriate.  As indicated above, the Tax Court noted that taxes are not dischargeable in a Chapter 7 bankruptcy if they become due within three years before the date the bankruptcy was filed.  Because the petitioner filed bankruptcy a week too soon, the Tax Court held that his 2009 taxes were dischargeable and could be collected.  As a result, the IRS settlement officer did not abuse discretion in sustaining the IRS levy.  In addition, the Tax Court, held that the IRS did not abuse the bankruptcy automatic stay provision that otherwise operates to bar creditor actions to collect on debts that arose before the bankruptcy petition was filed. 

Conclusion

The Tax Court’s conclusion in Ashmore is not surprising.  The three-year rule has long been a part of the bankruptcy code.  Indeed, in In re Reine, 301 B.R. 556 (Bankr. W.D. Mo. 2003), the debtor filed the Chapter 7 bankruptcy petition more than three years after filing the tax return, but within three years of due date of return.  The court held that the debtor’s tax debt was not dischargeable.

Timing matters.

December 6, 2017 in Bankruptcy, Income Tax | Permalink | Comments (0)

Thursday, November 30, 2017

PACA Trust Does Not Prevent Chapter 11 DIP’s Use Of Cash Collateral

Overview

In 1930, the Congress enacted the Perishable Agricultural Commodities Act (PACA) to address unfair and fraudulent practices in the marketing of perishable agricultural commodities in interstate and foreign commerce.  7 U.S.C. §§ 499a et seq.  A provision in the PACA requires a covered “dealer” to “promptly pay” for the purchase of perishable agricultural commodities.  One way that the PACA ensures prompt payment is via the creation of a PACA trust to hold the proceeds of the sale of perishable commodities for the for the benefit of the unpaid seller until full payment is made. 7 U.S.C. § 499e(c)(2).   

This PACA trust provision was added in 1984 to address the problem of buyers filing bankruptcy after purchasing perishable commodities, but before full payment was made.  Basically, once an unpaid seller learns that a buyer has become insolvent, a PACA trust is created and the PACA trust funds (amounts owed to the seller) are escrowed for pro rata distribution to the PACA trust beneficiary or beneficiaries.  The point is that the assets in a PACA trust are excluded from the bankruptcy estate of a bankrupt buyer.

A recent case involved an interesting question - whether the PACA trust bars a bankruptcy debtor-in-possession (DIP), from using the cash collateral of the PACA trust in the continued operation of the DIP’s business.  Is the status of the perishable commodity seller as a PACA trust beneficiary sufficient, by itself, to bar the DIP’s use of the cash collateral?

The rights of a DIP to use cash collateral of a PACA trust, that’s the topic of today’s post.

Chapter 11 and the DIP

A DIP is a party (individual or corporation) that has filed a Chapter 11 (reorganization) bankruptcy petition.  While creditors of the DIP have liens in the DIP’s property, the DIP remains in control of the property and continues to operate the underlying business.  The DIP essentially continues to operate the business in a fiduciary capacity for the creditors’ best interest.  Thus, ordinary business operations are permissible, but the DIP has to get court approval for actions that are beyond the scope of normal business practices.    


Recent Bankruptcy Case

In a recent Chapter 11 bankruptcy case, In re Cherry Growers, Inc., No. 17-04127-swd, 2017 Bankr. LEXIS 3838 (W.D. Mich. Nov. 1, 2017), the debtor, as a Chapter 11 DIP, filed a motion for an order authorizing its use of cash collateral.  A bank, the DIP’s principal secured creditor, supported the motion.  However, a claimant asserting PACA rights opposed the motion because, in its view, such an order would violate the claimant’s PACA trust rights as well as the rights of others as beneficiaries of the PACA trust.

As mentioned above, the PACA creates a statutory trust to protect growers of perishable agricultural products against the risk of non-payment by buyers and others.  A PACA claimant, as a seller of eligible produce, has a trust claim against the qualifying inventory and proceeds that is superior to the claims and liens of the buyer’s creditors with no regard to whether the creditors are secured or unsecured and without regard to the priority level of the claim.  Under the facts of the case, the claimant held an equitable interest in the bankruptcy estate with respect to its $337,159.18 PACA claim, and the question before the court was whether that equitable interest was sufficient to deny the debtor’s requested (and otherwise consensual) use of its secured lender’s cash collateral, especially where a sufficient equity cushion existed to adequately protect the PACA claimant’s claim.

The court held an interim hearing on the motion at which it took testimony, granted interim relief and scheduled a final hearing. At the final hearing PACA claimant argued that its PACA claim reached all of the DIP’s property, at least if the DIP could not prove otherwise.  The claimant asserted that its status as PACA trust beneficiary was sufficient to bar a debtor from utilizing the cash collateral.  The claimant also argued that in the absence of proof the contrary from the DIP, all income derived during the case from any of the property in the DIP’s possession, would constitute proceeds of the PACA trust, and that the DIP could not use any of the property because it belonged to the PACA claimant and not the bankruptcy estate.

The court did note the power of the PACA trust.  Specifically, the court pointed out that, under PACA, growers and suppliers of perishable agricultural products who have properly preserved their rights under the statute are entitled to the benefit of a broad and powerful “floating trust” in their buyer’s qualifying inventory and proceeds thereof. These trust claims are to be paid first from trust assets, even prior to any claims or interests of secured creditors in such property. Furthermore, the court noted that the commingling of trust assets is specifically contemplated under the federal regulations implementing PACA. As the court recognized, PACA is “designed to promote priority payment to the PACA claimant.” 

However, the court held that to conclude that the subject matter of the PACA trust is excluded from the bankruptcy estate overstated the case holdings that the PACA claimant cited.  Instead, the court determined that the PACA expressly contemplates the commingling of trust and non-trust property, the creation of a “floating trust,” and the continued operation of the PACA trustee. Thus, within the context of a Chapter 11 bankruptcy, the DIP presumptively continues operating its business in accord with applicable non-bankruptcy law.  In turn, the court reasoned, this meant that it made sense to think in terms of permitting the DIP to use its buildings and equipment to conduct its business as it had done for years, along with the cash and cash equivalents derived from that use, even though they may be impressed to some extent with a statutory trust, as long as the DIP provides adequate protection of the PACA claimant’s interest in the estate property. In addition, because the value of the property of the estate that the PACA claimant believed to be impressed with the PACA trust far exceeded the claimant’s claim, the court concluded that the DIP had met its burden of showing that the claimant would be adequately protected. Therefore, the court granted the DIP’s motion authorizing the use of the cash collateral in the property in which the PACA claimant had an equitable interest, in accordance with 11 U.S.C. §363 “as long as the DIP provides adequate protection of [the PACA claimant’s] interests in the estate property.”  Because the DIP’s property that the PACA claimant alleged was subject to the PACA trust was much greater than the PACA claimant’s $337,159.18 claim, the court found that the PACA claimant’s interests were adequately protected.

The court also disagreed with the PACA claimant’s assertion that the DIP bore the burden of proof that the property that the DIP wanted to utilize in its business operations were not property of the PACA trust.  Instead, the court determined that the PACA claimant had to first prove that the claimant had an interest in the DIP’s property.  After that, the DIP had to establish that adequate protection was provided to the PACA claimant.  In so holding, the court distinguished a contested matter under 11 U.S.C. §363 from that involving a battle of competing property interests. 

Conclusion

What’s the “take-home” from the court’s decision?  Certainly, PACA claimants have substantial rights.  But, there are limits on those rights.  In addition, according to the court, a PACA claimant’s equitable interests in the PACA trust are not bankruptcy estate property, but the assets themselves are under 11 U.S.C. §541.  The case could also indicate that DIPs may have more leverage with creditors in getting authority to use cash collateral to conduct continuing business operations. 

November 30, 2017 in Bankruptcy | Permalink | Comments (0)

Tuesday, November 14, 2017

What Interest Rate Applies To A Secured Creditor's Claim in a Reorganization Bankruptcy?

Overview

In the context of Chapter 12 (farm) bankruptcy, unless a secured creditor agrees otherwise, the creditor is entitled to receive the value, as of the effective date of the plan, equal to the allowed amount of the claim.  Thus, after a secured debt is written down to the fair market value of the collateral, with the amount of the debt in excess of the collateral value treated as unsecured debt which is generally discharged if not paid during the term of the plan, the creditor is entitled to the present value of the amount of the secured claim if the payments are stretched over a period of years.

What does “present value” mean?  It means that a dollar in hand today is worth more than a dollar to be received at some time in the future.  It also means that an interest rate will be attached to that deferred income.  But, what interest rate will make a creditor whole? A recent decision by the Second Circuit Court of Appeals for the Second Circuit sheds some light on the issue.

Determining Present Value

Basically, present value represents the discounted value of a stream of expected future incomes.  That stream of income received in the future is discounted back to present value by a discount rate.  The determination of present value is highly sensitive to the discount rate, which is commonly express in terms of an interest rate.  Several different approaches have been used in Chapter 12 bankruptcy cases (and nearly identical situations in Chapters 11 and 13 cases) to determine the discount rate.  Those approaches include the contract rate – the interest rate used in the debt obligation giving rise to the allowed claim; the legal rate in the particular jurisdiction; the rate on unpaid federal tax; the federal civil judgment rate; the rate based on expert testimony; a rate tied to the lender’s cost of funds; and the market rate for similar loans.

