Thursday, June 11, 2020
County commissioners (also known in some states as supervisors or something similar) often find themselves dealing with unique situations. In rural counties, the commissioners are often familiar with the common ag issues that arise that are within the commission’s jurisdiction. In the more urban counties, some of the things that a county commissioner can have deal with can be rather surprising. So, what are a few of the more common items that a county commissioner must deal with in an agricultural context?
The ag-related matters that a county commissioner may have to deal with – it’s the topic of today’s post.
Fences and State Fence Law
Robert Frost once said that, “Fences make good neighbors.” G.K. Chesterton has been quoted as saying, “Whenever you remove any fence, always pause long enough to ask why it was put there in the first place.” For rural landowners, perhaps one of the most common and contentious issues involves disputes concerning partition fences. Partition fences are those that separate adjoining lands. Each state has numerous laws concerning partition fences. Those laws involve such issues as the construction of fences and what a fence is to be built of, what is deemed to be a “legal” fence, liability for damages caused by livestock that escape their enclosure, the maintenance of partition fences, the role of the county commissioners serving as fence viewers in settling fence disputes and rules for handling stray animals.
In some instances, adjoining landowners may come to an agreement as to how to allocate the responsibility between themselves for the building and/or maintenance of a partition fence. If an agreement is reached, it may be wise to put the agreement in writing and record it in the county Register of Deeds office in the county where the fence is located. However, if the adjoining landowners cannot reach an agreement concerning fence building and/or maintenance, the “fence viewers” should be called. In many states, the county commissioners (or their designees) in the county where the fence in question is located are the fence viewers. The statutory procedures vary from state to state, but the basic approach is that if adjoining landowners can’t settle their dispute personally, then the “fence viewers” can be called to determine how a fence should be built and/or maintained. That means that country commissioners must know and understand state fence law.
County commissioners often must deal with zoning issues. In the agricultural context, the issues can include matters involving how an applicable zoning ordinance applies to a particular tract of land based on how the land is used as well as the size of the tract. Many ordinances are drafted in general language designed to have broad application. That means that they sometimes are not clear in how they apply to a particular agricultural operation. Is simply cutting hay on a five-acre tract, “agricultural” or is it still residential or some other classification. Commissioners must be well-trained on zoning issues and what statutory language means and how the courts interpret it.
Generally, a county’s zoning authority arises under a specific state statute, which grants cities and counties the ability to enact “planning and zoning laws and regulations” “for the protection of the public health, safety and welfare.” But, as applied to agriculture, care should be taken to think through clearly just exactly what constitutes “agriculture.” For example, is a 600-head hog confinement building “agriculture” or is it a commercial/industrial building?
To establish a new zoning regulation, it’s often the case that a county must first require a planning commission to recommend the nature and number of zones or districts which it deems necessary and the boundaries of the same, as well as appropriate regulations. Additionally, it’s typically the case that regulations must be uniform for each class or kind of building and land uses throughout each district, but the regulations in one district may differ from those in other districts.
Commonly, once the planning commission has made its recommendation based on public input, the governing body either may: (1) Approve the recommendations by the adoption of the same by ordinance in a city or resolution in a county; (2) override the planning commission's recommendations by a super-majority vote of the membership of the governing body; or (3) return the matter to the planning commission for further consideration, together with a statement specifying the basis for the governing body's failure to approve or disapprove.” A similar process is followed if a county wishes to amend an existing zoning regulation.
Following this process, a county is limited in what type of zoning regulations may be adopted. Under the usual process that is common in many states, the county may adopt zoning regulations which may include, but are not limited to provisions which: (1) provide for planned unit developments; (2) permit the transfer of development rights; (3) preserve structures and districts listed on the local, state or national historic register; (4) control the aesthetics of redevelopment or new development; (5) provide for the issuance of special use or conditional use permits; and (6) establish overlay zones. Thus, so long as the zoning regulation is for the protection of the public health, safety and welfare, and falls within one of these six types, then it is within the scope of the county’s zoning authority.
The scope of a county’s zoning authority with regards to wind generation is a big issue in many rural counties. The Kansas Supreme Court, construing Kansas law, has addressed the issue. Zimmerman v. Board. of County. Commissioners, 289 Kan. 926, 939, 218 P.3d 400, 410 (2009). In Zimmerman, the Wabaunsee County commissioners passed a zoning regulation prohibiting commercial wind farms in the entire county. The Kansas Supreme Court found that under K.S.A. §§12-753(a) and 12-755, the county’s zoning regulation was not unreasonable since the county commissioners found that commercial wind farms would adversely affect aesthetics of the county, commercial wind farms were not in conformance with a comprehensive plan which sought to maintain open spaces and scenic landscape, a large portion of the community’s wishes were against the wind farms.
However, while the county zoning ordinance banned all large-scale commercial windfarms, it allowed for small windfarms, and also established zoning regulations concerning the construction of small windfarms, including density and spacing requirements, as well as setback distance requirements. The court ultimately upheld the zoning regulation, which established the counties ability to ban all commercial wind development, as well as establish setback distances for small scale wind farms.
Zimmerman also established that a county’s ability to pass zoning regulations affecting wind power generation was not preempted by state law, namely the Kansas Electric Public Utilities Act (KEPUA). There the court held that KEPUA only preempted local zoning in two situations, (1) placement or siting of nuclear power plants, and (2) placement or siting of electrical transmission lines. Hence, any county regulation regarding wind turbine setbacks would not be preempted by state law, unless it is specifically asserted by the KCC or “clearly stated” by legislation such as KEPUA.
To restate, the Kansas Supreme Court has held local governments have the power to pass zoning regulations, so long as that power is “exercised in conformity with the statute which authorizes the zoning.’ See Genesis Health Club, Inc. v. City of Wichita, 285 Kan. 1021, 1033, 181 P.3d 549 (2008). The same requirements apply to counties when they adopt or modify zoning regulations, particularly in a wind generation setting. At least in Kansas, so long as a county follows the state law procedures set out above, and so long as the zoning regulation is for the protection of the public health, safety and welfare, then it will be valid. Particularly in a wind generation setting, a Kansas county has the authority to establish setbacks for wind turbines, under Zimmerman, so long as the state statutory process is followed, and so long as that authority hasn’t been specifically preempted by a state law such as the Kansas Electric Public Utilities Act. The same is likely true in many other states.
Being a county commissioner can be a rewarding experience. But, it can be a difficult job and requires knowledge of many issues to properly represent the county. This is particularly true for those counties that have a mix of urban and agricultural interests.
Saturday, June 6, 2020
Spray-drift issues with respect to dicamba and the use of dicamba-related herbicides on dicamba tolerant (DT) soybeans and cotton increased substantially during the 2017 growing season across portions of the primary soybean (and cotton) growing parts of the country. The use of dicamba increased in an attempt to control weeds in fields planted with crops that are engineered to withstand it. Some states, notably Missouri and Arkansas, took action to ban dicamba products because of drift-related damage issues.
Now, the U.S. Circuit Court of Appeals for the Ninth Circuit has vacated the conditional new-use registrations of XtendiMax (by Bayer (formerly Monsanto), BASF’s Engenia and Corteva’s FeXapan for use on dicamba-tolerant (DT) soybean and cotton finding that the Environmental Protection Agency’s (EPA’s) late 2018 decision to extend the 2016 registrations violated the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA). The decision creates major problems for producers that purchased and planted DT seed because the associated weed control technology cannot be used.
What are the implications of the recent federal court’s opinion? Does it apply nationwide? What are the drift issues associated with dicamba? What options do affected farmers have going forward?
Uniqueness of Dicamba
In many instances, spray drift is a straightforward matter. The typical scenario involves either applying chemicals in conditions that are unfavorable (such as high wind), or a misapplication (such as not following recommended application instructions). But, dicamba is a unique product with its own unique application protocol.
- Dicamba is a very volatile chemical and is rarely sprayed in the summer months. This is because when the temperature reaches approximately 90 degrees Fahrenheit, dicamba will vaporize such that it can be carried by wind for several miles. This can occur even days after application.
- The typical causes of spray drift are application when winds are too strong, a temperature inversion (temperature not decreasing with atmospheric height) exists or there has been a misapplication of the chemical.
- For the new dicamba soybeans, chemical manufacturers reformulated the active ingredient to minimize the chance that it would move off-target due to it volatility.
- Studies have concluded that the new formulations are safe when applied properly, but if a user mixes-in unapproved chemicals, additives or fertilizer, the safe formulations revert to the base dicamba formulation with the attendant higher likelihood of off-target drift.
- Soybeans have an inherit low tolerance to dicamba. As low as 1/20,000 of an application rate can cause a reaction. A 1/1000 of rate can cause yield loss.
- The majority of crops damaged from vapor drift may not actually result in yield loss. That’s particularly the case if drift damage occurs before flowering. However, if the drift damage occurs post-flowering the likelihood of yield loss increases. Also, studies have shown that a slight rain event can stop the volatilizing of dicamba.
- The label is the law. This is particularly true with the new chemicals used on Xtend crops. The labels are very specific with respect to additives, nozzles, boom height, and wind speed and direction.
DT Seeds and Associated Herbicides
In 2015, the Obama Administration’s USDA deregulated DT soybean and cotton seeds via the Plant Patent Act (PPA). At that point, Monsanto began to sell the DT seeds in advance of the 2016 growing season. This was done before EPA had approved the companion dicamba herbicides for over-the-top (OTT) use. In 2016, approximately 1.7 million acres of DT soybeans and 50,000 acres of DT cotton were planted. The prior versions of dicamba herbicides could not legally be used on the emergent DT crops, but some farmers applied those older, more volatile versions to the DT crops. In the fall of 2016, the EPA announced that it would grant two-year conditional registrations for three lower-volatility, OTT dicamba herbicides (Monsanto’s XtendiMax; Dupont’s FeXapan; and BASF’s Engenia) in 34 states. The EPA has the authority to grant conditional registrations of pesticides and herbicides under FIFRA, and the EPA cited the benefits of the grant as providing an effective tool to treat noxious weeds and glyphosate-resistant weeds. The EPA noted that the lower-volatility formulations posed little-to-no risk of adverse environmental effects if used according to the label.
Throughout the 2017 growing season, complaints of alleged dicamba-caused damage to commercial crops and other plants increased. Bayer/Monsanto proposed label changes to XtendiMax for use during the 2018 growing season to address off-site drift. The EPA approved additional label restrictions for OTT dicamba products for the 2018 growing season. In late 2018, the EPA granted conditional extensions to the 2016 registrations for two more years. The EPA determined that doing so would provide growers with an additional tool to help manage weeds that are difficult to control for which few alternatives are available, and would provide a long-term benefit by delaying resistance to other herbicides when used appropriately. The EPA also noted that, based on field trials and land-grant university research, non-DT crops could be damaged by off-site drift that could result in yield reductions if the drift occurred during the reproductive growth states of the non-DT crops and, as a result, imposed more restrictions on OTT applications of the dicamba herbicides to DT soybeans and cotton.
Challenge to the Registrations
In National Family Farm Coalition v. United States Environmental Protection Agency, No. 19-70115, 2020 U.S. App. LEXIS 17495 (9th Cir. Jun. 3, 2020), a coalition of activist groups sought review of the EPA’s 2016 registration decision for XtendiMax, and then amended the petition to include the 2017 label amendments. Oral argument in the case was held in August of 2018. However, the EPA granted the additional two-year conditional registrations before the court decided the case. As a result, the court dismissed the petition. The plaintiffs again sued in early 2019, challenging the EPA’s late 2018 decision to extend the registrations for the OTT dicamba herbicides for two more years. The court did not hear oral arguments in the case until15 months later.
Under FIFRA, the EPA must determine that any amendment to a pesticide/herbicide registration “would not significantly increase the risk of any unreasonable adverse effect on the environment.” Such effects include “any unreasonable risk to man or the environment, taking into account the economic, social and environmental costs and benefits of the use of any pesticide…”. 7 U.S.C. §136(bb). The court determined that the EPA “substantially understated the risks that it acknowledged” and “entirely failed to acknowledge other risks.” The court believed that the EPA understated the DT seed acreage plantings in 2018, failed to account for substantial non-compliance with label restrictions, and didn’t account for social cost of DT soybeans and DT cotton achieving a monopoly or near monopoly due to farmers planting DT seeds simply to avoid drift problems. But, the court failed to mention that some farmers refused to plant DT seeds for the express purpose of possibly being drifted upon and suing for damages. The court also made no mention of the fact that numerous drift complaints in 2017 did not result in any yield loss and in some cases resulted in a yield bump.
The court also determined that the EPA didn’t account for the social cost of “divisiveness” that dicamba-related issues was creating in rural communities.
As a result, the court vacated the registrations even though it noted the harshness that its decision would have on growers that had already purchased DT soybean and cotton seeds and the associated dicamba products.