In 2004, however, the U.S. Supreme Court, in, addressed the issue in the context of a Chapter 13 case that has since been held applicable in Chapter 12 cases.  Till v. SCS Credit Corporation, 541 U.S. 465 (2004).    In Till, the debtor owed $4,000 on a truck at the time of filing Chapter 13.  The debtor proposed to pay the creditor over time with the payments subject to a 9.5 percent annual interest rate.    That rate was slightly higher than the average loan rate to account for the additional risk that the debtor might default.  The creditor, however, argued that it was entitled to a 21 percent rate of interest to ensure that the payments equaled the “total present value” or were “not less than the [claim’s] allowed amount.”  The bankruptcy court disagreed, but the district court reversed and imposed the 21 percent rate.  The United States Court of Appeals for the Seventh Circuit held that the 21 percent rate was “probably” correct, but that the parties could introduce additional concerning the appropriate interest rate.  

On further review by the U.S. Supreme Court, the Court held that the proper interest rate was 9.5 percent.  That rate, the Court noted, was derived from a modification of the average national loan rate to account for the risk that the debtor would default.  The Court’s opinion has been held to be applicable in Chapter 12 cases.  See, e.g., In re Torelli, 338 B.R. 390 (Bankr. E.D. Ark. 2006); In re Wilson, No. 05-65161-12, 2007 Bankr. LEXIS 359 (Bankr. D. Mont. Feb. 7, 2007); In re Woods, 465 B.R. 196 (B.A.P. 10th Cir. 2012).   The Court rejected the coerced loan, presumptive contract rate and cost of funds approaches to determining the appropriate interest rate, noting that each of the approaches was “complicated, impose[d] significant evidentiary costs, and aim[ed] to make each individual creditor whole rather than to ensure the debtor’s payments ha[d] the required present value.”  A plurality of the Court explained that these difficulties were not present with the formula approach.  The Court opined that the formula approach requires that the bankruptcy court determine the appropriate interest rate by starting with the national prime rate and then make an adjustment to reflect the risk of nonpayment by the debtor.  While the Court noted that courts using the formula approach have typically added 1 percent to 3 percent to the prime rate as a reflection of the risk of nonpayment, the Court did not adopt a specific percentage range for risk adjustment.

Since the Supreme Court’s Till decision, the Circuit Courts have split on whether the appropriate interest rate for determining present value should be the market rate or a rate based on a formula.  In the most recent Circuit Court case on the issue, the Second Circuit held that a market rate of interest should be utilized if an efficient market existed in which the rate could be determined.  In re MPM Silicones, L.L.C., No. 15-1682(l), 2017 U.S. App. LEXIS 20596 (2nd Cir. Oct. 20, 2017).  In the case, the debtor filed Chapter 11 and proposed a reorganization plan that gave first-lien holders an option to receive immediate payment without any additional “make-whole” premium, or the present value of their claims by utilizing an interest rate based on a formula that resulted in a rate below the market rate.   The bankruptcy court confirmed the plan, utilizing the formula approach of Till.   The federal district court affirmed.  On further review, the appellate court reversed noting that Till had not conclusively specified the use of the formula approach in a Chapter 11 case.  The appellate court remanded the case to the bankruptcy court for a determination of whether an efficient market rate could be determined based on the facts of the case. 

Conclusion

The interest rate issue is an important one in reorganization bankruptcy.  The new guidance of the appropriate interest rate in a Chapter 11 is instructive.  That’s particularly true because of the debt limit of $4,153,150 that applies in a Chapter 12.  That limit is forcing some farmers to file Chapter 11 instead.  There is no debt limit in a Chapter 11 case.  Whether the Second Circuit’s recent decision will be followed by other appellate courts remains to be seen.  But, the market rate, as applied to an ag bankruptcy, does seem to recognize that farm and ranch businesses are subject to substantial risks and uncertainties from changes in price and from weather, disease and other factors.  Those risks are different depending on the type of agricultural business the debtor operates.  A market rate of interest would be reflective of those factors.

November 14, 2017 in Bankruptcy | Permalink | Comments (0)

Monday, October 9, 2017

Tough Financial Times in Agriculture and Lending Clauses – Peril for the Unwary

Overview

The farm economy continues to struggle. Of course, certain parts of the country are experiencing more financial trauma than are other parts of the country, but recent years have been particularly difficult in the Corn Belt and Great Plains.  Aggregate U.S. net farm income has dropped by approximately 50 percent from its peak in 2011.  It is estimated to increase slightly in 2017, but it has a long way to go to get back to the 2011 level.  In addition, the value of farmland relative to the value of the crops produced on it has fallen to its lowest point ever.  A dollar of farm real estate has never produced less value in farm production, and real net farm income relative to farm real estate values have not been as low as presently since 1980 to 1983.

A deeper dive on farm financial data indicates that after multiple years of declining debt-to-asset ratios, there was an uptick in 2015 and 2016.  Relatedly, default risk remains low, but it also increased in 2015 and 2016.  Also, there has been a decline in the ratio of working capital to assets, and a drop in the repayment capacity of ag loans.  As a financial fitness indicator, repayment capacity is a key.  At the beginning of the farm debt crisis in the early 1980s, it dropped precipitously due to a substantial increase in interest payments and a decline in farm production.  That meant that land values could no longer be supported, and they dropped substantially.  Consequently, many farmers found themselves with collateral value that was lower than the amount borrowed.   Repayment capacity is currently a serious issue that could lead to additional borrowing.

While financial conditions may improve a bit in 2017 and on into 2018, working capital may continue to erode in 2017 which could lead to increased debt levels.  That’s because average net farm income will remain at low levels.  This could lead to some agricultural producers and lenders having to make difficult decisions before next spring.  It also places a premium on understanding clause language in lending document and the associated rights and obligations of the parties.

Two clauses deserve close attention.  One clause contains “cross collateralization” language.  “Cross-collateralization” is a term that describes a situation when the collateral for one loan is also used as collateral for another loan. For example, if a farmer takes out multiple loans with the same lender, the security for one loan can be used as cross-collateral for all the loans.  A second clause contains a “co-lessee” provision.  That’s a transaction involving joint and several obligations of multiple parties.

Today’s post takes a deeper look at the implications of cross-collateral and co-lessee language in lending documents.  My co-author for today’s post is Joe Peiffer of Peiffer Law Office in Hiawatha, Iowa.  Joe brought the issues with cross-collateralization and co-lessee clause language to my attention.  Joe has many years of experience working with farmers in situations involving lending and bankruptcy, and has valuable insights. 

Cross-Collateralization Language 

As noted above, clause language in lending and leasing documents should be carefully reviewed and understood for their implications.  This is particularly true with respect to cross-collateralization language.  For example, the following is an example of such a clause that appears to be common in John Deere security agreements.  Here is how the language of one particular clause reads:

Security Interest; Missing Information.  You grant us and our affiliates a security interest in the Equipment (and all proceeds thereof) to secure all of your obligations under this Contract and any other obligations which you may have to us or any of our affiliates or assignees at any time and you agree that any security interest you have granted or hereafter grant to us or any of our affiliates shall also secure your obligations under this Contract.  You agree that we may act as agent for our affiliates and our affiliates may as agent for us, in order to perfect and realize on any security interest described above.  Upon receipt of all amounts due and to become due under this Contract, we will release our security interest in the Equipment (but not the security interest for amounts due an affiliate), provided no event of default has occurred and is continuing.  You agree to keep the Equipment free and clear of all liens and encumbrances, except those in favor of us and our affiliates as described above, and to promptly notify us if a lien or encumbrance is placed or threated against the Equipment.  You irrevocably authorize us, at any time, to (a) insert or correct information on this Contract, including your correct legal name, serial numbers and Equipment descriptions; (b) submit notices and proofs of loss for any required insurance; (c) endorse your name on remittances for insurance and Equipment sale or lease proceeds; and (d) file a financing statement(s) which describes either the Equipment or all equipment currently or in the future financed by us.  Notwithstanding any other election you may make, you agree that (1) we can access any information regarding the location, maintenance, operation and condition of the Equipment; (2) you irrevocably authorize anyone in possession of that information to provide all of that information to us upon our request; (3) you will not disable or otherwise interfere with any information gathering or transmission device within or attached to the Equipment; and (4) we may reactivate such device.”

So, what does that clause language mean?  Several points can be made:

  • The clause grants Deere Financial and its affiliates a security interest in the equipment pledged as collateral to secure the obligations owed to it as well as its affiliates.
  • When all obligations (including debt on the equipment purchased under the contract and all other debts for the purchase of equipment that Deere Financial finances) to Deere under the contract are paid, Deere Financial will release its security interest in the equipment. That appears to be straightforward and unsurprising.  However, the release does not release the security interest of the Deere’s affiliates.  This is the cross-collateral provision. 
  • The clause also makes Deere Financial the agent of its affiliates, and it makes the affiliates the agent of Deere Financial for purposes of perfection. What the clause appears to mean is that if a financing statement was not filed timely, perfection by possession could be pursued.
  • The clause also irrevocably authorizes John Deere to insert or correct information on the contract.
  • The clause allows John Deere to access any information regarding the location, maintenance, operation and condition of the collateral.
  • The clause also irrevocably authorizes anyone in possession of that information to provide it to John Deere upon request.
  • Also, under the clause, the purchaser agrees not to disable or interfere with any information gathering or transmission device in or attached to the Equipment and authorizes John Deere to reactivate any device.