Comments on the Court’s Decision
The court’s decision to vacate the registrations has implications for farmers in the 34 states where the conditional registrations allowed OTT dicamba. At least that’s the general belief expressed in farm (and other) media. It is true, that any case brought via the Administrative Procedure Act (APA) gives rise to the possibility that the court could vacate the administrative decision or rule with respect to all persons and in all areas of the country, rather than simply with respect to either the parties to the lawsuit or the areas within the court’s jurisdiction. However, the U.S. Supreme Court recently held that the text of the APA does not permit that broad of a remedy. Trump v. Hawaii, 138 S. Ct. 2392 (2018). 5 U.S.C. §706 states in relevant part as follows:
“To the extent necessary to decision and when presented, the reviewing court shall decide all relevant questions of law, interpret constitutional and statutory provisions, and determine the meaning or applicability of the terms of an agency action. The reviewing court shall— “(2) hold unlawful and set aside agency action, findings, and conclusions found to be— (A) arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law;…”
As applied in the dicamba case, the provision doesn’t specify whether the registrations should be set aside on their face or as applied to the plaintiff. There is also no clear statement in the APA that the traditional rules of fundamental fairness (equity) are displaced. Given this, and the guidance from the Supreme Court’s recent APA decision, the appropriate remedy for the Ninth Circuit to utilize is equitable in nature – determining the rights of the parties to the case rather than a vacatur that impacts farmers in all 34 states involved.
It is also worth noting that the Ninth Circuit delayed hearing oral arguments for 15 months with full knowledge that waiting until planting season was beginning to hear the case and render its decision would cause maximum damage to impacted farmers, again points to an equitable remedy instead of a wholesale vacatur.
In his First Inaugural Address, President Abraham Lincoln stated, “At the same time, the candid citizen must confess that if the policy of the Government upon vital questions affecting the whole people is to be irrevocably fixed by decisions of the Supreme Court, the instant they are made in ordinary litigation between parties in personal actions the people will have ceased to be their own rulers, having to that extent practically resigned their Government into the hands of that eminent tribunal.” President Lincoln was speaking of the Supreme Court and pointing out that Supreme Court opinions are not the supreme law, the Constitution is. Likewise, for a lower court to render a decision vacating DT seed registrations impacting farmers in areas of the country outside of the court’s jurisdiction is contrary to Supreme Court precedent and principles of equity.
So what’s next? It depends on what the EPA chooses to do. EPA could seek a full en banc review by all of the Ninth Circuit judges rather than the three-judge panel that heard the case. The EPA could also request the court stay its opinion until the soybean and cotton growing seasons are over. The EPA could also simply choose to ignore the court’s opinion outside the Ninth Circuit. In that event, only farmers in Arizona would be impacted by the court’s decision. This approach, for example, is a tactic that the IRS often employs in tax cases that it loses. It issues a “non-acquiescence” to the court’s opinion, explains why the court was wrong, and continues audit activity in areas outside the court’s jurisdiction. If the EPA were to do that, the major soybean and cotton growing regions would not be impacted in 2020.
Presently, disaffected farmers and ag retailers are considering what changes to plans need to be made. Some are also inquiring about refunds for technology fees associated with the seed purchases. But, for many farmers, perhaps the largest hurdle going forward will be the lack of alternative products to compensate for the increase of acres. The supply chain was not counting on the millions of acres currently attributed to DT traits being impacted in such a manner.
The Ninth Circuit’s opinion potentially creates havoc for many soybean and cotton farmers. The next few days should be instructive in learning how far reaching the court’s decision will be for the present growing season. It may just be time for the EPA to tell the Ninth Circuit to go “pound sand” in terms of the court trying to impose its decision outside of the states within the Ninth Circuit.
Friday, May 8, 2020
Earlier this week President Trump asked the U.S. Department of Justice (DOJ) to investigate the pricing practices of the major meatpackers. In addition, 11 state Attorneys General have asked the DOJ to do the same. They pointed out in the DOJ request that the four largest beef processors control 80 percent of U.S. beef processing. According to USDA data, boxed beef prices have recently more than doubled while live cattle prices dropped approximately 20 percent over the same timeframe. The concern is that the meatpackers are engaged in price manipulation and other practices deemed unfair under federal law.
Questions about the practices of the meatpacking industry are not new – they have been raised for well over a century. Indeed, a very significant federal law was enacted a century ago primarily because of the practices of the major meatpackers. So, why is there still talk about investigations? Is existing law ineffective?
Meatpacking industry practices, investigations and the law – it’s the topic of today’s post.
The United States Senate authorized an investigation of the buying and selling of livestock in 1888 to determine if anti-competitive practices were present. The investigation revealed that major meatpackers were engaging in unfair, discriminatory and anti-competitive practices by means of price fixing, agreements not to compete, refusals to deal and similar arrangements. The Senate report contributed to the political support for the Sherman Act of 1890.
In 1902, an injunction was sought against the major meatpackers alleging antitrust violations. The injunction was issued in 1903 and was sustained by the Supreme Court in 1905. See, e.g., Swift & Company v. United States, 196 U.S. 375 (1905). The injunction, however, was not successful in correcting the situations deemed anti-competitive. The same defendants or their successors were indicted and tried for alleged violations of the antitrust laws, but were acquitted after trial in 1912. The dominance and anti-competitive activities of the packers continued, and in 1917, President Wilson directed the Federal Trade Commission (FTC) to investigate the packing industry. The FTC report documented widespread anti-competitive practices involving operations of stockyards, actions of commission persons, operation of weighing facilities, disposal of dead animals and control of packing plants.
During congressional debate of the Packers and Stockyards Act (PSA), the major packers signed a consent decree in an attempt to ward off the new legislation. The consent decree was entered into on February 27, 1920, and it enjoined the “Big Five” meatpackers (Swift & Co., Armour & Co., Cudahy Packing Co., Wilson & Co., and Morris & Co.) from certain activities. The Big Five were prohibited from maintaining or entering into any contract, combination or conspiracy, in restraint of trade or commerce, or monopolizing or attempting to monopolize trade or commerce. The consent decree also prohibited the Big Five from engaging in any illegal trade practice as well as owning an interest in any public stockyard company, any stockyard terminal railroad or any stockyard market newspaper or journal. The injunction also prohibited the Big Five from having an interest in the business of manufacturing, selling or transporting, distributing or otherwise dealing in any of numerous food products, mainly fish, vegetables, fruits, and groceries and many other commodities not related to the meatpacking industry. Similarly, the injunction prohibited the Big Five from using or permitting others to use their distribution systems or facilities for the purchase, sale, handling, transporting or dealing in any of the enumerated articles or commodities. The injunction also prevented the owning or operating of any retail meat markets except in-plant sales to accommodate employees. Because the Big Five controlled all the warehousing in their exercise of monopoly power, the injunction prevented them from having an interest in any public cold storage warehouse or engaging in the business of selling or dealing in fresh milk or cream.
Even though the Attorney General of the United States personally appeared before the House Committee on Agriculture and recommended against the proposed legislation on the ground that the consent decree would eliminate the evils in the packing industry and make legislation unnecessary, President Harding signed the PSA into law on April 15, 1921. Consequently, some of the “Big Five” filed suit seeking to have the consent decree either vacated or declared void. However, in 1928, the United States Supreme Court upheld the consent decree. Swift & Co. v. United States, 276 U.S. 311 (1928). Similarly, the Supreme Court turned down a request to modify the decree in 1932. Swift & Co. v. United States, 286 U.S. 106 (1932). A similar request was also rejected in 1961. Swift & Co. v. United States, 367 U.S. 909 (1961). The decree, however, was terminated on November 23, 1981. United States v. Swift & Co., 1982-1 Trade Cas. (CCH) ¶64,464 (N.D. Ill. 1981).
The PSA was “the most far-reaching measure and extend[ed] further than any previous law into the regulation of private business with few exceptions.” 61 Cong. Rec. 1872 (1921). In addition, the powers given to the Secretary of Agriculture were more “wide-ranging” than the powers granted to the FTC, the Act was upheld as constitutional in several court cases from 1922 to 1934. Unquestionably, the PSA extends well beyond the scope of other antitrust law.
One of the major provisions of the PSA concerns price manipulation.
Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) 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. This is a distinct concern in the livestock industry.
In recent years, numerous courts have addressed the issue of whether the statutory language requires a producer to prove that a packer’s conduct had an adverse impact on competition. For example, in late 2001, a nationwide class action lawsuit was certified against Iowa Beef Processors (subsequently acquired by Tyson Fresh Meats, Inc.) on the issue of whether Tyson’s use of “captive supply” cattle (cattle acquired other than on the open, cash market) violated Section 202 of the PSA. Pickett v. IBP, Inc., No. 96-A-1103-N, 2001 U.S. Dist. LEXIS 22453 (M.D. Ala. Dec. 26, 2001). The class included all cattle producers with an ownership interest in cattle that were sold to Tyson, exclusively on a cash-market basis, from February 1994 through and including the end of the month 60 days before notice was provided to the class. The claim was that Tyson’s privately held store of livestock (via captive supply) allowed Tyson to need not rely on auction-price purchases in the open market for most of their supply. Tyson was then able to use this leverage to depress the market prices for independent producers on the cash and forward markets, in violation of the PSA. In early 2004, the federal jury in the case returned a $1.28 billion verdict for the cattle producers. However, one month later the trial court judge, while not disturbing the economic findings that the market for fed cattle was national, that the defendant’s use of captive supply depressed cash cattle prices and that cattle acquired on the cash market were of higher quality than those the defendant acquired through captive supplies, granted the defendant’s motion for judgment as a matter of law, thereby setting the jury’s verdict aside. The trial court judge ruled that Tyson was entitled to use captive supplies to depress cash cattle prices to “meet competition” and assure a “reliable and consistent” supply of cattle. Pickett v. Tyson Fresh Meats, Inc., 315 F. Supp. 2d 1172 (M.D. Ala. 2004). On appeal, the U.S. Court of Appeals for the Eleventh Circuit affirmed. Pickett v. Tyson Fresh Meats, Inc., 420 F.3d 1272 (11th Cir. 2005). The U.S. Supreme Court declined to hear the case. 547 U.S. 1040 (2006). Later the U.S. Court of Appeals for the Tenth Circuit reached the same conclusion. See Been, et al. v. O.K. Industries, 495 F.3d 1217 (10th Cir. 2007), cert. den., 131 S. Ct. 2876 (2011). The courts held that to establish a violation of §202 of the PSA, a plaintiff must show that defendant’s practice injured or was likely to injure competition. In other words, the courts held that to demonstrate that a monopsonist (e.g., a single buyer that significantly controls the market) engaged in unfair practices, the seller must show that the buyer’s practices threatened to injure competition by arbitrarily decreasing prices paid to sellers with likely effect of increasing resale prices.
Most of the other courts that have considered the issue have also determined that Section 202 of the PSA requires a producer to prove that a packer’s conduct adversely impacted competition. See, e.g., London v. Fieldale Farms Corp., 410 F.3d 1295 (11th Cir. 2005), cert. den., 546 U.S. 1034 (2005); Adkins v. Cagle Foods, JV, LLC, 411 F.3d 1520 (11th Cir. 2005); Terry v. Tyson Farms, Inc., 604 F.3d 272 (6th Cir. 2010), cert. den., 131 S. Ct. 1044 (2011). While the United States Court of Appeals for the Fifth Circuit, in a contract poultry production case, ruled that the plain language of Section 202 does not require a plaintiff to prove an adverse effect on competition, the court granted en banc review with the full court later reversing the 3-judge panel decision. Wheeler, et al. v. Pilgrim’s Pride Corp., No. 07-40651, 2009 U.S. App. LEXIS 27642 (5th Cir. Dec. 15, 2009).
In 2009, contract poultry growers in Texas, Arkansas, Oklahoma and Louisiana brought a PSA price manipulation case against the company that provided them with chicks, feed, medicine and other inputs. City of Clinton v. Pilgrim’s Pride Corporation, 654 F. Supp. 2d 536 (N.D. Tex. 2009). The company had filed for Chapter 11 bankruptcy and, as part of reorganizing its business activities closed certain facilities and terminated some grower contracts. The terminated growers claimed the defendant’s actions violated Section 192(e) of the PSA as actions that had the effect of manipulating the price of chicken by terminating those growers that were not near another poultry integrator so that they couldn’t sell their chickens to one of the defendant’s competitors, and terminating those growers who would not upgrade their chicken houses to include cool-cell technology even though not required by grower contracts. While the court held that the defendant could have a legitimate business reason for its decisions and might be able to show that the plaintiffs were not harmed by its actions, the court determined that the plaintiffs’ pleadings were sufficient to survive a motion to dismiss. In addition, the court held that the Texas growers had posed legitimate claims under the Texas Deceptive Trade Practices Act. In the subsequent bankruptcy proceeding, the bankruptcy court also held that the chicken supplier did not violate Section 192 of the PSA when it sought to reduce the supply of chicken on the commodity market by curtailing production in geographic areas where the supplier controlled the market. The court reasoned that the supplier closed plants and terminated particular grower contracts with the business purpose of trying to avoid going out of business, and that such conduct was more beneficial than detrimental to competition because if the supplier had gone out of business competition would have been lessened. In re Pilgrim’s Pride Corp., et al., 448 B.R. 896 (Bankr. N.D. Tex. Mar. 2, 2011). In a later proceeding in the same case, the court ruled on the claim that the supplier had violated Section 192 of the PSA when the supplier induced the growers to sign a new contract that allowed the supplier to terminate the contract for “economic necessity.” The court held that the growers failed to establish that the supplier had engaged in the kind of unfair or deceptive acts that Section 192 prohibited. The court held that the “economic necessity” clause was valid and enforceable because it provided flexibility and efficiency that the PSA encouraged and because the supplier had a valid business reason for utilizing the clause. In re Pilgrim’s Pride Corp., et al., No. 08-45664 (DML), 2011 Bankr. LEXIS 960 (N.D. Tex. Mar. 24, 2011).