Example.  Consider the following example of the effect of cross-collateralization by machinery sellers and financiers:

 

Assets

Value

 

Creditor

Amount

Equity by Item

JD 4710 Sprayer 90' Boom

       60,000

 

JD Finance

       84,000

(24,000)

JD 333E Compact Track Loader

       50,000

 

JD Finance

       35,000

 15,000

JD 8410T Crawler Tractor

       70,000

 

JD Finance

       50,000

 20,000

JD 612C 12 Row Corn Head

       70,000

 

JD Finance

       25,000

 45,000

     

Farm Plan

       58,571

(58,571)

Total Value

     250,000

 

Total Liabilities

     252,571

  (2,571)

           
     

Equity with Cross Collateralization

        (2,571)

 
           
     

Equity without Cross Collateralization

       80,000

 

The equity in the equipment without cross-collateralization is the sum of the equity in the Compact Track Loader, the Crawler Tractor and the Row Corn Head. 

Sellers that finance the purchase price of the item(s) sold (termed a “purchase money” lender) seem to be using cross-collateralization provisions with some degree of frequency.  As noted, the cross-collateralization provisions of the John Deere security agreement will allow John Deere to offset its under-secured status on some machinery by using the equity in other financed machines to make up the unsecured portion of its claims.  Other machinery financiers (such as CNH and AgDirect) are utilizing similar cross-collateral provisions in their security agreements. 

Can A “Dragnet” Lien Defeat a Cross-Collateralization Provision?

Would a bank’s properly filed financing statement and perfected blanket security agreement be sufficient to defeat a cross-collateralization provision?  It would seem inequitable to allow an equipment financier’s subsequently filed financing statement to defeat the security interest of a bank.  So far, it appears that when a purchase money security interest holder has sought to enforce a cross-collateralization clause, the purchase money security interest holder has always backed down.  For example, in one recent scenario, John Deere Financial sought to enforce its cross-collateralization agreement against a Bank in a situation similar to the one set forth above.  The Bank properly countered that its blanket security interest in farm equipment perfected before any of the Deere Financial purchase money security interests were perfected defeated the Deere Financial cross-collateralization.  Deere Financial backed down thereby allowing the Bank to have all the equity in the equipment, $80,000, be paid to the Bank by the auctioneer after the liquidation auction.

A “Co-Lessee” Clause

When a guarantee on a loan cannot be obtained, a proposal may be made for “joint and several obligations.”  In that situation, the lessor tries to compel one lessee to cover another lessee’s obligations or joint obligations.  It’s a lease-sublease structure, with the original lessee becoming the sublessor.  While the original lessee/sublessor has no rights to use the equipment (those rights are passed to the sublessee), the original lessee/sublessor remains legally obligated for performance.  The sublease can then be assigned as collateral to the original lessor.    

While a co-borrower situation is not uncommon, a transaction involving co-lessees is different inasmuch as a lease involves the right to use and possess property along with the obligation to pay for the property.  A loan document simply involves the repayment of debt.  So, what if a co-lessee arrangement goes south and the lessor tries to compel one lessee to cover another lessee’s joint obligation? What is the outcome?  That’s hard to say simply because there aren’t any litigated cases on the issue with published opinions.  But, numerous legal (and (tax) issues would be involved.  For instance, with a true lease (see an earlier post on the distinction between a true lease and a capital lease), what if the lessees argue over the use and possession of the equipment or the removal of liens or maintenance of the property or the rental or return of the property?  What about the payment of taxes?  Similar issues would arise in a lease/purchase situation that encounters problems.  What is known is that in such a dispute numerous Uniform Commercial Code issues are likely to arise under both Article 2 and Article 9.

The following is an example of John Deere’s co-lessee clause when it has an additional party sign on a lease:

“By signing below, each of the co-lessees identified below (each, a “Co-Lessee”) acknowledges and agrees that (1) the Lessee indicated on the above referenced Master Lease Agreement (the “Master Agreement”) and EACH CO-LESSEE SHALL BE JOINTLY AND SEVERALLY LIABLE FOR ANY AND ALL OF THE OBLIGATIONS set forth in the Master Agreement and each Lease Schedule entered into from time to time thereunder including, but not limited to, the punctual payment of any periodic payments or any other amounts which may become due and payable under the terms of the Master Agreement, whether or not said Co-Lessee signs each Lease Schedule or receives a copy thereof, and (2) it has received a complete copy of the Master Agreement and understands the terms thereof.

In the event (a) any Co-Lessee fails to remit to the Lessor indicated above any Lease Payment or other payment when due, (b) any Co-Lessee breaches any other provision of the Master Agreement or any Lease Schedule and such default continues for 10 days; (c) any Co-Lessee removes any Equipment (as such term is more fully described in the applicable Lease Schedule) from the United States; (d) a petition is filed by or against any Co-Lessee or any guarantor under any bankruptcy or insolvency law; (e) a default occurs under any other agreement between any Co-Lessee (or any of Co-Lessee's affiliates) and Lessor (or any of Lessor's affiliates); (f) or any Co-Lessee or any guarantor merges with or consolidates into another entity, sells substantially all its assets, dissolves or terminates its existence, or (if an individual) dies; or (g) any Co-Lessee fails to maintain the Insurance required by Section 6 of the Master Agreement, Lessor may pursue any and all of the rights and remedies available to Lessor under the terms of the Master Agreement directly against any one or more of the Co-Lessees. Nothing contained in the Addendum shall require Lessor to first seek or exhaust any remedy against any one Co-Lessee prior to pursuing any remedy against any other Co-Lessee(s).

Capitalized terms not defined in this Addendum shall have the meaning provided to them in the Master Agreement.”

Clearly, a party signing on as a co-lessee on a John Deere lease is assuming a great deal of risk. 

Conclusion

Times are tough for many involved in production agriculture. The same is true for many agribusiness and agricultural lenders.  If a producer is presented with a lending transaction that involves either a cross-collateralization or a co-lessee clause, legal counsel with experience in such transactions should be consulted.  Fully understanding the risks involved can pay big dividends.  Failing to understand the terms of these clauses can lead to the financial failure of the farmer that signs the document.

October 9, 2017 in Bankruptcy, Secured Transactions | Permalink | Comments (0)

Tuesday, August 22, 2017

The Business of Agriculture – Upcoming CLE Symposium

Overview

On September 18, Washburn School of Law will be having its second annual CLE conference in conjunction with the Agricultural Economics Department at Kansas St. University.  The conference, hosted by the Kansas Farm Bureau (KFB) in Manhattan, KS, will explore the legal, economic, tax and regulatory issue confronting agriculture.  This year, the conference will also be simulcast over the web.

That’s my focus today – the September 18 conference in Manhattan, for practitioners, agribusiness professionals, agricultural producers, students and others. 

Symposium Topics

Financial situation.  Midwest agriculture has faced another difficult year financially.  After greetings by Kansas Farm Bureau General Counsel Terry Holdren, Dr. Allen Featherstone, the chair of the ag econ department at KSU will lead off the day with a thorough discussion on the farm financial situation.  While his focus will largely be on Kansas, he will also take a look at nationwide trends.  What are the numbers for 2017?  Where is the sector headed for 2018? 

Regulation and the environment.  Ryan Flickner, Senior Director, Advocacy Division, at the KFB will then follow up with a discussion on Kansas regulations and environmental laws of key importance to Kansas producers and agribusinesses. 

Tax – part one.  I will have a session on the tax and legal issues associated with the wildfire in southwest Kansas earlier this year – handling and reporting losses, government payments, gifts and related issues.  I will also delve into the big problem in certain parts of Kansas this year with wheat streak mosaic and dicamba spray drift.

Weather.  Mary Knapp, the state climatologist for Kansas, will provide her insights on how weather can be understood as an aid to manage on-farm risks.  Mary’s discussions are always informative and interesting. 

Crop Insurance.  Dr. Art Barnaby, with KSU’s ag econ department, certainly one of the nation’s leading experts on crop insurance, will address the specific situations where crop insurance does not cover crop loss.  Does that include losses caused by wheat streak mosaic?  What about losses from dicamba drift?

Washburn’s Rural Law Program.  Prof. Shawn Leisinger, the Executive Director of the Centers for Excellence at the law school (among his other titles) will tell attendees and viewers what the law school is doing (and planning to do) with respect to repopulating rural Kansas with well-trained lawyers to represent the families and businesses of agriculture.  He will also explain the law school’s vision concerning agricultural law and the keen focus that the law school has on agricultural legal issues.

Succession Planning.  Dr. Gregg Hadley with the KSU ag econ department will discuss the interpersonal issues associated with transitioning the farm business from one generation to the next.  While the technical tax and legal issues are important, so are the personal family relationships and how the members of the family interact with each other.