In June of 2010, the 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 includes, but is 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) is stated to depend on the nature and circumstances of the challenged conduct. The regulations specifically note 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 note that a PSA violation can occur without a finding of harm or likely harm to competition, but as noted above, that is contrary to numerous court opinions that have decided the issue. The regulations eventually made it into the form of an Interim Final Rule but were later withdrawn. 82 FR 48594 (Oct. 18, 2017).
The current request that the DOJ investigate the meatpacking industry is nothing new. As noted, investigations of the industry have been going on for over 130 years. A good case can be made that the courts have not carried out the legislative intent of the PSA provision concerning price manipulation.
Friday, April 17, 2020
Disrupted Economic Activity and Force Majeure – Avoiding Contractual Obligations in Time of Pandemic
The China-originated virus that has impacted major parts of the globe, including the United States, has created health problems for some and, in the United States, governmental reaction to it has created legal and economic issues for many more. One of those legal issues involves existing contracts. In the United States, the issuance of various Executive Orders by state governors as a result of the anticipated impact of the virus has shut down significant economic activity in those states and triggered problems up and down the food supply chain. What happens when a supply chain is disrupted? What recourse exists for a farmer that entered into a contract to sell corn to an ethanol plant, and now the ethanol price has collapsed and the plant refuses to pay? What if a hog buyer won’t buy hogs because the processing plant is shut-down? What if a milk buyer backs out of a milk contract because the milk market has disintegrated? Grain can be stored and milk can be dumped, but what do you do with a 300-lb. fat hog?
The non-performance of contract obligations in the time of massive economic disruption and the concept of “force majeure” – it’s the topic of today’s post.
Clause contained in a written contract. A common provision in some agricultural contracts (particularly hog production contracts) is known as a “force majeure” provision. Under such a provision, a contracting party is not liable for damages due to the delay or failure to perform under the contract because of an event that is beyond the party’s control. Performance is excused until it becomes possible for the party to perform under the contract. But, does the China Flu (commonly referred to as COVID-19) constitute an event covered by a force majeure provision that would excuse a contracting party’s performance? Recently, some hog integrators, ethanol plants and contract milk buyers have claimed that it does and have attempted to either terminate or renegotiate contracts with farmer-producers.
Force Majeure means “superior force” or “unavoidable accident.” It applies when there are circumstances beyond a party’s control that excuses the party from performing, such as an extraordinary event like war, riot, crime, pandemic, etc. Most often, a “force majeure” event involves an “act of God” (i.e. flooding, earthquakes, or volcanoes) or the failure of third parties (such as suppliers and subcontractors) to perform their obligations to a contracting party. However, sometimes a contracting party will attempt to use the clause to extract themselves from a contract that has turned out to not be profitable for them.
A force majeure clause is not uncommon in contracts. It concerns how the parties allocate risk and, in essence, frees the contracting parties from liability or obligation when an extraordinary event or circumstance beyond their control prevents at least one party from fulfilling their contractual obligations. The event or circumstance must be one that the parties couldn’t have anticipated at the time the contract was entered into; the party seeking to remove themselves from the contract must not have caused the problem; and the event or circumstance makes it impossible or impractical to perform the contract. As noted, a force majeure clause can apply when the contract is impacted by a war or strike or riot or an epidemic or pandemic or some other event that is deemed to be an “act of God” such as a flood, or earthquake, etc. But, the clause does not cover occurrences that are within the control of a contacting party such as negligence or a party’s malfeasance (misconduct or wrongdoing) that significantly impacts the ability of the party to perform under the contract. A force majeure clause is not intended to shield a party from the normal risks associated with an agreement. See, e.g., The Pillsbury Company v. Well’s Dairy, Inc., 752 N.W.2d 430 (Iowa 2008). In addition, non-performance may, however, only be suspended for the duration of the event or circumstance that triggered application of the clause.
The wording of a force majeure clause is critical and should be negotiated by the contracting parties so that it applies equally to all parties to the contract. Often, it is helpful if the clause includes examples of acts that will excuse performance under the provision. The following is a sample force majeure clause that is being used in some hog production contracts in Iowa:
“Any party to this agreement shall be relieved of its responsibilities and obligations hereunder when the performance of those responsibilities and obligations becomes impossible because of, but not limited to, acts of God, war, disaster, destruction of the party’s facilities not attributable to the action or inaction of the party, or change in governmental regulations or laws making this agreement illegal.”
The provision’s language is fairly standard force majeure language and includes examples of what events excuse nonperformance – acts of God, war, disaster, and change in regulations or law that make the contract illegal. But, is the present virus a covered event? Some hog integrators think so, as do some ethanol plants and milk buyers. Some of these parties are having their suppliers allege force majeure on them, citing current market conditions as a result of executive orders of state governors.
There is no “one-size-fits-all” force majeure clause language that will work for all contracts. In addition, the contracting parties should specify the affected party’s obligations upon the occurrence of a Force Majeure event. Perhaps the affected party should be given more time to perform under the contract rather than being completely excused from performance. The point is that “boilerplate” clause language will likely not properly allocate the risk between the parties. While the future is difficult, if not impossible to predict, thought should be given to the contingencies that might occur that are beyond the control of the parties and how risk should be allocated upon the happening of an unforeseen circumstance that renders performance impossible.
No clause language. If a contract doesn’t contain a force majeure clause what happens? In that event, common law principles apply. How does the law deal with unforeseen events? One common law principle is “frustration of purpose.” This can serve as a defense to contract enforcement and applies when some event that the parties did not contemplate makes contract performance substantially different than what the parties originally bargained for. Sometimes, frustration of purpose can be the result of government action. Impossibility of performance may also be another common law principle that might be invoked.
Without a force majeure clause, the basic assumption is that the risk associated with an unforeseen event was not assigned and performance is not possible. But, the common law typically looks to the impracticability of performance. But a question is commonly raised as to whether part performance can be made. If so, it will be required. But, remember, if performance can be rendered but doing so would result in a bargain that is completely different from what was originally bargained for, “frustration of purpose” may be a complete defense to performance.
What is covered? Some force majeure clauses also include acts of government. That’s an important point with respect to the present virus. The virus is not disrupting supply chains and causing contract legal issues. State governors are issuing Executive Orders dictating the businesses that can operate and those that cannot. These diktats, constitutionality aside, are having a significant negative impact on supply chains. For those force majeure clauses that include acts of government, an argument can be made that the clause will apply. However, the present economic chaos is not being created by a “change in governmental laws or regulations” that make the contract illegal (as the sample language quoted above states it). It is being created unilaterally by state governors. There has been no deliberative legislative body enact a law or a regulatory agency promulgate regulations after going through the notice and comment procedure. So, with respect to the virus, is it really “government action” that would be included in force majeure clause language? That perhaps is an open question. Standard force majeure clause language may need to be modified to account for these emergency declarations.
“Acts of God”
A contract may distinguish between “acts of God” and force majeure, and a contract may include an “act of God” clause rather than a force majeure clause. Many contracts contain language specifying that if a particular event occurs, then no performance is required. That type of language tends to deal with “acts of God.” Again, it’s a matter of how the parties allocated risk. For example, agricultural leasing arrangements are generally differentiated by the allocation of risk between the landlord and tenant. While this is a function of the type of lease involved, risk allocation is also dependent upon the terms of a written lease agreement or common law principles for oral leases. For example, a clause common in many leases requires the tenant to farm the land in accordance with good farming practices (i.e., not commit waste on the premises). See, e.g., Keller v. Bolding, 2004 N.D. 80, 678 N.W.2d 578 (2004). As a result, an understanding of the potential legal and economic risks involved in a leasing relationship and the negotiation of lease terms is very important. With that notion in mind, consider the case of K & M Enterprises v. Pennington, 764 So. 2d 1089 (La. Ct. App. 2000). In this case, the plaintiff leased ground from the defendant and planted 406 acres to corn. The growing crop was consumed by deer, and the tenant sued to recover the lost crop. The issue was whether the tenant bore the risk of the loss of the corn crop. The court determined that he did. The parties had a written lease, and the court determined that the contract language was clear and unambiguous. “Acts of God” were among the risks assumed by the tenant. While the parties clearly were thinking weather-related events to be “acts of God” that the tenant would assume any resulting damage on account of (and not consumption of the corn crop by deer), the court concluded that the complete devastation of the crop by deer was such an event. In addition, while the tenant sought permission (largely after the fact) to put up an electric fence, the court held that right was not included in the landlord’s responsibility to convey “peaceable possession” to the tenant.
Is the virus such an event that is comparable to those that fall under the category of an “act of God”? It likely is. Similar to the deer destroying over 400 acres of corn in Pennington, a pandemic isn’t typically an event that is foreseen. While it’s not a weather-related event that an act of God clause contemplates, it could be treated as an act of God. Thus, how the parties contractually allocated that risk is critical.
Other Possible Protection
In some states, an agricultural producer may be able to obtain a lien under state law to protect against contract termination or non-payment. For example, Iowa law provides for the filing of a “Commodity Production Contract Lien” with the Iowa Secretary of State’s office (commonly referred to as a “contract finisher’s lien.) Iowa Code §579B. The law applies to a “contract livestock facility” which is defined as an animal feeding operation where livestock is produced according to a production contract by a contract producer who owns or leases the facility. Iowa Code §579B.1(4). A qualifying “production contract” is an oral or written agreement that provides for the production of a commodity by a contract producer that is in force on or after May 24, 1999. Iowa Code §579B.1(16). A lien of this type is an agricultural lien and a producer who is a party to a production contract, if properly executed, automatically has a lien and the buyer is automatically a debtor, owing the amount under the contract in the event of a default. Iowa Code §579B.4(1)(a). State law in some states may also provide for a lien that could apply in the case of corn grown and sold under contract to an ethanol plant.
Interstate Commerce Issues
As noted above, it has been the unilateral actions of state governors that has had the effect of largely shutting down the national economy. The Congress has reacted by providing (at this time) $2.2 trillion in federal spending to deal with the economic effect of the actions of the state governors. Over 22 million people have filed for unemployment compensation. The governors’ actions have had a national interstate effect. State governors, however, do not have plenary police power when the exercise and effect of that power impacts interstate commerce. There has been much debate and discussion about federalism (the manner in which power is shared between the federal and state governments). What the governors are doing, however, has little to do with federalism. Clearly, the states have the power to regulate commerce within their respective boundaries. But, the Congress, under the Constitution, has the exclusive constitutional power to regulate interstate commerce. U.S. Constitution, Article I, Section 8, Clause 3. But, the discussion and analysis doesn’t end there.
While “commerce” is not explicitly defined in the Constitution, its interpretation determines the dividing line between federal and state power. Likewise, how “interstate” commerce is to be viewed remains debatable. In any event, however, the actions of state governors via executive orders that shut down selective businesses, etc., have affected interstate commerce in a very negative way. As such, they are largely unconstitutional on Commerce Clause grounds based on U.S. Supreme Court opinions dating back over 80 years. In those cases, the Supreme Court has determined that activity constitutes “commerce” if it has a “substantial economic effect” on interstate commerce or if the “cumulative effect” of one act could have such an effect on commerce. For example, in 1937, the U.S. Supreme Court said, in a case involving alleged unfair labor practices, that “though activities may be intrastate in character when separately considered, if they have such a close and substantial relation to interstate commerce that their control is essential or appropriate to protect that commerce from burdens and obstructions, Congress cannot be denied the power to exercise the control.” NLRB v. Jones & Laughlin Steel Corp., 301 U.S. 1 (1937). Thus, even within a state, if commerce is regulated in a way that it harms interstate commerce, only the Congress has the power to regulate it. Indeed, in 1942, the U.S. Supreme Court dealt with a case involving a farmer that grew wheat and consumed it on his own farm. Wickard v. Filburn, 317 U.S. 111 (1942). The wheat never touched interstate commerce. Even so, the Court said his conduct could still be regulated by the Congress because, “the stimulation of commerce is a use of the regulatory function quite as definitely as prohibitions or restrictions thereon.” Even purely local activity can impact the interstate commercial economy. As an example, the Court has upheld the federal regulation of intrastate marijuana production. Gonzales v. Raich, 545 U.S. 1 (2005).