Tax – part two.  I will return with a second session on tax issues.  This time my focus will be on hot-button issues at both the state and national level.  What are the big tax issues for agriculture at the present time?  There’s always a lot to talk about for this session.

Water.  Prof. Burke Griggs, another member of our “ag law team” at the law school, will share his expertise on water law with a discussion on interstate water disputes, the role of government in managing scarce water supplies, and what the relationship is between the two.   What are the implications for Kansas and beyond?

Producer panel.  We will close out the day with a panel consisting of ag producers from across the state.  They will discuss how they use tax and legal professionals as well as agribusiness professionals in the conduct of their day-to-day business transactions.

Conclusion

The Symposium is a collaborative effort of Washburn law, the ag econ department at KSU and the KFB.  For lawyers, CPAs and other tax professionals, application has been sought for continuing education credit.  The symposium promises to be a great day to interact with others involved in agriculture, build relationships and connections and learn a bit in the process.

We hope to see you either in-person or online.  For more information on the symposium and how to register, check out the following link:  http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html

August 22, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Monday, July 31, 2017

Agricultural Law in a Nutshell

Overview

Today's post is a deviation from my normal posting on an aspect of agricultural law and tax that you can use in your practice or business.  That’s because I have a new book that is now available that you might find useful as a handbook or desk reference.  Thanks to West Academic Publishing, my new book “Agricultural Law in a Nutshell,” is now available.  Today’s post promotes the new book and provides you with the link to get more information on how to obtain you copy.

Content

The Nutshell is taken from my larger textbook/casebook on agricultural law that is used in classrooms across the country.  Ten of those 15 chapters are contained in the Nutshell, including some of the most requested chapters from my larger book – contracts, civil liabilities and real property.  Also included are chapters on environmental law, water law and cooperatives.  Bankruptcy, secured transactions, and regulatory law round out the content, along with an introductory chapter.  Not included in this Nutshell are the income tax, as well as the estate and business planning topics.   Those remain in my larger book, and are updated twice annually along with the other chapters found there. 

Style

The Nutshell is designed as a concise summary of the most important issues facing agricultural producers, agribusinesses and their professional advisors.  Farmers, ranchers, agribusinesses, legal advisors and students will find it helpful.  It’s soft cover and easy to carry.

Rural Law Program

The Nutshell is another aspect of Washburn Law School’s Rural Law Program.  This summer, the Program placed numerous students as interns with law firms in western Kansas.  The feedback has been tremendous and some lawyers have already requested to be on the list to get a student for next summer.  Students at Washburn Law can take numerous classes dealing with agricultural issues.  We are also looking forward to our upcoming Symposium with Kansas State University examining the business of agriculture and the legal and economic issues that are the major ones at this time.  That conference is set for Sept. 18, and a future post will address the aspects of that upcoming event.

Conclusion

You can find out more information about the Nutshell by clicking here:  http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/agriculturallawnutshell/index.html

July 31, 2017 in Bankruptcy, Civil Liabilities, Contracts, Cooperatives, Environmental Law, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Thursday, July 27, 2017

What Are A Farmer’s Rights When a Grain Elevator Fails?

Overview

Low commodity prices over the past couple of years for many commodities, particularly in the Midwest and the Great Plains, have resulted in financial stress for many farmers.  For example, 2015 farm income in Kansas was the lowest since 1985.  Prices have dropped and are volatile and subject to economic conditions around the world.  In addition, the cost of production has continued to rise.  All of this have an impact on a farmer’s ability to repay debt.  That repayment capacity has dropped dramatically over the past two-three years.  All of this makes marketing important as well as the proper utilization of crop revenue insurance.  Ultimately, continued low prices will also have an impact on land values and, in some areas, that impact is already being noticed. 

An associated concern is the strain placed on grain elevators.  If an elevator fails, what’s the impact on farmers that have deposited grain and on the agricultural community?  What are the rights that a farmer has when an elevator fails?  How much can be recovered, and when can it be recovered?  Are there any legal remedies?  These issues are the focus of today’s post.

Stored Grain

A farmer that has stored grain at an elevator that files bankruptcy is not a creditor of the elevator.  That’s because the grain in storage is the farmer’s property.  The farmer’s ownership of the grain is evidenced by a warehouse receipt or a scale ticket.  Both of those serve as prima facie evidence of the farmer’s ownership of the stored grain.  So, the farmer’s relationship with the elevator is not a creditor/debtor relationship, but a bailee/bailor one.  Uniform Commercial Code (U.C.C.) §7-102(a)(1).  In addition, that relationship is not impacted just because the elevator will return to the farmer grain of like quality rather than the identical grain that the farmer delivered to the elevator.  See 54 A.L.R. 1166 (1928). 

Under the UCC, commingled grain that is stored in an elevator is owned in common by the persons storing the grain.  U.C.C. §7-207(b); see also, United States v. Luther, 225 F.2d 499 (10th Cir. 1955), cert. den., 350 U.S. 947 (1956); In re Bucyrus Grain, Co., Inc., 78 B.R. 296 (Bankr. D. Kan. 1987).  So, if there isn’t a grain shortage when an elevator fails, a farmer with grain stored at the elevator can get his grain in accordance with his warehouse receipt or scale ticket.  The bankruptcy trustee can’t retain farmer-stored grain in the bankruptcy estate if there isn’t a shortage.  The trustee only succeeds to the rights the that bankrupt elevator had and, as noted above, stored grain is not the elevator’s property.  Under the Bankruptcy Code, the bankruptcy trustee, after notice and hearing, can dispose of property which an entity other than the bankruptcy estate has an interest in.  11 U.S.C. §725.  This all means that once a farmer establishes ownership to the grain and pays the associated storage costs, the farmer is entitled to his grain. 

But, what if there isn’t enough grain in the elevator to cover all of the claims of farmers that have warehouse receipts or scale tickets.  If that is the case at the time the elevator files bankruptcy, the farmers holding those indicia of ownership share pro rata in the remaining grain.  In this situation, what typically happens is that the bankruptcy trustee will sell all of the grain that is in storage and make a pro rata distribution of the proceeds of sale along with any bond money that the elevator’s bonding company might have.  If, after the pro rata distribution, a famer has not been made whole, the famer becomes a general, unsecured creditor of the elevator to the extent of the shortfall. 

Farmer Priority in Bankruptcy

In the shortfall situation, there is a bit of relief that the Bankruptcy Code provides.  Under 11 U.S.C. §507(a)(6), an unsecured claim of a farmer (grain producer) in an amount of up to $6,325 against a grain storage facility (e.g., grain elevator) has priority.  The priority is a sixth priority claim.  It’s after domestic support obligations, administrative expenses, certain types of other specified unsecured claims, “allowed” unsecured claims, and unsecured claims for contributions to an employee benefit plan, but before certain unsecured claims of individuals and governmental units.  For purposes of the priority provision, a “grain producer” is someone (“an entity”) that engages in the growing of wheat, corn flaxseed, grain sorghum, barley, oats, rye, soybeans, other dry edible beans, and rice.  11 U.S.C. §557(b)(1). “Grain storage facility” means a site or physical structure used to store grain for producers or to store grain acquired from producers for resale.  11 U.S.C. §557(b)(2). 

While the $6,325 provision is likely to be of limited assistance, the Bankruptcy Court for the District of Kansas, affirmed by the Kansas Federal District Court, has held that the priority provision also gives priority status ahead of secured creditors with respect to grain owned by farmers that the elevator stores.  In re Esbon Grain Co., 55 B.R. 308 (Bankr. D. Kan. 1985), aff’d., First National Bank v. Nugent, 72 B.R. 528 (D. Kan. 1987).  That means that the financier of the elevator cannot participate in the pro rata distribution of the elevator’s remaining grain to the farmers that stored grain in the elevator at the time the elevator filed bankruptcy.  The court reached its decision based on a Kansas statutory provision that gives grain depositors priority over a warehouse owner and the owner’s creditors in the grain stored in the elevator.  Kan. Stat. Ann. §34-2,107.  A different court in a different state could reach a different conclusion. 

There is also another bankruptcy priority provision that can aid a farmer with grain stored in an elevator that fails.  11 U.S.C. §503(b)(9) includes as an administrative expense, entitled to first-tier priority, “the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.”  If a farmer can qualify for this provision, it is much stronger that the sixth-priority claim under 11 U.S.C. §507(a)(6).  That’s because it is an administrative expense under the definition of 11 U.S.C. §507(a)(1) which makes it a first-tier priority.  It also is not subject to the limit of $6,325 noted above that applies to sixth-priority claims. 

There is also an expedited procedure for determining ownership of the grain that is stored at an elevator at the time the elevator files bankruptcy.  11 U.S.C. §557(c). 

Grain Sold on Contract

One of the perils of grain contracting is the financial instability of the buyer.  For grain that has been sold on contract to an elevator that then files bankruptcy before the delivery date specified in the contract, the farmer-seller can refuse to deliver the grain if the elevator is insolvent.  The only exception to that rule is if the elevator can make cash payment.  U.C.C. §2-702.  If delivery has already been made as specified in the contract (whether under a forward, deferred payment or deferred pricing contract) and then the elevator files bankruptcy, the farmer-seller is an unsecured creditor and also is ineligible to participate in state indemnity/insurance funds or elevator bonding protection.  See e.g., Iowa Code §203D; In re Woods Farmers Co-op Elevator Co., 107 B.R. 678 (Bankr. N.D. 1989).  While ownership of grain stored under a warehouse receipt or scale ticket remains with the farmer, delivery of grain that is sold under a contract causes title to the grain to pass to the elevator.  As noted, that makes the outcome different. 