This all means that it is the Congress that has the power to stimulate (and regulate) interstate commerce and, therefore, if actions are taken in a state that either prevent the stimulation of or have the effect of regulating interstate commerce, the federal government can act. The President, as the head of the executive branch and via the Justice Department certainly has the constitutional authority to do so. To say that the President, as some have claimed, is powerless to make decisions concerning economic activity and that those decisions lie solely with the governors is absurd. The only argument is whether the President can act alone or whether the President’s power is concurrent with the state’s power to regulate intrastate activity. However, the issue is not a federalism issue, it’s a commerce issue and one where the conduct of governors has certainly had widespread interstate commerce economic impacts. While some of the state governors may believe that federalism gives them all of the power without accountability to deal with public health issues, that's not the way that federalism works. It's also not the manner in which the U.S. Supreme Court has interpreted the Commerce Clause in a very long time.
The actions of state governors in response to the virus has disrupted economic activity and has had a significant impact on agricultural contracts. Whether a party can be excused from performing, such as buying corn or hogs or milk, depends on the contract language and, perhaps, the common law in a particular jurisdiction. Farmers who find themselves in the situation of contract termination on the basis of “force majeure” would be well-advised to seek legal counsel immediately. By accepting a contract termination or failing to respond to an attempted termination, a contracting party implicitly agrees to mitigate their own damages. Mitigation of damages requires a reasonable effort to contract with another source. Hopefully, the restrictions on economic activity will be short-lived and the contract issues some farmers are facing will diminish.
Wednesday, April 8, 2020
The 2018 Farm Bill legitimized the commercial production of hemp by removing it from being a “controlled substance” under federal law. As a result, it becomes another possible crop for commercial production. But, many questions abound surrounding hemp production. What must a producer know to engage in the commercial production of hemp? Will there be a market for hemp that is produced? Are any special loans available to help start up the hemp growing operation? What about labeling and licensing requirements? How can risk best be managed? How should contracts for the production of hemp be structured?
As part of the requirements for my agricultural law course at the law school, Emily J. Young, devoted her research paper to the topic of hemp production. Emily will be graduating from Washburn Law School next month. Today’s post is the result of her research into the matter.
Questions surrounding hemp production - it’s the topic of today’s post.
2018 Farm Bill
Historically, federal law made no distinction between hemp and other cannabis plants. They were considered to be a Schedule I drug – a controlled substance under federal law. However, the Agriculture Improvement Act of 2018, P.L. 115-334 (also known as the 2018 Farm Bill), removed hemp from the Controlled Substances Act. 21 U.S.C. §§801 et seq. While hemp is a plant from the cannabis family, the 2018 Farm Bill excludes hemp from the statutory definition of marijuana under the Controlled Substance Act if it contains a delta-9 tetrahydrocannabinol (THC, marijuana’s primary psychoactive chemical) concentration of not more than 0.3% on a dry weight basis. 7 USC § 1639o(1).
In addition, the 2018 Farm Bill establishes a framework where the states and the federal government share regulatory authority over hemp production. See generally 7 U.S.C § 5940; 7 CFR Part 990. Section 10111 of the 2018 Farm Bill requires each state department of agriculture to consult with the state’s governor and attorney general to develop a plan for hemp licensing and regulation. The plan must be submitted to the United States Department of Agriculture (USDA). A state’s plan cannot be implemented until the USDA approves it. If a state does not develop its own regulatory program for hemp, the USDA will develop a system regulating hemp growers in that state.
Kansas enacted industrial hemp legislation in 2018 (K.S.A. 2018 Supp. 2-3901 et seq.) and experienced its first harvest in 2019. The Industrial Hemp Research Program is administered through the Kansas Department of Agriculture (KDA). The KDA anticipates making a Commercial Industrial Hemp Program available for the 2020 growing season, but the timeline and transition to a commercial program is presently unknown. The KDA submitted the state plan on January 23, 2020 for inclusion into the U.S. Domestic Hemp Production Program and is awaiting a response. Currently, the KDA lists 24 active processor licenses that may accept hemp during the 2020 growing season.
The 2018 Farm Bill also provides that farmers growing industrial hemp can receive banking services in the same manner available to farmers of other commodities. Indeed, the Board of Governors of the Federal Reserve System along with the Federal Deposit Insurance Corporation, Financial Crimes Enforcement Network, Office of the Comptroller of the Currency, and the Conference of State Bank Supervisors issued a joint press release on December 3, 2019 emphasizing that banks are no longer required to file a Suspicious Activity Report (SAR) for customers solely because they are engaged in the growth or cultivation of hemp in accordance with applicable laws and regulations. However, for hemp-related customers, the Board of Governors indicated that banks are expected to follow standard SAR procedures and file a SAR if indicia of suspicious activity is present.
While the 2018 Farm Bill legalizes hemp, the production of hemp is more heavily regulated than is the production of other crops due to the effect of the presence of Cannabidiol (CBD), the natural compound in the flower of the female cannabis plant, which is contained in both the hemp and marijuana varieties. While the CBD derived from hemp does not contain THC at illegal levels, the present uncertainty concerning hemp varieties and growing methods could, at least theoretically, potentially cause illegal levels of THC to be present in a harvested hemp crop. In addition, hemp has a similar appearance to marijuana that can make it more difficult for law enforcement officials to enforce drug laws governing marijuana.
Thus, while marijuana remains a Schedule I controlled substance (making illegal its cultivation and sale) CBD can legally be produced from hemp if it is produced by a licensed grower in accordance with federal and state regulations. In 2018, there were approximately 75,000 acres of hemp grown via permit in the U.S. It is estimated that permitted U.S. acres of hemp grown in 2019 was between 100,000 and 200,000.
Production Methods and Economics
Farmers grow hemp for grain, fiber, and floral material. Hemp is usually planted between May and June and harvested in September or October. It is either cultivated as a row crop or via a horticultural method. Row crop cultivation is generally cheaper and less risky compared to horticultural cultivation and is typically used to grow grain and fiber. The horticultural method involves hemp growing in a manner similar to marijuana. The grower typically uses clone plants (cuts from the mother plant) instead of seeds to have a more uniform crop and higher CBD content. January 2020 pricing indicates that a prospective grower would pay an average of $4.25/plant for clone plants. Plant spacing under the horticultural method is approximately of 1,000 to 2,200 plants per acre. If the crop is grown for CBD extraction, the current market price is anywhere between $63 and $675 per pound for the hemp flower and approximately $1.00 per percent of CBD per pound for biomass (the organic material of the hemp plant remaining after the flower is harvested and processed). Each plant yield approximately one pound of flower. CBD content varies based on the variety planted and the growing conditions.
The January 2020 industrial seed price average ranged from $3.72 to $8.00 per pound, with an average price of $4.57. Viable seeding density is 25 to 35 pounds per acre. Hemp grain can sell for an amount between $0.60 to $1.70 per pound, and on average, a farmer can harvest 1,100 pounds of grain per acre. This “traditional” hemp is grown for the manufacture of such items as textiles and bioplastics, and is drilled in a manner comparable to wheat at an approximate rate of 100 plants per square yard. The plant grows tall with the tops harvested for seed production. It is the stalks that are used for industrial purposes.
After input and harvest costs, farmers can net approximately $250-300 per acre on grain (traditional hemp). Hemp fiber is presently selling for approximately $275 per ton, and crops can yield between 4 and 5 tons of hemp fiber per acre. These returns are presently higher than returns on corn, soybeans and wheat. According to data from the Department of Agricultural Economics at Kansas State University, a Kansas farmer in the North Central region of the state can expect net revenue of $46.20 per acre on corn; $48.12 per acre on soybeans and a net loss of $62.93 per acre on wheat. https://agmanager.info/farm-mgmt-guides/2020-farm-management-guides-non-irrigated-crops.
Funding the operation
The 2020 growing season is the first-time hemp producers are eligible to apply for operating, ownership, beginning farmer, and farm storage facility loans through the Farm Service Agency (FSA). A complete loan application requires proof of crop insurance (unless ineligible); a farm operating plan with income history; and a contract for the sale of the crop. New growers are likely unable to secure a purchase contract before the season starts. As a result, most hemp producers in Kansas are either using private funding or local credit unions.
Initial license requirements
As of March 2020, the Industrial Hemp Research Program is the only program available to growers in Kansas. Anyone interested in a license for 2021 growing season should review the application checklists to determine the requirements and fees associated with the type of license being sought. See https://agriculture.ks.gov/divisions-programs/plant-protect-weed-control/industrial-hemp/industrial-hemp-applications.
A license is required for the listing and use of an approved variety of industrial hemp. K.A.R. 4-34-5(e)(1) https://agriculture.ks.gov/docs/default-source/pp-industrial-hemp/approved-varieties-final.pdf?sfvrsn=9faf85c1_4. Only authorized seeds or clone plants are permitted to be grown at this time unless otherwise approved by the KDA during the application process. K.A.R. 4-34-2; 2018 Supp. K.S.A. 2-3901(b)(11). Authorized seeds include properly imported seeds or clones from another state and accompanied with a proper certification label or seeds from local Kansas distributers that have been tested and the certificate of analysis (COA) meets KDA standards. 2018 Supp. K.S.A. §2-3901(b)(11). These labels will need to be retained until the pre-harvest inspection (and for 5 years after) to prove that the hemp inspected was grown from the seeds or clones as shown on the label. §§K.A.R. 4-34-17; K.A.R. 4-34-21.
Several private insurance companies offer small hail policies and limited coverage for hemp growers. The USDA presently offers two programs to help with loss of a hemp crop. Producers may apply now through their local FSA office, and the deadline to sign up for both programs was March 16, 2020. However, these programs do not cover loss of ‘hot’ crops (THC in excess of 0.3%).
Multi-Peril Crop Insurance Pilot Insurance Program. This program provides coverage against loss of yield because of insurable causes (natural causes such as weather, insects and disease) of loss for hemp grown for fiber, grain or Cannabidiol (CBD) oil. There are minimum acreage requirements - 5 acres for CBD and 20 acres for grain and fiber. To be eligible for MPCI, a hemp producer must also have at least a one-year history of production and have a contract for the sale of the insured hemp. The program is available in 21 states, including Kansas.
Noninsured Crop Disaster Assistance Program. This program protects against losses associated with lower yields, destroyed crops or prevented planting where no permanent federal crop insurance program is available. In general, assistance is available for losses that exceed 50 percent of the crop or for prevented plantings that exceed 35 percent of the intended crop acres. The amount paid is 55 percent of the average market price for crop losses.
Types of contracts. A purchase contract is typically entered into after a grower has completed harvest or immediately before harvest once quantity and grade of the crop is known. The buyer then makes a purchase offer for the crop with the price reflecting market demands and crop quality.
A production contract is an agreement entered into between the grower and buyer for the crop before planting. The contract denotes the obligations of the parties and specifies the quantity, quality, and price or a method to determine price of the crop. Under a production contract, a processor usually supplies the seed and inputs and the grower provides the labor and the land. The harvested crop is then delivered to the processor who pays the agreed upon price adjusted for certain contract specifications. Typically, under a production contract, the grower has no ownership rights in the seed or the harvested crop. As such, the grower cannot legally sell the crop to a third party or pledge it as collateral.
Under a split processing agreement, the processor extracts the CBD and returns a portion of the finished product to the grower. Under a typical agreement, the processor retains 40 percent of the extract as the processing fee and returns 60 percent to the grower either in kind or in accordance with market value.
Quantity. A contract may require production from a set number of acres or the delivery of pounds of biomass. If production from an acreage is specified, the grower is obligated to deliver all the crop produced on the identified acres in accordance with a “best efforts” or “best farming practices” measure of performance. Thus, if there is complete crop failure and the grower has utilized “best efforts” or utilized “best farming practices,” the grower is not liable for the shortfall and the buyer is not obligated to pay. Currently, litigation in Oregon involves claims surrounding a “best farming practices” clause. See https://hempindustrydaily.com/oregon-hemp-production-lawsuits-may-offer-lessons-for-farmers/.
Alternatively, a contract may contain a “passed acreage clause.” This clause allows the buyer to refuse acceptance of the entire crop produced from the designated acreage. This clause is common in vegetable contracts and may could be utilized in hemp contracts.
A contract could also be structured as an output contract where no quantity is specified, and the grower sells the entire output to the buyer.
Quality and crop conditions. A contract will likely set forth quality standards for the crop and how those quality standards are to be established. Related provisions will denote acts that can give rise to contract termination, the grower’s right to cure and whether the grower retains the right to sell the crop if a processor (buyer) rejects it.