Legal Remedy?

As noted in my blogpost of July 19, co-op directors are subject to fiduciary duties of obedience, loyalty and care.  If a breach of any of those duties can be tied to the elevator’s failure, that might provide a legal remedy for disaffected farmers.  However, that could be a difficult connection to make, and take time and money to establish it. 

Conclusion

Tough economic times can lead to numerous legal issues.  The failure of a grain elevator can cause large problems for farmers and for the local community it serves.  A farmer that knows their rights and where they stand if an elevator fails, can be in a better position than are those farmers that aren’t as well informed.

July 27, 2017 in Bankruptcy, Secured Transactions | Permalink | Comments (0)

Wednesday, March 29, 2017

Qualified Farm Indebtedness – A Special Rule for Income Exclusion of Forgiven Debt

Overview

The drop in crop prices in recent months has introduced financial strain for some producers.  Bankruptcy practitioners are reporting an increase in clients dealing with debt workouts and other bankruptcy-related concerns.    

An important part of debt resolution concerns the income tax consequences of any debt relief to the debtor.  One of those rules concerns the tax treatment of discharged “qualified farm indebtedness.”  The rule can be a useful tool in dealing with the income tax issues associated with debt forgiveness for farmers that are not in bankruptcy.  There’s also another option that might come into play in certain situations – a purchase price adjustment.

That’s the focus of today’s post.

Recourse Debt

Except for debt associated with installment land contracts and Commodity Credit Corporation loans, most farm debt is recourse debt.  With recourse debt, the collateral stands as security on the loan.  If the collateral is insufficient to pay off the debt, the debtor is personally liable on the obligation and the debtor's non-exempt assets are reachable to satisfy any deficiency. 

When the debtor gives up property, the income tax consequences involve a two-step process.   Basically, it is as if the property is sold to the creditor, and the sale proceeds are applied on the debt.  There is no gain or loss (and no other income tax consequence) up to the income tax basis on the property.  Then, the difference between fair market value and the income tax basis is gain or loss.  Finally, if the indebtedness exceeds the property's fair market value, the debtor remains liable for the difference and if it is forgiven, the amount is discharge of indebtedness income. 

However, special rules can apply to minimize the tax impact of discharge of indebtedness income. 

General Rules

Under I.R.C. §108(a)(1)(A)-(C), a debtor need not include in gross income any amount of discharge of indebtedness if the discharge occurs as part of a bankruptcy case or when the debtor is insolvent, or if the discharge is of qualified farm debt.  If one of these provisions applies to exclude the debt from income, Form 982 must be completed and filed with the return for the year of discharge. 

Qualified Farm Indebtedness

What is it?  The qualified farm debt rule applies to the discharge of qualified farm indebtedness that is discharged via an agreement between a debtor engaged in the trade or business of farming and a “qualified person.”  A qualified person includes a lender that is actively and regularly engaged in the business of lending money and is not related to the debtor or to the seller of the property, is not a person from which the taxpayer acquired the property, or is a person who receives a fee with respect to the taxpayer’s investment in the property. I.R.C. §49(a)(1)(D)(iv).  Under I.R.C. §108(g)(1)(B), a “qualified person” also includes federal, state or local governments or their agencies.

In addition, qualified farm debt is debt that is incurred directly in connection with the taxpayer’s operation of a farming business; and at least 50 percent of the taxpayer’s aggregate gross receipts for the three tax years (in the aggregate) immediately preceding the tax year of the discharge arise from the trade or business of farming. I.R.C. §§108(g)(2)(A)-(B). Off-farm income and passive rental arrangements can cause complications in meeting the gross receipts test. 

Solvency.  The qualified farm debt exclusion rule does not apply to the extent the debtor is insolvent or is in bankruptcy.  Farmers are also under a special rule – for all debtors other than farmers, once solvency is reached there is income from the discharge of indebtedness.  The determination of a taxpayer’s solvency is made immediately before the discharge of indebtedness.  “Insolvency” is defined as the excess of liabilities over the fair market value of the debtor’s assets.  Both tangible and intangible assets are included in the calculation.  In addition, both recourse and nonrecourse liabilities are included in the calculation, but contingent liabilities are not.  The separate assets of the debtor’s spouse are not included in determining the extent of the taxpayer’s insolvency.  Property exempt from creditors under state law is included in the insolvency calculation.  Carlson v. Comr., 116 T.C. 87 (2001).

Maximum amount discharged.  There is a limit on the amount of discharged debt that can be excluded from income under the exception. The excluded amount cannot exceed the sum of the taxpayer’s adjusted tax attributes and the aggregate adjusted bases of the taxpayer’s depreciable property that the taxpayer holds as of the beginning of the tax year following the year of the discharge.  

Reduction of tax attributes.  The debt that is discharged and which is excluded from the taxpayer’s gross income is applied to reduce the debtor’s tax attributes. I.R.C. §108(b)(1).  Unless the taxpayer elects to reduce the basis of depreciable property first, I.R.C. §108(b)(2) sets forth the general order of tax attribute reduction (which, by the way occurs after computing tax for the year of discharge (I.R.C. §108(b)(4)(A)).  The order is as follows:  net operating losses (NOLs) for the year of discharge as well as NOLs carried over to the discharge year; general business credit carryovers; minimum tax credit; capital losses for the year of discharge and capital losses carried over to the year of discharge; the basis of the taxpayer’s depreciable and non-depreciable assets; passive activity loss and credit carryovers; and foreign tax credit carryovers.

Those attributes that can be carried back to tax years before the year of discharge are accounted for in those carry back years before they are reduced.  Likewise, any reductions of NOLs or capital losses and carryovers first occur in the tax year of discharge followed by the tax year in the order in which they arose.

The tax attributes are generally reduced on a dollar-for-dollar basis (i.e., one dollar of attribute reduction for every dollar of exclusion).  However, any general business credit carryover, the minimum tax credit, the foreign tax credit carryover and the passive activity loss carryover are reduced by 33.33 cents for every dollar excluded.

If the amount of income that is excluded is greater than the taxpayer’s tax attributes, the excess is permanently excluded from the debtor’s gross income and is of no tax consequence.  Alternatively, if the taxpayer’s tax attributes are insufficient to offset all of the discharge of indebtedness, the balance reduces the basis of the debtor’s assets as of the beginning of the tax year of discharge.

Discharged debt that would otherwise be applied to reduce basis in accordance with the general attribute reduction rules specified above and also constitutes qualified farm indebtedness is applied only to reduce the basis of the taxpayer’s qualified property.  I.R.C. §1017(b)(4)(A).  The basis reduction is to the qualified property that is depreciable property, then to the qualified property that is land used or held for use in the taxpayer’s farming business, and then to any other qualified property that is used in the taxpayer’s farming business or for the production of income.  This is the basis reduction order unless the taxpayer elects to have any portion of the discharged amount applied first to reduce basis in the taxpayer’s depreciable property, including real property held as inventory.  I.R.C. §§108(b)(5)(A); 1017(b)(3)(E).

Purchase Price Adjustment

Instead of triggering discharge of indebtedness income, if the original buyer and the original seller agree to a price reduction of a purchased asset at a time when the original buyer is not in bankruptcy or insolvent, the amount of the reduction does not have to be reported as discharge of indebtedness income.  I.R.C. §108(e)(5)(A).  The seller also doesn’t have immediate adverse tax consequences from the discharge.  Instead, the profit ratio that is applied to future installment payments is impacted.  Priv. Ltr. Rul. 8739045 (Jun. 20, 1987). 

Conclusion

Farmers often have favorable tax rules.  The qualified farm indebtedness rule is one of those.  In the right situation, it can provide some relief from the tax consequences of financial distress.

March 29, 2017 in Bankruptcy | Permalink | Comments (0)

Thursday, January 12, 2017

Farm Financial Stress – Debt Restructuring

Overview

The current financial situation in agriculture is difficult for many producers.  Low crop and livestock prices, falling land values and increasing debt levels are placing some ag producers in a serious bind.  Chapter 12 bankruptcy is an option for some, although the current debt limits of Chapter 12 are barring some from utilizing its relief provisions. 

When dealing with financial distress, restructuring debt is often involved.  This is one of the topics that Joe Peiffer (of Peiffer Law in Cedar Rapids, Iowa) and I will be addressing at Washburn Law School on February 1 during our 3-hour CLE event, “Common Problems Faced by Farmers and Ranchers in Difficult Financial Times.”  The seminar will also be simulcast live over the web for those that cannot attend in-person.  Here’s the link for registration:    http://washburnlaw.edu/farmersandrancherscleregister

One of the issues that we will be addressing are the strategies that can be used to negotiate with creditors and restructure debt.  While many ag deals are done at the coffee shop or while leaning-up against the pick-up or a fencepost, debt restructuring negotiations with creditors don’t typically occur in that manner.   Today’s post is a bit of a teaser of the upcoming seminar that is my summary of Joe’s thoughts on debt restructuring and the options and opportunities that might be present during that process.