A contract will likely contain language specifying the condition of the crop on delivery and the buyer’s right of inspection. A processor may require a sample from each load a grower brings in before accepting the crop. They may also want to specify the timeframe they have to inspect the crop to account for changes in the crop. For example, contract language may address the issue of crop rejection as well as applicable discounts if a delivered crop’s CBD content falls below the contract-specified percentage after delivery but before processing. This clause could also address any related pricing issues associated with the change in CBD or THC content from time of delivery to time of processing.
Force majeure events/cancellation provision. A force majeure provision allows a party to suspend or terminate its obligations when certain events happen beyond their control. Such a clause may be present in a contract involving hemp production with thought given to triggering events.
Other provisions. Additional contract clauses may address such matters as choice of law and dispute resolution.
I.R.C. §280E limits income tax deductions for businesses that traffic in controlled substances to cost-of-goods-sold (COGS) as an adjustment to gross receipts. See also C.C.A. 201504011 (Dec. 12, 2014). Because hemp is no longer a Schedule I controlled substance, the I.R.C. §280E limitations don’t apply. While hemp producers and resellers must follow the inventory costing methods of Treas. Reg. §1.471, they are not subject to the uniform capitalization rules if average gross receipts are $25 million or less (inflation-adjusted for years beginning after 2017) for the three preceding tax years and the business does not fall within the definition of a “tax shelter.” Likewise, if these tests are met, the business need not calculate an I.R.C. §263A adjustment.
The removal of hemp as a federally controlled substance provides another crop growing option for growers to consider. However, the regulatory system governing hemp production is complex and involves both state and federal regulatory bodies. Contracts for hemp production also present unique issues. Economically, hemp production can be an addition to a farmer’s common crop production routine or may serve as an alternative depending on anticipated net revenues. Is hemp the present-day equivalent of the Jerusalem Artichoke of the 1980s? Only time will tell.
Wednesday, April 1, 2020
Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy
The disaster/emergency legislation enacted in late March is wide-ranging and far-sweeping in its attempt to provide economic relief to the damage caused by various federal and state “shut-downs” brought on by a widespread viral infection that originated in China in late 2019 and has spread to the United States. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides relief to small businesses and their employees, including farmers and ranchers, as well as to certain students. Some states have also acted to temporarily stop mortgage foreclosures.
I am grateful to Joe Peiffer of Ag and Business Legal Strategies located in Hiawatha, Iowa, for his input on some of the topics discussed below.
Recent disaster/emergency legislation related to loan relief, small business and bankruptcy – it’s the topic of today’s post.
Deferral of Student Loan Payments
The CARES Act provides temporary relief for federal student loan borrowers by requiring the Secretary of Education to defer student loan payments, principal, and interest for six months, pthrough September 30, 2020, without penalty to the borrower for all federally owned loans. This provides relief for over 95 percent of student loan borrowers.
The CARES Act makes the following changes to the bankruptcy Code:
- A one-year increase in the debt limit to $7.5 million (from $2.73 million) for small businesses that file Chapter 11 bankruptcy. For one year after date of enactment, following the bill’s enactment, the measure temporarily excludes federal payments related to COVID-19 from income calculations under Chapter 11 bankruptcy proceedings. It would also allow debtors experiencing hardship because of COVID-19 to modify existing bankruptcy reorganization plans. CARES Act, §1113.
- Individuals and families currently undergoing Chapter 13 bankruptcy may seek payment plan modifications if they are experiencing a material financial hardship due to the virus, including extending payments for up to seven years after the due date of the initial plan payment. This provision expires one year after date of enactment.
- “Income” for Chapter 7 and Chapter 13 debtors does not include virus-related payments from the federal government. This provision expires one year after date of enactment.
- For Chapter 13 debtors, “disposable income” for purposes of plan confirmation does not include virus-related payments. This is also a one-year provision.
“Small Employer” Relief
The CARES Act provides qualified small businesses various options.
- Immediate SBA Emergency Economic Injury Disaster Grants. These $10,000 grants (advances) are to be used for authorized costs such as providing paid sick leave; maintaining payroll to retain employees; meeting increased material costs; making rent or mortgage payments; and repaying obligations which cannot be met on account of revenue losses. The grants are processed directly through the Small Business Association (SBA), but the SBA may utilize lenders (that are an SBA authorized lender) for the processing and making of the grants. A grant applicant may request an expedited disbursement. If such a request is made, the funds are to be disbursed within three days of the request. The CARES Act also removes standard program requirements including that the borrower not be able to secure credit elsewhere or that the borrower has been in business for at least a year, as long as the business was in operation as of January 31, 2020. CARES Act, §1110.
- Traditional SBA Economic Injury Disaster Loans (EIDL). The CARES Act expands this existing program such that the SBA can provide up to $2 million in loans to meet financial obligations and operating expenses that couldn’t be met due to the virus such as fixed debts, payroll, accounts payable and other bills attributable to actual economic injury. The loans are available to businesses and organizations with less than 500 employees. The interest rate is presently 3.75 percent and cannot exceed 4 percent for small businesses that can receive credit elsewhere. Businesses with credit available elsewhere are ineligible. The interest rate for non-profits is 2.75%. The length of the loan can be for up to 30 years with loan terms determined on a case-by-case basis, based on the borrower’s repayment ability. Applications will be accepted through December of this year.
- Forgivable SBA 7(a) Loan Program Paycheck Protection Loans. The Paycheck Protection Loan Program (PPP) is an extension of the existing SBA 7(a) loan program with many of the existing restrictions on 7(a) loans waived for a set timeframe including guarantee and collateral requirements and the requirements that the borrower cannot find credit elsewhere. In addition, a small business loan borrower is eligible for loan forgiveness on existing SBA 7(a) loans. The 7(a) loan program is the SBA's primary program for providing financial assistance to small businesses. For borrowers with an existing 7(a) loan, the SBA will pay principal, interest, and any associated loan fees for a six-month period starting on the loan’s next payment due date. Payment on deferred loans start with the first payment after the deferment period. However, this relief does not apply to loans made under the PPP.
- For purposes of the PPP, a “qualified small business” is defined as a business in existence as of February 15, 2020 paying employees or independent contractors that does not have more than 500 employees or the maximum number of employees specified in the current SBA size standards, whichever is greater; or if the business has more than one location and has more than 500 employees, does not have more than 500 employees (those employed full-time, part-time or on another basis) at any one location and the business' primary NAICS code starts with "72" (Accommodation and Food Service – e.g., hotels, motels, restaurants, etc.); or is a franchisee holding a franchise listed on the SBA's registry of approved franchise agreements; or has received financing from a Small Business Investment Corporation.
Farmers and ranchers are eligible for PPP loans if the business has 500 or fewer employees; or the business has average annual gross receipts of $1 million or less. If neither of those tests can be satisfied, the ag business can still qualify if the net worth of the business does not exceed $15 million and the average net income after federal income taxes (excluding carry over losses) for the two full fiscal years before the date of the PPP application does not exceed $5 million. Affiliation rules are used, when applicable, in determining qualification under the tests.
Sole proprietorships and self-employed individuals (i.e., independent contractors) may qualify under this program if the sole proprietor/self-employed person has a principal residence in the United States, and the individual filed or will file a Schedule C for 2019.
Note: While the SBA guidance on the issue only refers to Schedule C businesses, it seemed that “Schedule F” should be able to be substituted. Further guidance, discussed below, has added some clarity to the issue.
Additionally, certain I.R.C. §501(c)(3) organizations; qualified veterans’ organizations; employee stock ownership plans; and certain Tribal businesses are also eligible. Ineligible businesses are those that have engaged in any illegal activity at the federal or state level; household employers; any business with a 20 percent or more owner that has a criminal history; any business with a presently delinquent SBA loan; banks; real estate landlords and developers; life insurance companies; and businesses located in foreign countries.
The terms and conditions, like the guaranty percentage and loan amount, may vary by the type of loan. The lender must be SBA-approved. The loan proceeds can be used for payroll costs (up to a per-employee cap of $100,000 of cash wages (as prorated for the covered period)); a mortgage or rent obligation; payment of utilities; and any other debt obligation incurred before the “covered period” (February 15, 2020 – June 30, 2020) – however, amounts incurred on this expense is not eligible for forgiveness) plus compensation paid to an independent contractor of up to $100,000 per year. Included in the definition of “payroll costs” are salary, wages, commissions, or similar compensation; guaranteed payments of a partner in a partnership and a partner’s share of income that is subject to self-employment tax (subject to a per-partner cap of $100,000); cash tips; payment for vacation, parental, family, medical or sick leave; an allowance for dismissal or separation; payments for providing group health care benefits, including insurance premiums; payment of retirement benefits; payment of state or local tax assessed on the compensation of employees; and agricultural commodity wages. Not included in the computation of payroll costs are Federal FICA and Medicare taxes and Federal income tax withholding (but, SBA has subsequently taken the position that this is to be ignored such that the computation should be based on gross payroll); any compensation paid to an employee whose principal place of residence is outside the United States (e.g., H-2A workers); qualified sick leave and family leave wages that receive a credit under the Families First Coronavirus Response Act.
Note: Wages for an H-2A worker employed under an H-2A contract for over 180 days can establish their U.S. address as their principal residence and include their wages in average payroll. Once, associated utility costs should also count as eligible expenses.
Under the PPP, the bank can lend up to 250 percent of the lesser of the borrower’s average monthly payroll costs (before the virus outbreak) or $10,000,000 (with some exclusions including compensation over $100,000). For example, if the prior year’s payroll was $300,000, the maximum loan would be $62,500 (total payroll of $300,000 divided by 12 months = 25,000 x 2.5 = $62,500). The SBA guarantee is 100 percent.
Note: For farm borrowers, some lenders have been reported as claiming that the receipt of a PPP loan makes the farmer ineligible for the ag part of the CARES Act Food Assistance Program. That is incorrect. It is also incorrect that the receipt of a PPP loan by a farmer impacts the farmer’s USDA subsidies. The is no statutory support for either of those propositions.
Self-employed taxpayers became eligible for loans on April 10, 2020. For a self-employed taxpayer, the loan amount is based on the taxpayer’s net self-employment earnings, limited to $100,000 of net self-employment income. The maximum loan to a self-employed taxpayer is set at 20.8333 percent of self-employment earnings (plus other payroll costs). For a Schedule C taxpayer, that amount can be determined from line 31 (net profit). If that amount is over $100,000, the loan is limited to $100,000. If line 31 is a loss, the loan amount would normally be zero, but one-half of employee payroll costs can be added in. For a 2019 Schedule F, the applicable line is line 34. A copy of the taxpayer’s 2019 Schedule C (or Schedule F) must be provided to SBA.
Note: The SBA has taken the position that a loss is shown on line 34 of Schedule F that the taxpayer does not qualify for any loan based on earnings and could only qualify for a loan based on employee payroll costs.Thus, the income of a farmer reported on Form 4797 (as the result of an equipment trade, for example, will not qualify. Thus, while a farmer’s Schedule F income might be a loss, but significant income may be present on Form 4797 (which is not subject to self-employment tax), such a farmer will not be able to reconcile the Schedule F to include all equipment gains. Likewise, gains attributable to farmland and buildings are also excluded. Presently, it is unknown whether rental income that is not reported Schedule F qualifies (such as that reported on either Schedule E or on Form 4835).
The amount of loan forgiveness for a self-employed taxpayer equals 2/13 of the 2019 line 31 income. Thus, for a loan that is limited to $20,833, the amount forgiven would be $15,384 ($100,000/52 x 2.5).
For partnerships, filing is at the partnership level. This precludes each partner from receiving a loan. The law is unclear, however, whether income is based on guaranteed payments to partners or partnership gross receipts. According to the SBA’s interpretation, a partnership is allowed to count all employee payroll costs. In addition, the partnership can count all self-employment income of partners computed as the total self-employment income reported on line 14a of Schedule K/K-1. That amount is then reduced by any I.R.C. §179 expense deduction claimed; unreimbursed partnership expenses claimed, and depletion claimed on oil and gas properties. That result is then multiplied by 92.35% to arrive at net self-employment earnings. If the final amount exceeds $100,000, it is to be reduced to $100,000.
Note. Multiplying by 92.35% for Schedule F farmers appears not to be required but may be required in a future announcement since the same calculations usually apply to Schedule C and Schedule F filers on Schedule SE.
Note: Many farm partnerships have a manager managed LLC structure that allows for a reduction in self-employment tax. Even though this income is considered to be ordinary income, it appears that none of that income will qualify for a PPP loan.
Note: S or C corporations are only allowed to use taxable Medicare wages & tips from line 5c of Form 941. These wages are subject to FICA and Medicare taxes.
Based on the SBA position, if it is determined to apply to Form 943 filers, commodity wages will not be allowed for calculating total employee payroll costs. Thus, it is possible that if a farmer received an original PPP loan using commodity wages, the loan may need to be revised.
Likewise, if a taxpayer has an interest in more than one partnership that are treated as self-employed entities, a question remains as to whether each entity can qualify for a loan. For instance, if a farmer is a partner in three partnerships and earns at least $100,000 of net self-employment earnings in each partnership, can each partnership use the farmer’s full $100,000 compensation limit or must it be allocated among each partnership?
For an LLC that is taxed as a partnership, only the amount a partner receives as a guaranteed payment is taxed as self-employment income. For taxpayer’s with interests in multiple single-member LLCs, a holding company can file for the entities under its ownership or each entity can file for a loan. What is not known is whether if only one entity is profitable whether a loan can be filed only for the profitable entity. Similarly, it is not known whether a taxpayer’s compensation from each entity is allowed in full (if it is doesn’t exceed $100,000/entity) even though total earnings exceeds $100,000, or whether the taxpayer’s compensation is limited to $100,000.
The interest rate is set at one percent and cannot exceed 4 percent. Payments, including principal, interest and fees can be deferred anywhere from six to 12 months, and the SBA will reimburse lenders for loan original origination fees. A borrower can then apply for loan forgiveness to the extent the loan proceeds were used to cover payroll costs (at least 75 percent), mortgage interest, rent and utility payments during the eight-week period following loan disbursement.
Note: According to the SBA, the forgivable portion of the non-payroll costs is limited to 25 percent.
The borrower must have been in business as of February 15, 2020 and employed employees and paid salaries and taxes or had independent contractors and filed Form 1099-MISC for them. Guarantee fees are waived, and the loans are non-recourse to the borrower, shareholders, members and partners of the borrower. There is no collateral that is required, and the borrower need not show an inability to secure financing elsewhere before qualifying for financing from the SBA.
The SBA will pay lenders for processing loans under the Payroll Protection Program in an amount of 5 percent of the loan up to $350,000; 3 percent of the loan from $350,000 to $2 million; and 1 percent of loans of $2 million or more. Lender fees are payable within five days of disbursement of the loan.
A borrower under the PPP can apply for loan forgiveness on amounts the borrower incurs after February 14, 2020, in the eight-week period immediately following the loan origination date (e.g., the receipt of the funds) on the following items (not to exceed the original principal amount of the loan): gross payroll costs (not to exceed $100,000 of annualized compensation per employee); payments of accrued interest on any mortgage loan incurred prior to February 15, 2020; payment of rent on any lease in force prior to February 15, 2020 (no differentiation is made between payments made to unrelated third parties and related entities (self-rents)); fuel for business vehicles and, payment on any utilities, including payment for the distribution of electricity, gas, water, transportation, telephone or internet access for which service began before February 15, 2020. The amount forgiven is not considered taxable income to the borrower. Documentation of all payment received under the PPP is necessary to receive forgiveness. Any amount that remains outstanding after the amount forgiven is to be repaid over two years, after a six-moth deferral, at a one percent interest rate.
Note: For a sole proprietorship or self-employed individual, it is unclear whether the loan forgiveness amount is based on eight weeks of self-employment income in 2019 plus amounts spent on qualified amounts, or whether the amount forgiven is limited to eight weeks of self-employment income.
The amount forgiven will be reduced proportionally by any reduction in the number of full-time equivalent employees retained as compared to the prior year. The proportional reduction in loan forgiveness also applies to reductions in the pay of any employee. The reduction if loan forgiveness applies when the reduction of employees or an employee’s prior year’s compensation exceeds 25 percent. It is increased for wages paid to employees that are paid tips. A borrower will not be penalized by a reduction in the amount forgiven for termination of an employee made between February 15, 2020 and April 26, 2020, as long as the employee is rehired by June 30, 2020.
Note: For both the loan calculation and the amount of forgiveness a taxpayer cannot include any owner’s health insurance or retirement payments. Reference is to simply be made to Schedule C or Schedule F net income.
Note: As for loan forgiveness for the self-employed owner compensation, apparently Schedule C (of Schedule F) compensation shown on the 2019 return is used. This amount is then divided by 52 (weeks in the year) and multiplied by eight. The resulting amount is (apparently) forgiven.
The SBA “audits” the requirements that taxpayers certify both that there was economic uncertainty and that the funds were actually needed in order to keep employees on the payroll and paid during the period February 15, 2020 through June 30, 2020. For farmers, with sufficient liquidity that not poised to shut-down, being able to establish that that the funds were needed for payroll purposes could be difficult to establish. This could be particularly true for grain farmers and others that are currently planting crops, have sufficient liquidity or lines-of-credit available, and have an adequate percent of their crop insured and have the ability to pay their employees. For dairy, livestock and produce operations, it will likely be much easier to satisfy the payroll requirement. Clearly, documentation as to the need for the loan is critical to maintain, as is documentation after the end of the eight-week loan forgiveness period.
Note: A taxpayer that receives a PPP loan is ineligible for the Employee Retention Tax Credit. (discussed next), and is barred from applying for unemployment.
Certain qualified small businesses are eligible for loan forgiveness of certain SBA loans. A “covered loan” is a loan added under new §7(a)(36) of the Small Business Act (15 U.S.C. §636(a)). The amount forgiven is equal to the sum of costs incurred and payment made during the eight-week period beginning on the covered loan’s origination date. Forgiven amounts are excluded from gross income up to the principal amount of the loan. To be forgiven, loan proceeds must be used to cover rent paid under a lease agreement in force before February 15, 2020; a mortgage that was entered into in the ordinary course of business that is the borrower’s liability, and is a mortgage on real or personal property incurred before February 15, 2020; or utilities (electricity, gas, water transportation, telephone or internet access) for which service began before February 15, 2020. The borrower must verify that the amount for which forgiveness is requested was used for the permissible purposes. The amount of loan forgiveness is subject to a reduction formula tied to employee layoffs. The numerator of the formula it the average number of full-time employees per month. The denominator is, at the borrower’s election, the average number of full-time employees per month employed from Feb. 15, 2019 to Jun. 30, 2019 or the average number of full-time employees per month employed from Jan. 1, 2020 to Feb. 29, 2020.
Note: Expenses attributable to loan forgiveness (rent, mortgage, utilities, etc.) are not deductible. See I.R.C. §265.
Employers with seasonal employees use a different formula to calculate payroll costs. A seasonal employer uses the average total monthly payments for payroll for the twelve-week period beginning Feb. 15, 2019; or, by election, Mar. 1, 2019 through Jun. 1, 2019. As an alternative, the employer may choose to use any consecutive 12-week period between May 1, 2019 and September 15, 2019. Thus, if payroll costs are much higher in the summer time to harvest crops, the employer will qualify for a larger PPP loan.
To receive any loan forgiveness, the employer must spend at least 75 percent of the loan proceeds on labor costs. There is also a reduction formula for employee salaries and wages, with the amount forgiven reduced by the amount of any reduction in salary or wages of any employee during the covered period. That is the excess of 25 percent of total salary and wages for the most recent quarter for that employee. For purposes of this formula, employees earning over $100,000 are excluded. If an employer rehires the employees or raises salaries and wages back to their prior level by Jun. 30, 2020, the rehire is not considered for purposes of the formula. CARES Act, §1106.
- Employee Retention Credit. If a government order requires an employer to partially or fully suspend operations due to the virus (there is no statutory definition of “partially” or “fully”), or if business gross receipts have declined by more than 50 percent as compared to the same quarter in the immediately prior year, the employer can receive a payroll tax credit equal to 50 percent of employee compensation (“qualified wages”) up to $10,000 (per employee) paid or incurred from March 13, 2020 and January 1, 2021. For employers with greater than 100 full-time employees, qualified wages are wages paid to employees when they are not providing services (“services” is undefined) due to the coronavirus-related circumstances described above. For eligible employers with 100 or fewer full-time employees, all employee wages qualify for the credit, whether the employer is open for business or subject to a shut-down order. Qualified wages must not “exceed the amount such employee would have been paid for working an equivalent duration during the 30 days immediately preceding such period.” As noted, the credit applies to the first $10,000 of compensation, including health benefits, paid to an eligible employee. The credit is provided for wages paid or incurred from March 13, 2020 through December 31, 2020.
- The credit is allowed in each calendar quarter against Medicare tax or the I.R.C. §3221(a) tax imposed on employers at the rate of 50 percent of wages paid to employees during the timeframe of the virus limited to the applicable employment taxes as reduced by any credits allowed under I.R.C. §§3111(e) and (f) as well as the tax credit against amounts for qualified sick leave wages and qualified family leave wages an employer pays for a calendar quarter to eligible employees under the FFCRA. Thus, “applicable employment taxes” are reduced by the I.R.C. §§3111(e)-(f) credits and those available under the FFCRA. Then, the resulting amount is reduced by the Employee Retention Credit. If a negative amount results, the negative amount is treated as an overpayment that will be refunded pursuant to I.R.C. §6402(a) and I.R.C. §6413(b). CARES Act, §2301.
- Express Loan Program. The SBA’s Express Loan Program loan limit is increased to $1 million (from $350,000) until December 31, 2020. This program features an accelerated turnaround time for SBA review, with a response to applications within 36 hours. CARES Act, §1102(c).
- Tax Credit to Fund Paid Sick Leave. An employer with an employee that is paid sick-leave on account of the virus receives a FICA tax credit (employer share only) equal to the lesser of wages plus health care costs or $511 per day for up to 10 days. An employer providing sick leave to an employee with a sick family member, the credit is $200 per day, up to a maximum of $10,000.
Planning strategies. For businesses with immediate cashflow needs, a $10,000 EIDL grant can be applied for. Simultaneously, application can be made for PPL program loan. But, as noted, the basis for the separate loans and the costs being paid with each loan are different. An application can then be made seeking loan forgiveness. If this approach is inadequate, a traditional EIDL loan can be applied for. Also, if the business has sufficient cashflow, one of the FICA/Medicare tax credit options can be considered. Also, for employers with employees impacted by the virus or are caring for affected family members, the sick leave credit or the employee retention credit can be utilized if business operations were suspended or if gross receipts declined substantially.
The CARES Act contains many provisions that small employers can utilize to bridge the economic divide created by the government reaction to the virus. As the new programs are implemented rules will be developed that should address presently unanswered questions. The SBA has up to 30 days following the enactment of the CARES Act to issue regulations implementing and providing guidance on certain CARES Act provisions. In addition, the Treasury Department is required to issue regulations implementing and providing guidance under many CARES Act provisions. Issuance of regulations and guidance could delay loan approval and disbursement or modify/waive certain loan requirements.
The disaster/emergency legislation also made numerous tax changes. Those will be addressed in a future post.
Friday, March 13, 2020
Periodically on this blog I write about recent caselaw and IRS developments that farmers, ranchers and others should be aware about. The courts are constantly churning out cases that are important to agriculture and tax developments are always non-stop. It’s amazing how broad the reach is of the issues the courts and IRS address that touches agriculture in one way or another. Many of these issues may not be given much thought on a daily basis, but perhaps they should.
In today’s post, I look at a few more recent developments of relevance to agriculture – it’s the focus of today’s post.
IRS Loses Valuation Case
Grieve v. Comr., T.C. Memo. 2020-28
When interests in closely-held businesses are transferred, either by death or gift, and either federal estate or gift tax is involved, the valuation issue becomes highly relevant. For farms and ranches, blocks of non-controlling stock may be involved and the IRS may seek to apply a premium to the value of the stock to increase estate or gift taxes owed. Recently, the U.S. Tax Court shot down an IRS attempt to attach a premium to a gift of non-controlling stock among family members.
In the case, after the petitioner’s wife died, he formed two LLCs (Rabbit and Angus) for financial management and estate planning purposes. He then transferred some of the Class B shares of Rabbit to a grantor-retained annuity trust (GRAT) and the Class B shares of Angus to an irrevocable trust. The petitioner filed a 2013 gift tax return (Form 709) and attached appraisal reports that reported a taxable gift of nearly $10 million. The IRS rejected that valuation, claiming that the proper valuation was $17.8 million, and issued a notice of deficiency.
The Tax Court examined both appraisal reports, noting that the petitioner’s appraisal reports included independent analysis of the LLC shares using a combination of market and income approaches to determine the total value. Conversely, the Tax Court noted that the IRS included an assumption that selling the Class B share would encourage the petitioner’s daughter (who solely owned the Class A shares) to sell her 0.2 percent interest in the entities, which would increase the petitioner’s interests. However, the daughter testified that she would not be inclined to sell her interest, and if she were to sell, would seek a much higher premium that the IRS estimated. The Tax Court also determined that the IRS appraisal also relied on additional hypothetical scenarios that were inconsistent and insufficient to consider a change to the petitioner’s appraisal and the discounts concluded in the report. In addition, the Tax Court noted that the IRS appraiser failed to provide support for the valuations, and also did not provide evidence that his appraisal methodology was subject to peer review.
The Tax Court concluded that the IRS failed to provide sufficient evident to support its expert appraiser’s conclusion that the interests of the LLCs were undervalued and that the petitioner’s gifts of the assets to the two trusts were likewise undervalued. The Tax Court rejected the IRS position that the petitioner had underreported gift tax by $4.4 million and also rejected the IRS penalties of $600,000.