Debt Restructuring Negotiations

Debt restructuring negotiations do not involve a formal, specifically prescribed process with one exception – mediation.  Rather, debt restructuring negotiations take place informally.  However, when mediation is utilized, it is a formal process that is often prescribed by state law.   So, what makes for a successful debt restructuring negotiation?  As with any negotiation on any subject, it is critical to understand what each party views as important.  What are their priorities?  For a creditor, collecting on a delinquent debt is always of supreme importance.  Likewise, if there is a non-delinquent, marginal loan, the creditor will be interested in obtaining guarantees, either private or via government entities such as the USDA or the Small Business Administration.  The creditor will also likely attempt to obtain additional collateral so that the farm debtor’s line of credit can continue and any projected loss to the creditor is minimized or eliminated. 

On the other side, a farmer’s goals typically include staying on the farm and continuing the farming business.  The farmer probably also wants to maintain ownership of assets and their lifestyle.  Also, another common goal of farm debtors is to get the farming operation to the most economical size (often downsizing) without triggering a tax bill that can’t be paid. 

Once the goals of the creditors and the farmer are identified, they must be prioritized.  That’s when reality begins to set in.  Are the goals realistic?  Are there any that can’t be achieved?  Those that can’t be achieved must be eliminated and the realistic goals focused on.  Creditors have to realize that debts won’t be paid in full and on time.  Farm debtors have to understand that they can’t retain all of their farm assets.  So, the parties should strive to find common ground somewhere in the middle.  There probably are some areas of agreement that can be reached.   But, to get there, both parties will likely have to compromise.  Neither the creditors nor the farm debtor should view negotiations in absolutist terms.  Still, even if a mediation agreement is reached and a release obtained, that doesn’t meet that the parties still won’t end up in court.  To avoid litigation, some “out-of-the-box” thinking will likely be required. 

Being creative.  Joe relates a matter that he dealt with a few years ago.  He was representing a farm debtor and the banker showed a great willingness to be creative in dealing with the farmer’s debt situation.  The balance on the loan owed the bank exceeded the collateral values by well over $1,000,000.  The farm debtor had a dairy operation that was losing money to the tune of more than $70,000 every month, and there was virtually no likelihood of a successful reorganization.  At mediation, the banker suggested that if the farmer would immediately surrender the cows, calves, grain, sileage and other personal property securing the loan, and agree to surrender the farm under non-judicial foreclosure he would pay Joe's clients $100,000.  The banker's reasoning was that by paying the farm debtor $100,000, the amount he expected to pay his attorney if the farmer filed a Chapter 12 bankruptcy, the farmer could have a fresh start and he would speedily obtain control of the collateral minimizing his losses. 

The farm debtor put a great deal of thought into the prospect of getting $100,000 and not having the uncertainty of a bankruptcy.  They opted to take the money offered to them.   The deal was structured so that the bank’s $100,000 payment was in consideration for them selling their homestead to the Bank.  Because the money constituted proceeds from the sale of their homestead, the funds were exempt under state (IA) law from the claims of their other creditors for a reasonable time to allow purchase of a later homestead.   After closing, the farm debtor held the proceeds in a “Homestead Account” separate from all other money they.  They did not add other money to that account, nor did they spend the money in that account until they purchased a new homestead.

 Non-Judicial Foreclosure Can be Beneficial

The use of a non-judicial foreclosure provided under state law (in Iowa, the procedure is set forth in Iowa Code § 654.18) allows farmers and their creditors to fashion remedies that can be mutually beneficial.  This remedy can be utilized either before or as a part of a mediated settlement.  The creditor gets possession and ownership of the real estate collateral much quicker than would be the case in a traditional foreclosure.  The right of redemption and right of first refusal present in a traditional foreclosure are eliminated.  The creditor waives any deficiency that could exist if the collateral cannot cover the indebtedness.  But, of course, a farm debtor must be mindful of the potential for discharge of indebtedness income if this procedure is utilized and the farmer has exempt assets that could make them solvent once a deficiency is forgiven.

A benefit to a farm debtor of non-judicial foreclosure is that the creditor is generally able to make other beneficial concessions.  Also, under a non-judicial foreclosure, the farmer deeds the farm to the creditor subject to a period of time (typically five-business days) during which the transaction can be cancelled.  If the transaction is not cancelled, the creditor gives notice of the non-judicial foreclosure to junior lien holders who then a period of time (generally 30 days) to redeem from the creditor and each other. 

Deed Back to Bank with Sale of Homestead Back to Farmer on Real Estate Contract

During the farm financial crisis of the 1980s in many parts of the Midwest and Great Plains, farm and ranch debt restructurings often involved debtors deeding back their farms to the creditor with the creditor then selling back the house and an acreage on a real estate contract.  This approach allowed the farmer to retain the homestead while allowing the bank to realize cash from the balance of its real estate collateral.  But, if the debtor missed a payment, the bank, could institute a contract forfeiture procedure that would take only 30 days to finish once the Notice of Forfeiture was properly served after mediation.

Sale of Non-Essential Assets in the Tax Year Before Filing Chapter 12

The “right-sizing” of a farm operation must always be considered as a part of a debt restructuring negotiation.  If the farmer has over-encumbered assets it can be in his best interest to liquidate some assets, reduce debt and restructure the farming operation.  The liquidation of assets that are not absolutely necessary to the “newer” farming operation can also have the effect of decreasing the farmer’s level of debt beneath the maximum allowable so that the farmer is eligible to file Chapter 12.    However, selling-off of farm assets often leads to incurring significant income taxes.  But, in a Chapter 12 farm bankruptcy, a special tax provision, 11 U.S.C. §1222(a)(2)(A), can be utilized to move taxes from a priority to a non-priority position which can then result in the taxes being discharged.

Formal Written Agreements Contained in Bank Minutes are Essential

Under federal law, to be enforceable in the event the institution is declared insolvent, debt restructuring agreement involving federally insured institutions must be in writing, approved by the board of directors, sealed and included in the bank’s minutes.  Reliance on any oral agreements with a bank is not wise as they are unenforceable (see, e.g., Iowa Code § 535.17 and 12 U.S.C. §1823(e)).  If the bank goes broke and the Debt Settlement Agreement is not memorialized as is required by 12 U.S.C. § 1823(e), the FDIC or the purchaser of the notes from the FDIC will not be bound by the Debt Settlement Agreement. Thus, if any agreement with a bank is to be enforced, it must be in writing signed by the proper parties and comply with any statutorily-required formalities.

Conclusion

As Joe has pointed out on numerous occasions, debt restructuring negotiations provide farmers and their creditors with substantial opportunities to reach an agreement that satisfies both parties’ needs.  Preparation is the key to a successful negotiation for both creditors and farmers.  Consideration of the other party’s priorities and needs can lead to opportunities for cooperation that will minimize the need for court intervention and bankruptcies.  Frequently, the need to “right-size” a farming operation will lead to significant income tax consequences that can only be addressed in a Chapter 12 bankruptcy.  When this occurs, cooperation between the creditor and farmer can allow the creditor to receive the liquidation proceeds of most of its collateral in the tax year before filing the bankruptcy while allowing the farmer to avail himself of the favorable tax provisions of 11 U.S.C. § 1222(a)(2)(A).  All parties to debt restructuring negotiations should be prepared to accept reality, make reasonable concessions and consider the needs of the other party to reach agreement.

This is just a sample of one of the numerous issues that Joe and I will discuss at the law school seminar on February 1.  Again, if you can’t attend in-person, you can watch a live simulcast over the web of our presentations.  Here’s the link for registration information:   http://washburnlaw.edu/farmersandrancherscleregister

January 12, 2017 in Bankruptcy | Permalink | Comments (0)

Friday, January 6, 2017

Top Ten Agricultural Law Developments of 2016 (Five Through One)

Overview

Today we continue our look this week at the biggest developments in agricultural law and taxation during 2016.  Out of all of the court rulings, IRS developments and regulatory issues, we are down to the top five developments in terms of their impact on ag producers, rural landowners and agribusinesses. 

So, here are the top five (as I see them) in reverse order:

(5) Pasture Chiseling Activity Constituted Discharge of “Pollutant” That Violated the CWA. The plaintiff bought approximately 2,000 acres in northern California in 2012. Of that 2,000 acres, the plaintiff sold approximately 1,500 acres. The plaintiff retained an environmental consulting firm to provide a report and delineation map for the remaining acres and requested that appropriate buffers be mapped around all wetlands. The firm suggested that the plaintiff have the U.S. Army Corps of Engineers (COE) verify the delineations before conducting any grading activities. Before buying the 2,000 acres, the consulting firm had provided a delineation of the entire tract, noting that there were approximately 40 acres of pre-jurisdictional wetlands. The delineation on the remaining 450 acres of pasture after the sale noted the presence of intact vernal and seasonal swales on the property along with several intermittent and ephemeral drainages. A total of just over 16 acres of pre-jurisdictional waters of the United States were on the 450 acres – having the presence of hydric soils, hydrophytic vegetation and hydrology (1.07 acres of vernal pools; 4.02 acres of vernal swales; .82 acres of seasonal wetlands; 2.86 acres of seasonal swales and 7.40 acres of other waters of the United States). In preparation to plant wheat on the tract, the property was tilled at a depth of 4-6 inches to loosen the soil for plowing with care taken to avoid the areas delineated as wetlands. However, an officer with the (COE) drove past the tract and thought he saw ripping activity that required a permit. The COE sent a cease and desist letter and the plaintiff responded through legal counsel requesting documentation supporting the COE’s allegation and seeking clarification as to whether the COE’s letter was an enforcement action and pointing out that agricultural activities were exempted from the CWA permit requirement. The COE then provided a copy of a 1994 delineation and requested responses to numerous questions. The plaintiff did not respond. The COE then referred the matter to EPA for enforcement. The plaintiff sued the COE claiming a violation of his Fifth Amendment right to due process and his First Amendment right against retaliatory prosecution. The EPA refused the referral due to the pending lawsuit so the COE referred the matter to the U.S. Department of Justice (DOJ). The DOJ filed a counterclaim against the plaintiff for CWA violations.

The court granted the government’s motion on the due process claim because the cease and desist letter did not initiate any enforcement that triggered due process rights. The court also dismissed the plaintiff’s retaliatory prosecution claim. On the CWA claim brought by the defendant, the court determined that the plaintiff’s owner could be held liable as a responsible party. The court noted that the CWA is a strict liability statute and that the intent of the plaintiff’s owner was immaterial. The court then determined that the tillage of the soil causes it to be “redeposited” into delineated wetlands. The redeposit of soil, the court determined, constituted the discharge of a “pollutant” requiring a national pollution discharge elimination system (NPDES) permit. The court reached that conclusion because it found that the “waters” on the property were navigable waters under the CWA due to a hydrological connection to a creek that was a tributary of Sacramento River and also supported the federally listed vernal pool fairy shrimp and tadpole shrimp. Thus, a significant nexus with the Sacramento River was present. The court also determined that the farming equipment, a tractor with a ripper attachment constituted a point source pollutant under the CWA. The discharge was not exempt under the “established farming operation” exemption of 33 U.S.C. §1344(f)(1) because farming activities on the tract had not been established and ongoing, but had been grazed since 1988. Thus, the planting of wheat could not be considered a continuation of established and ongoing farming activities. Duarte Nursery, Inc. v. United States Army Corps of Engineers, No. 2:13-cv-02095-KJM-AC, 2016 U.S. Dist. LEXIS 76037 (E.D. Cal. Jun. 10, 2016).

(4) Prison Sentences Upheld For Egg Company Executives Even Though Government Conceded They Had No Knowledge of Salmonella Contamination. The defendant, an executive of a large-scale egg production company (trustee of the trust that owned the company), and his son (the Chief Operating Officer of the company) pled guilty as “responsible corporate officers” to misdemeanor violations of 21 U.S.C. §331(a) for introducing eggs that had been adulterated with salmonella into interstate commerce from the beginning of 2010 until approximately August of 2010. They each were fined $100,000 and sentenced to three months in prison. They appealed their sentences as unconstitutional on the basis that they had no knowledge that the eggs at issue were contaminated at the time they were shipped. They also claimed that their sentences violated Due Process and the Eighth Amendment insomuch as the sentences were not proportional to their “crimes.” They also claimed that incarceration for a misdemeanor offense would violate substantive due process.

The trial court determined that the poultry facilities were in poor condition, had not been appropriately cleaned, had the presence of rats and other rodents and frogs and, as a result, the defendant and his son either “knew or should have known” that additional salmonella testing was needed and that remedial and preventative measures were necessary to reduce the presence of salmonella. The appellate court agreed, finding that the evidence showed that the defendant and son were liable for negligently failing to prevent the salmonella outbreak and that 21 U.S.C. §331(a) did not have a knowledge requirement. The appellate court also did not find a due process violation. The defendant and son claimed that because they did not personally commit wrongful acts, and that due process is violated when prison terms are imposed for vicarious liability felonies where the sentence of imprisonment is only for misdemeanors. However, the court held that vicarious liability was not involved, and that 21 U.S.C. §331(a) holds a corporate officer accountable for failure to prevent or remedy “the conditions which gave rise to the charges against him.” Thus, the appellate court determined, the defendant and son were liable for negligently failing to prevent the salmonella outbreak. The court determined that the lack of criminal intent does not violate the Due Process Clause for a “public welfare offense” where the penalty is relatively small (the court believed it was), the defendant’s reputation was not “gravely” damaged (the court believed that it was not) and congressional intent supported the penalty (the court believed it did). The court also determined that there was no Eighth Amendment violation because “helpless” consumers of eggs were involved. The court also found no procedural or substantive due process violation with respect to the sentences because the court believed that the facts showed that the defendant and son “had reason to suspect contamination” and should have taken action to address the problem at that time (even though law didn’t require it).

The dissent pointed out that the government stipulated at trial that its investigation did not identify any corporate personnel (including the defendant and son) who had any knowledge that eggs sold during the relevant timeframe were contaminated with salmonella. The dissent also noted that the government conceded that there was no legal requirement for the defendant or corporation to comply with stricter regulations during the timeframe in issue. As such, the convictions imposed and related sentences were based on wholly nonculpable conduct and there was no legal precedent supporting imprisonment in such a situation. The dissent noted that the corporation “immediately, and at great expense, voluntarily recalled hundreds of millions of shell eggs produced” at its facilities when first alerted to the problem. As such, according to the dissent, due process was violated and the sentences were unconstitutional. United States v. Decoster, 828 F.3d 626 (8th Cir. 2016).

(3) The IRS and Self-Employment Tax. Two self-employment tax issues affecting farmers and ranchers have been in the forefront in recent years – the self-employment tax treatment of Conservation Reserve Program (CRP) payments and the self-employment tax implications of purchased livestock that had their purchase price deducted under the de minimis safe harbor of the capitalization and repair regulations. On the CRP issue, in 2014 the U.S. Court of Appeals ruled that CRP payments in the hands of a non-farmer are not subject to self-employment tax. The court, in Morehouse v. Comr., 769 F.3d 616 (8th Cir. 2014), rev’g, 140 T.C. 350 (2013), held the IRS to its historic position staked out in Rev. Rul. 60-32 that government payments attributable to idling farmland are not subject to self-employment tax when received by a person who is not a farmer. The court refused to give deference to an IRS announcement of proposed rulemaking involving the creation of a new Rev. Rul. that would obsolete the 1960 revenue ruling. The IRS never wrote the new rule, but continued to assert their new position on audit. The court essentially told the IRS to follow appropriate procedure and write a new rule reflecting their change of mind. In addition, the court determined that CRP payments are “rental payments” statutorily excluded from self-employment tax under I.R.C. §1402(a). Instead of following the court’s invitation to write a new rule, the IRS issued a non-acquiescence with the Eighth Circuit’s opinion. O.D. 2015-02, IRB 2015-41. IRS said that it would continue audits asserting their judicially rejected position, even inside the Eighth Circuit (AR, IA, MN, MO, NE, ND and SD).

In 2016, the IRS had the opportunity to show just how strong its opposition to the Morehouse decision is. A Nebraska non-farmer investor in real estate received a CP2000 Notice from the IRS, indicating CRP income had been omitted from their 2014 return. The CP2000 Notice assessed the income tax and SE Tax on the alleged omitted income. The CRP rental income was in fact included on the return, but it was included on Schedule E along with cash rents, where it was not subject to self-employment tax. The practitioner responded to the IRS Notice by explaining that the CRP rents were properly reported on Schedule E because the taxpayer was not a farmer. This put the matter squarely before the IRS to reject the taxpayer’s position based on the non-acquiescence. But, the IRS replied to the taxpayer’s response with a letter informing the taxpayer that the IRS inquiry was being closed with no change from the taxpayer’s initial position that reported the CRP rents for the non-farmer on Schedule E. 

On the capitalization and repair issue, taxpayers can make a de minimis safe harbor election that allows amounts otherwise required to be capitalized to be claimed as an I.R.C. §162 ordinary and necessary business expense. This de minimis expensing election has a limit of $5,000 for taxpayers with an Applicable Financial Statement (AFS) and $2,500 for those without an AFS. Farmers will fall in the latter category. In both cases, the limit is applied either per the total on the invoice, or per item as substantiated by the invoice. One big issue for farmers and ranchers is how to report the income from the sale of purchased livestock that are held for productive use, such as breeding or dairy animals for which the de minimis safe harbor election was made allowing the full cost of the livestock to be deducted. It had been believed that because the repair regulations specify when the safe harbor is used, the sale amount is reported fully as ordinary income that is reported on Schedule F where it is subject to self-employment tax for a taxpayer who is sole proprietor farmer or a member of a farm partnership. In that event, the use of the safe harbor election would produce a worse tax result that would claiming I.R.C. §179 on the livestock.