IRAs and the Constitution
Conard v. Comr., 154 T.C. No. 6 (2020)
So that people are disincentivized from using their retirement savings for things other than retirement, the IRS hits withdrawals before age 59-1/2 with a 10 percent penalty. Exceptions to the penalty apply, but even if a taxpayer fits within an exception the amount withdrawn still must be reported into income. Exemptions include distributions made post-death; because the account owner is total and permanently disabled, to cover qualified post-secondary education expenses; distributions made after being called to active military duty for 180 days; or within a year of a child’s birth or adoption.
The U.S. Tax Court recently dealt with a constitutional challenge to such penalty exemptions. In the case, the petitioner had not yet reached age 59-1/2 at the time the she received a distribution from a qualified retirement plan. Consequently, the IRS assessed the 10 percent early withdrawal penalty of I.R.C. §72(t). She sought review of the asserted tax deficiency and challenged the additional tax on the basis that the application of the tax to her early distribution violated the Constitution’s Fifth Amendment Due Process Clause because exceptions exist to the penalty that are applicable to taxpayers that haven’t reached age 59-1/2, such as for disability, etc.
The Tax Court disagreed, applying the rational basis test (low-level scrutiny) to evaluate the constitutionality of the Code provision. The Tax Court determined that test applied because the provision did not invade a substantive constitutional right or freedom or involve a suspect classification. As a result, the constitutionality of the provision could only be overcome by an explicit demonstration that the statute established hostile and oppressive discrimination against particular persons and classes. The Tax Court noted that the petitioner did not claim that the penalty provision concerned a substantive constitutional right or freedom or involved a suspect classification. Age is not a suspect classification for purposes of equal protection. Thus, the provision was presumed constitutional if it had a legitimate governmental purpose. The Tax Court noted that Committee Reports concerning the provision provided that the statute aimed “to provide means for financing retirement” and that penalties for early withdrawals were “designed to insure that retirement plans will not be used for other purposes.” An exemption from the penalty for disability, for example, satisfied a legitimate objective of encouraging taxpayers to provide for times of inability to work.
Huge FBAR Penalty Imposed
In recent years, some farmers and ranchers have started operations in locations other than the United States. Others may have bank accounts in foreign jurisdictions. Still others may serve as an agent under a power of attorney for someone that has a bank account in a foreign jurisdiction. In that event, every year, under the Bank Secrecy Act, anyone that owns or has an interest in or signature authority over certain foreign accounts such as bank accounts, brokerage accounts and mutual funds, must report the account(s) by filing a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form 114. The proper box must also be checked on Schedule B of Form 1040. Failure to do so can trigger a penalty. Willful failure to do so can result in a monstrous penalty. A recent case points out how bad the penalty can be for misreporting.
In the case, the taxpayer had a foreign bank account with aggregate highest balance of $1.9 million, $770,000 and $1.76 million for the three tax years at issue. Form 1040, Schedule B contains a question with a box to be checked asking whether the taxpayer had a financial interest in or signature authority over a financial account located in a foreign country. The box on Schedule B was checked “No” which was the default in the software that the return preparer used. The taxpayer also did not file an FBAR Form for any of the three years. The FBAR Form is required to be filed when the aggregate account balance exceeds $10,000.
The IRS claimed that the taxpayer had constructive knowledge of his reporting requirements by signing his tax returns which included a reference to the FBAR on Schedule B, and that the naming his sister's Canadian address on the accounts was an act of concealment. The taxpayer argued that he was simply negligent and there was no will failure to file the FBARs. The Court examined the definition of willfulness for purposes of FBAR filing and concluded that the taxpayer could have easily determined the need to file the FBAR. Accordingly, the court held that the taxpayer willfully failed to file the FBAR Form and assessed penalties for the years at issue in the amount of $988,245.
Lakes Have Constitutional Rights?
Drewes Farms Partnership v. City of Toledo, No. 3:19 CV 434, 2020 WL 966628 (N.D. Ohio Feb. 27, 2020) No. 3:19 CV 434 2020 U.S. Dist. LEXIS 36427 (N.D. Ohio Feb. 27, 2020)
The genesis of this case actually began in a bar in Toledo (no word on whether the bar was across from the depot). Apparently, the inebriated were commiserating over the pollution of Lake Erie. Ultimately, the ideas of that night got formulated into a ballot question at a special election for the citizens of Toledo concerning whether Lake Erie should be granted legal rights that people have. It was the first rights-based legislation in the U.S. aimed at protecting an ecosystem – Lake Erie, its tributaries and the species that live there.
When election time came, sufficient Toledo citizens voted to add the “Lake Erie Bill of Rights” (LEBOR) to the city’s charter in early 2019. The LEBOR prohibited any infringement of the “rights” of Lake Erie to “exist, flourish, and naturally evolve” without explaining the kind of conduct that would infringe those “rights.” The plaintiff, a farming operation that grows crops in four counties near Toledo and Lake Erie, sued to invalidate the LEBOR on constitutional grounds for lack of due process as being void for vagueness. The court agreed and vacated the LEBOR in its entirety.
There are always developments involving agriculture. It’s good to stay informed.
Tuesday, March 3, 2020
The cases and rulings of relevance to agricultural producers, ag businesses and rural landowners continue to churn out. In today’s post a take a brief look at three of them – a couple of bankruptcy-related cases and a case involving a claim of constitutional takings.
“Shared Responsibility” Payment Is Not a “Tax”
United States v. Chesteen, No. 19-30195 (5th Cir. Feb. 20, 2020), rev’g., No. 18-2077, 2019 U.S. Dist. LEXIS 29346 (E.D. La. Feb. 25, 2019).
In a bankruptcy proceeding, some unsecured creditors receive a priority in payments over other unsecured creditors. These are termed “priority claims” and they are not subject to being discharged in bankruptcy. Priority claims are grouped into 10 categories with descending levels of priority. 11 U.S.C. §507(a)(1)-(10). One of those priority claims is for “allowed unsecured claims of governmental units” to the extent the claims are for “a tax on or measured by income or gross receipts…”. 11 U.S.C. §507(a)(8). But, does that provision apply to the penalty that had to be paid through 2018 for not having an acceptable form of government-mandate health insurance under Obamacare – the so-called “Roberts Tax”? The U.S. Court of Appeals for the Fifth Circuit recently answered that question.
In the case, the debtor filed Chapter 13 bankruptcy. The IRS filed a proof of priority claim for $5,100.10, later amending the claim to $5,795.10 with $695 of that amount being an excise tax under I.R.C. §5000A as a result of the debtor’s failure to maintain government mandated health insurance under Obamacare. The debtor objected to the $695 amount being a priority claim that could not be discharged, and the bankruptcy court agreed, finding that the “Roberts Tax” under Obamacare was not a priority claim, but rather a dischargeable penalty in a Chapter 13 case. On appeal, the federal trial court reversed, holding that the penalty was a tax that was a non-dischargeable priority claim. The trial court noted that the creditor bore the burden to establish that the Roberts Tax was a priority claim and noted that it was the purpose and substance of the statute creating the tax that controlled whether the tax was a tax or a penalty. The trial court noted that a tax is a pecuniary burden levied for the purpose of supporting government while a monetary penalty is a punishment for an unlawful act or omission. On this point, the trial court noted that Chief Justice Roberts, in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), upheld the constitutionality of Obamacare on the basis that the “shared responsibility payment” was a tax paid via a federal income tax return and had no application to persons who did not pay federal income tax. The trial court noted that the amount was collected by the IRS and produced revenue for the government. It also did not punish an individual for any unlawful activity and, the trial court noted, the IRS has no criminal enforcement authority if a taxpayer failed to pay the amount.
On further review, the appellate court reversed, reinstating the bankruptcy court’s determination. The appellate court held that the “Roberts Tax” was not entitled to priority in bankruptcy because it was not among the types of taxes listed in the bankruptcy code to have priority treatment under 11 U.SC. §507(a)(8)(E)(i). The appellate court noted that the “Roberts Tax” could not be a priority tax claim in a debtor’s bankruptcy estate because the “tax” applied only when a person failed to buy the government-mandated health insurance, rather than when a transaction was entered into. As such, the “Roberts Tax” was a penalty that could be discharged in bankruptcy. The appellate court also noted that the “tax” zeroed out the “tax” beginning in 2019, thereby nullifying any tax effect that it might have had.
Cram-Down Interest Rate Determined
In re Country Morning Farms, Inc., No. 19-00478-FPC11, 2020 Bankr. LEXIS 307 (E.D. Wash. Feb. 4, 2020).
Under the reorganization provisions of the Bankruptcy Code (Chapters 11, 12 and 13), a debtor can reorganize debts and pay for most (but not all) secured property by paying the present value of the collateral (what the collateral is presently worth) rather than the entire debt. The procedure for doing this is commonly known as a “cram down” – the terms of the repayment are forced upon the creditor. The debtor must pay the present value of the collateral (the creditor’s allowed secured claim) via the reorganization bankruptcy. Because the repayment of the written-down debt will be paid over time in accordance with the reorganization plan, an interest rate is attached to ensure that the creditor receives the present value of the claim. But, what is the appropriate interest rate in such a setting and how is it determined? Over the years, courts struggled in determining the appropriate interest rate to use in a reorganization bankruptcy cram-down setting. The U.S. Supreme Court settled the waters with a decision in 2004 by using the “Prime Plus” method. The issue of the appropriate interest rate was again as issue in a dairy bankruptcy case from the state of Washington.
In the case, the debtor filed Chapter 11 bankruptcy and the debtor and the bank could not agree on the appropriate interest rate to be used in the debtor’s reorganization plan. The parties agreed that the “Prime Plus” method set forth in Till v. SCS Credit Corp., 541 U.S. 465 (2004) was the appropriate method to determine the “cram down” interest rate.” The parties agreed that the prime rate was presently 4.75 percent and that an additional amount as a “risk factor” should be added to the prime rate. The debtors proposed a 6 percent interest rate, based on the risk associated with their dairy business. The bank claimed that the appropriate interest rate was 7.75 percent – the highest rate factor under the Till analysis. The bank cited the length of the plan, the volatility of the dairy market, the debtor’s capital structure, and conflicting projections from an expert when determining the appropriate risk factor. The court determined that the appropriate interest rate was 7 percent which raised the interest rate on some of the debtor’s loans and lowered it on others.
Reversion to Agricultural Use Classification Not a Taking
Bridge Aina Le’a, LLC v. State Land Use Commission, No. 18-15738, 2020 U.S. App. LEXIS 5138 (9th Cir. Feb. 19, 2020).
Sometimes, a governmental body enacts a statute or promulgates a regulation that restricts a private property owner’s use of their property. The restriction on land use may be so complete that, in effect, the restriction amounts to the government “taking” the property. However, these regulatory restrictions on private property usage do not involve a physical taking of the property but can still give rise to Fifth Amendment concerns and trigger the payment of “just compensation” to the landowner. The legal issues concerns the point at which a defacto regulatory taking has occurred.
In a key case decided in 1978, the U.S. Supreme Court set forth a multi-factored balancing test for determining when governmental regulation of private property effects a taking requiring compensation. In Penn Central Transportation Co. et al. v. New York City, the 438 U.S. 104 (1978), the Court held that a landowner cannot establish a “taking” simply by being denied the ability to exploit a property interest believed to be available for development. Instead, the Court ruled that in deciding whether particular governmental action effects a taking, the character, nature and extent of the interference with property rights as a whole are the proper focus rather than discrete segments of the owner’s property rights. Later, the Court determined that the touchstone for deciding when a regulation is a taking is whether the restriction on property usage is functionally equivalent to a physical taking of the property. Lingle, et al. v. Chevron U.S.A. Inc., 544 U.S. 528 (2005). The issue of a regulatory taking came up in a recent case from Hawaii.
Under the facts of the recent case, 1,060 acres of undeveloped land on the northeast portion of the Island of Hawaii were designated as conditional urban use. For the 40 prior years, the tract was part of a 3,000-acre parcel zoned for agricultural use. In 1987, the landowner at the time sought to develop a mixed residential community of the 1,060 acres as the first phase of development on the entire 3,000 acres. The landowner petitioned the defendant to reclassify the 1,060 acres as urban. The defendant did so in 1989 on development conditions that ran with title to the land. The land remained undeveloped at the time the plaintiff acquired it in 1999. In 2005, the defendant amended the condition so that fewer affordable housing units needed to be developed. Developmental progress was hampered by the requirement that the plaintiff prepare an environmental impact statement for the development project.
In late, 2008, the defendant ordered the plaintiff to show cause for the nondevelopment. In the summer of 2010, some affordable housing units had been constructed, but upon inspection they were determined to not be habitable. The developer then stated that it lacked the funds to complete the development. In 2011, the defendant ordered the land’s reversion to its prior agricultural use classification due to the unfulfilled representations that the land would be developed. The land was given its conditional urban use classification based on those representations. The plaintiff was one of the landowners and challenged the reversion as illegal, and that it amounted to an unconstitutional regulatory taking of the land. The trial court jury found for the plaintiff on the constitutional claim and the trial court denied the defendant’s motion for a judgment as a matter of law.