An alternative interpretation of the repair regulations is that the self-employment tax treatment of the gain or loss on sale of assets for which the purchase price was deducted under the de minimis safe harbor is governed by Treas. Reg. §1.1402(a)-6(a). That regulation states that the sale of property is not subject to selfemployment tax unless at least one of two conditions are satisfied: (1) the property is stock in trade or other property of a kind which would properly be includible in inventory if on-hand at the close of the tax year; or (2) the property is held primarily for sale to customers in the ordinary course of a trade or business. Because purchased livestock held for dairy or breeding purposes do not satisfy the first condition, the question comes down to whether condition two is satisfied – are the livestock held primarily for sale to customers in the ordinary course of a trade or business? The answer to that question is highly fact-dependent. If the livestock whose purchase costs have been deducted under the de minimis rule are not held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business, the effect of the regulation is to report the gain on sale on Part II of Form 4797. This follows Treas. Reg. §1.1402(a)-6(a) which bars Sec. 1231 treatment (which would result in the sale being reported on Part I of Form 4797). In that event, the income received on sale would not be subject to self-employment tax.

In 2016, the IRS, in an unofficial communication, said that the alternative interpretation is the correct approach. However, the IRS was careful to point out that the alternative approach is based on the assumptions that the livestock were neither inventoriable nor held for sale, and that those assumptions are highly fact dependent on a case-by case basis. The IRS is considering adding clarifying language to the Farmers’ Tax Guide (IRS Pub. 225) and/or the Schedule F Instructions.

(2) TMDLs and the Regulation of Ag Runoff. Diffused surface runoff of agricultural fertilizer and other chemicals into water sources as well as irrigation return flows are classic examples of nonpoint source pollution that isn’t discharged from a particular, identifiable source. A primary source of nonpoint source pollution is agricultural runoff. As nonpoint source pollution, the Clean Water Act (CWA) leaves regulation of it up to the states rather than the federal government. The CWA sets-up a “states-first” approach to regulating water quality when it comes to nonpoint source pollution. Two key court opinions were issued in 2016 where the courts denied attempts by environmental groups to force the EPA to create additional federal regulations involving Total Maximum Daily Loads (TMDLs). The states are to establish total maximum daily TMDLs for watercourses that fail to meet water quality standards after the application of controls on point sources. A TMDL establishes the maximum amount of a pollutant that can be discharged or “loaded” into the water at issue from all combined sources on a daily basis and still permit that water to meet water quality standards. A TMDL must be set “at a level necessary to implement water quality standards.” The purpose of a TMDL is to limit the amount of pollutants in a watercourse on any particular date. Two federal court opinions in 2016 reaffirmed the principle that regulation of nonpoint source pollution is left to the states and not the federal government.

In Conservation Law Foundation v. United States Environmental Protection Agency, No. 15-165-ML, 2016 U.S. Dist. LEXIS 172117 (D. R.I. Dec. 13, 2016), the plaintiff claimed that the EPA’s approval of the state TMDL for a waterbody constituted a determination that particular stormwater discharges were contributing to the TMDL being exceeded and that federal permits were thus necessary. The court, however, determined that the EPA’s approval of the TMDL did not mean that EPA had concluded that stormwater discharges required permits. The court noted that there was nothing in the EPA’s approval of the TMDL indicating that the EPA had done its own fact finding or that EPA had independently determined that stormwater discharges contributed to a violation of state water quality standards. The regulations simply do not require an NPDES permit for stormwater discharges to waters of the United States for which a TMDL has been established. A permit is only required when, after a TMDL is established, the EPA makes a determination that further controls on stormwater are needed.

In the other case, Gulf Restoration Network v. Jackson, No. 12-677 Section: “A” (3), 2016 U.S. Dist. LEXIS 173459 (E.D. La. Dec. 15, 2016), numerous environmental groups sued the EPA to force them to impose limits on fertilizer runoff from farm fields. The groups claimed that many states hadn’t done enough to control nitrogen and phosphorous pollution from agricultural runoff, and that the EPA was required to mandate federal limits under the Administrative Procedure Act – in particular, 5 U.S.C. §553(e) via §303(c)(4) of the CWA. Initially, the groups told the EPA that they would sue if the EPA did not write the rules setting the limits as requested. The EPA essentially ignored the groups’ petition by declining to make a “necessity determination. The groups sued and the trial court determined that the EPA had to make the determination based on a 2007 U.S. Supreme Court decision involving the Clean Air Act (CAA). That decision was reversed on appeal on the basis that the EPA has discretion under §303(c)(4)(B) of the CWA to decide not to make a necessity determination as long as the EPA gave a “reasonable explanation” based on the statute why it chose not to make any determination. The appellate court noted that the CWA differed from the CAA on this point. On remand, the trial court noted upheld the EPA’s decision not to make a necessity determination. The court noted that the CWA gives the EPA “great discretion” when it comes to regulating nutrients, and that the Congressional policy was to leave regulation of diffused surface runoff up to the states. The court gave deference to the EPA’s “comprehensive strategy of bringing the states along without the use of federal rule making…”.

Also, in 2016 the U.S. Supreme Court declined to review a decision of the U.S. Court of Appeals for the Third Circuit which had determined in 2015 that the EPA had acted within its authority under 33 U.S.C. §1251(d) in developing a TMDL for the discharge of nonpoint sources pollutants into the Chesapeake Bay watershed.  American Farm Bureau, et al. v. United States Environmental Protection Agency, et al., 792 F.3d 281 (3d Cir. 2015), cert. den., 136 S. Ct. 1246 (2016).

(1) The Election of Donald Trump as President and the Potential Impact on Agricultural and Tax Policy. Rural America voted overwhelmingly for President-elect Trump, and he will be the President largely because of the sea of red all across the country in the non-urban areas. So, what can farmers, ranchers and agribusinesses anticipate the big issues to be in the coming months and next few years and the policy responses? It’s probably reasonable to expect that same approach will be applied to regulations impacting agriculture. Those with minimal benefit and high cost could be eliminated or retooled such that they are cost effective. Overall, the pace of the generation of additional regulation will be slowed. Indeed, the President-elect has stated that for every new regulation, two existing regulations have to be eliminated.

Ag policy.  As for trade, it is likely that trade agreements will be negotiated on a much more bi-lateral basis – the U.S. negotiating with one other country at a time rather than numerous countries. The President-elect is largely against government hand-outs and is big on economic efficiency. That bodes well for the oil and gas industry (and perhaps nuclear energy). But, what about less efficient forms of energy that are heavily reliant on taxpayer support? Numerous agricultural states are heavily into subsidized forms of energy with their state budgets littered with numerous tax “goodies” for “renewable” energy.” However, the President-elect won those states. So, does that mean that the federal subsidies for ethanol and biodiesel will continue. Probably. The Renewable Fuels Standard will be debated in 2017, but will anything significant happen? Doubtful. It will continue to be supported, but I expect it to be reviewed to make sure that it fits the market. Indeed, one of the reasons that bio-mass ethanol was reduced so dramatically in the EPA rules was that it couldn’t be produced in adequate supplies. What about the wind energy production tax credit? What about the various energy credits in the tax code? Time will tell, but agricultural interests should pay close attention.

The head of the Senate Ag Committee will be Sen. Roberts from Kansas. As chair, he will influence the tone of the debate of the next farm bill. I suspect that means that the farm bill will have provisions dealing with livestock disease and biosecurity issues. Also, I suspect that it will contain significant provisions crop insurance programs and reforms of existing programs. The House Ag Committee head will be Rep. Conaway from Texas. That could mean that cottonseed will become an eligible commodity for Agricultural Risk Coverage (ARC) and Price Loss Coverage (PLC). It may also be safe to assume that for the significant Midwest crops (and maybe some additional crops) their reference prices will go up. Also, it now looks as if the I.R.C. §179 issue involving the income limitation for qualification for farm program payments (i.e., the discrepancy of the treatment between S corporations and C corporations) will be straightened out. Other federal agencies that impact agriculture (EPA, Interior, FDA, Energy, OSHA) can be expected to be more friendly to agriculture in a Trump Administration.

Tax policy. As for income taxes, it looks at this time that the Alternative Minimum Tax might be eliminated, as will the net investment income tax that is contained in Obamacare. Individual tax rates will likely drop, and it might be possible that depreciable assets will be fully deductible in the year of their purchase. Also, it looks like the corporate tax rate will be cut as will the rate applicable to pass-through income. As for transfer taxes, President-elect Trump has proposed a full repeal of the federal estate tax as well as the federal gift tax. Perhaps repeal will be effective January 1, 2017, or perhaps it will be put off until the beginning of 2018. Or, it could be phased-in over a certain period of time. Also, while it appears at the present time that any repeal would be “permanent,” that’s not necessarily a certainty. Similarly, it’s not known whether the current basis “step-up” rule would be retained if the estate tax is repealed. That’s particularly a big issue for farmers and ranchers. It will probably come down to a cost analysis as to whether step-up basis is allowed. The President-elect has already proposed a capital gains tax at death applicable to transfers that exceed $10 million (with certain exemptions for farms and other family businesses). Repeal of gift tax along with repeal of estate tax has important planning implications. There are numerous scenarios that could play out. Stay tuned, and be ready to modify existing plans based on what happens. Any repeal bill would require 60 votes in the Senate to avoid a filibuster unless repeal is done as part of a reconciliation bill. Also, without being part of a reconciliation bill, any repeal of the federal estate tax would have to “sunset” in ten years.

January 6, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)