On further review, the appellate court reversed The appellate court stated held that no taking had occurred under the multi-factor analysis of Penn Central Transportation Company v. City of New York, 438 U.S. 104 (1978), because the reclassification did not result in the taking of all of the economic value of the property. Rather, the land retained substantial economic value, albeit at a much lesser amount than if it were classified as urban and developed. An expert valued the land at approximately $40 million as developed land and $6.36 million with an agricultural use classification. The appellate court held that the $6.36 million was neither de minimis nor derived from noneconomic uses. Thus, the defendant was entitled to judgment as a matter of law on the issue that a complete economic taking had occurred. It had not. The appellate court also held that the reversion did not interfere substantially with the plaintiff’s investment-backed expectations given that the development conditions were present at the time the plaintiff acquired the property and the plaintiff could expect them to be enforced. The appellate court also determined that the defendant acted properly in protecting the plaintiff’s due process rights by holding hearings over a long period of time. Thus, the appellate court concluded, no reasonable jury could conclude that the reversion effected a taking under the Penn Central factors. The appellate court vacated the trial court’s judgment for the plaintiff and reversed the trial court’s the trial court’s denial of the defendant’s motion for judgment as a matter of law, affirmed the trial court’s dismissal of the plaintiff’s equal protection claim and remanded the case.
The developments of relevance to agricultural interests keep rolling in. There will be more discussed in future posts.
Tuesday, February 18, 2020
The law impacts agricultural operations, rural landowners and agribusinesses in many ways. On a daily basis, the courts address these issues. Periodically, I devote a post to a “snippet” of some of the important developments. Today, is one of those days.
More recent developments in agricultural law and taxation – it’s the topic of today’s post.
IRS Rulings on Portability.
Priv. Ltr. Ruls. 201850015 (Sept. 5, 2018); 20152016 (Sept. 21, 2018); 201852018 (Sept. 18, 2018); 201902027 (Sept. 24, 2018); 201921008 (Dec. 19, 2018); 201923001 (Feb. 28, 2019); 201923014 (Feb. 19, 2019); 201929013 (Apr. 4, 2019).
Portability of the federal estate tax exemption between married couples comes into play when the first spouse dies and the taxable value of the estate is insufficient to require the use of all of the deceased spouse's federal exemption (presently $11.58 million) from the federal estate tax. Portability allows the amount of the exemption that was not used for the deceased spouse's estate to be transferred to the surviving spouse's exemption so that the surviving spouse can use the deceased spouse's unused exemption plus the surviving spouse’s own exemption when the surviving spouse later dies. Portability is accomplished by filing Form 706 in the deceased spouse’s and is for federal estate tax purposes only. Some states that have a state estate tax also provide for portability at the state level. That’s an important feature for those states – it’s often the case that a state’s estate tax exemption is much lower than the federal exemption.
Sometimes a tax election is not made on a timely basis. Over the past year, the IRS issued numerous rulings on portability of the federal estate tax exemption and the election that must be made to port the unused portion of the exemption at the death of the first spouse over to the surviving spouse. In general, each of the rulings involved a decedent that was survived by a spouse, and the estate did not file a timely return to make the portability election. The estate found out its failure to elect portability after the due date for making the election. The IRS determined that where the value of the decedent's gross estate was less than the basic exclusion amount in the year of decedent's death (including taxable gifts made during the decedent’s lifetime), “section 9100 relief” was allowed. Treas. Reg. §§301.9100-1; 301.9100-3
The rulings did not permit a late portability election and section 9100 relief when the estate was over the filing threshold, even if no estate tax was owed because of the marital, charitable, or other deductions. In addition, it’s important to remember that there is a 2-year rule under Rev. Proc. 2017-34, 2017-26 I.R.B. 1282 making it possible to file Form 706 for portability purposes without section 9100 relief
Not Establishing a Lawyer Trust Account Properly Results in Taxable Income.
Isaacson v. Comr., T.C. Memo. 2020-17.
Attorney trust accounts are critical to making sure that money given to lawyers by clients or third-parties is kept safe and isn’t comingled with law firm funds or used incorrectly. But most people (even some new lawyers) don’t fully understand attorney trust accounts. An attorney trust account is basically a special bank account where client funds are stored for safekeeping until time for withdrawal. The funds function to keep client funds separate from the funds of the lawyer or law firm. For example, a trust account bars the lawyer from using a client’s retainer fee from being used to cover law firm operating costs unless the funds have been “earned.” But, whether funds have been “earned” has special meaning when tax rules come into play – think constructive receipt here. This was at issue in a recent Tax Court case.
In the case, a lawyer received a contingency fee upon settling a case. He deposited the funds in his lawyer trust account but did not report the deposited amount in his income for the tax year of the deposit claiming that his fee was in dispute and, thus, subject to a substantial limitation on his rights to the funds. The IRS disagreed and claimed that the account was not properly established as a lawyer trust account under state (CA) law. The IRS also pointed out that the petitioner commingled his funds with his clients’ funds which gave him access to the funds. The IRS also asserted that the petitioner should have reported the amount in income even if he later had to repay some of the amount. The Tax Court agreed with the IRS on the basis that the lawyer failed to properly establish and use the trust account and because the he had taken the opposite position with respect to the fee dispute in another court action. The income was taxable in the year the IRS claimed.
Semi-Trailer in Farm Field Near Roadway With Advertising Subject to Permit Requirement.
Counties, towns, municipalities and villages all have various rules when it comes to billboard and similar advertising. Sometimes those rules can intersect with agriculture, farming activities and rural land. That intersection was displayed in a recent case.
In the case, the defendant owned farm ground along the interstate and parked his semi-trailer within view from the interstate that had a vinyl banner tied to it that advertised a quilt shop on his property. The plaintiff (State Transportation Department) issued the defendant a letter telling him to remove the advertising material. The defendant requested an administrative hearing. The sign was within 660 feet of the interstate and was clearly visible from the interstate. The defendant collected monthly rent of $300 from the owner of the quilt shop for the advertisement. The defendant never applied for a permit to display the banner. The defendant uses the trailer for farm storage and periodically moves it around his property. The administrative hearing resulted in a finding that the trailer was being used for advertising material and an order was adopted stating the vinyl sign had to be removed. The defendant did not appeal this order, but did not remove the banner. The plaintiff sued to enforce the order. After the filing of the suit, the defendant removed the vinyl sign only to reveal a nearly identical painted-on sign beneath it with the same advertising. The plaintiffs amended their complaint alleging that the painted-on sign was the equivalent of the vinyl sign ordered to be removed and requesting that the trial court order its removal. The trial court found that the trailer with the painted-on sign was not advertising material as the semi-trailer was being used for agricultural purposes and was not an advertisement. The court did concede that the semi-trailer was within 660 feet of the right-of-way of the interstate; was clearly visible to travelers on the highway; had the purpose of attracting the attention of travelers; defendant received a monthly payment for maintaining the sign. On further review, the appellate court reversed and remanded. The appellate court concluded that the trailer served a dual purpose of agricultural use and advertising and that there was no blanket exemption for agricultural use. The trailer otherwise satisfied the statutory definition as an advertisement because of its location, visibility, and collection of rental income. The appellate court concluded that the defendant could use the trailer for agricultural purposes in its current location, but that advertising on it was subject to a permit requirement.
Lack of Basis Information in Appraisal Summary Dooms Charitable Deduction for Conservation Easement Donation.
Oakhill Woods, LLC v. Comr., T.C. Memo. 2020-24.
The tax Code allows an income tax deduction for owners of property who relinquish certain ownership rights via the grant of a permanent conservation easement to a qualified charity (e.g., to preserve the eased property for future generations). I.R.C. §170(h). But, abuses of the provision are not uncommon, and the IRS has developed detailed rules that must be followed for the charitable deduction to be claimed. The IRS audits such transactions and has a high rate of success challenging the claimed tax benefits.
In this case, the petitioner executed a deed of conservation easement on 379 acres to a qualified land trust in 2010. The deed recited the conservation purpose of the easement. The petitioner claimed a $7,949,000 charitable deduction for the donation. Included with the petitioner’s return was an appraisal and Form 8283 which requires, among other things, basis information concerning the gifted property or an attached reasonable cause explanation of why the information was not included with the return. Basis information was not included on Form 8283, and the petitioner attached a statement taking the position that such information was not necessary. The IRS denied the deduction for noncompliance with Treas. Reg. §1.170A-13(c)(2). The Tax Court agreed with the IRS, noting that the lack of cost basis information was fatal to the deduction as being more than a minor and unimportant departure from the requirements of the regulation. The Tax Court cited its prior opinion in Belair Woods, LLC v. Comr., T.C. Memo. 2018-159. The Tax Court also rejected the petitioner’s argument that Treas. Reg. §1.170A-13(c)(4)(i)(D) and (E) was invalid. The petitioner claimed that the basis information was required with the return and not the appraisal summary, but the Tax Court rejected this argument because a “return” includes all IRS forms and schedules that are required to be a part of the return. As such, Form 8283 was an essential part of the return. In addition, the Tax Court noted that the underlying statute absolutely required basis information to be included with the appraisal summary and, in any event, the IRS’ interpretation of the statute via the regulation was reasonable.
Cram-Down Interest Rate Determined.
In re Country Morning Farms, Inc., No. 19-00478-FPC11, 2020 Bankr. LEXIS 307 (E.D. Wash. Feb. 4, 2020).
A "cramdown" in a reorganization bankruptcy allows the debtor to reduce the principal balance of a debt to the value of the property securing it. 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. 11 U.S.C. §1129(b)(2)(A). But, how is present value determined? The U.S. Supreme Court offered clarity in 2004. The matter of determining an appropriate discount rate was involved in a recent bankruptcy case involving a Washington dairy operation.
The debtor filed Chapter 11 bankruptcy and couldn’t agree with a creditor (a bank) on the appropriate interest rate to be used in the debtor’s reorganization plan. The parties agreed that the “Prime Plus” method set forth in Till v. SCS Credit Corp., 541 U.S. 465 (2004) was the appropriate method to determine the “cram down” interest rate.” The parties agreed that the prime rate was presently 4.75 percent and that an additional amount as a “risk factor” should be added to the prime rate. The debtor proposed a 6 percent interest rate, based on the risk associated with the dairy business. The bank claimed that the appropriate interest rate was 7.75 percent – the highest rate factor under the Till analysis. The bank cited the length of the plan, the volatility of dairy market, the debtor’s capital structure, and conflicting projections from an expert when determining the appropriate risk factor. The court determined that the appropriate interest rate was 7 percent which raised the interest rate on some of the debtor’s loans and lowering it on others.
There’s never a dull moment in the world of ag law and ag tax. These are just a few developments in recent weeks.
Friday, January 17, 2020
The fields of agricultural law and agricultural taxation are dynamic. Law and tax impacts the daily life of a farmer, rancher, agribusiness and rural landowner practically on a daily basis. Whether that is good or bad is not really the question. The point is that it’s the reality. Lack of familiarity with the basic fundamental and applicable rules and principles can turn out to be very costly. As a result of these numerous intersections, and the fact that the rules applicable to those engaged in farming are often different from non-farmers, I started out just over 25 years ago to develop a textbook that addressed the major issues that a farmer or rancher and their legal and tax counsel should be aware of. After three years, the book was complete – Principles of Agricultural Law - and it’s been updated twice annually since that time.
The 46th edition is now complete, and it’s the topic of today’s post – Principles of Agricultural Law.
The text is designed to be useful to farmers and ranchers; agribusiness professionals; ag lenders; educational professionals; laywers, CPAs and other tax preparers; undergraduate and law students; and those that simply want to learn more about legal and tax issues. The text covers a wide range of topics. Here’s just a sample of what is covered:
Ag contracts. Farmers and ranchers engage in many contractual situations, including ag leases, to purchase contracts. The potential perils of verbal contracts are numerous as one recent bankruptcy case points out. See, e.g., In re Kurtz, 604 B.R. 549 (Bankr. D. Neb. 2019). What if a commodity is sold under forward contract and a weather event destroys the crop before it is harvested? When does the law require a contract to be in writing? For purchases of goods, do any warranties apply? What remedies are available upon breach? If a lawsuit needs to be brought to enforce a contract, how soon must it be filed?
Ag financing. Farmers and ranchers are often quite dependent on borrowing money for keeping their operations running. What are the rules surrounding ag finance? This is a big issue for lenders also? For instance, in one recent Kansas case, the lender failed to get the debtor’s name exactly correct on the filed financing statement. The result was that the lender’s interest in the collateral (a combine and header) securing the loan was discharged in bankruptcy. In re Preston, No. 18-41253, 2019 Bankr. LEXIS 3864 (Bankr. D. Kan. Dec. 20, 2019).
Ag bankruptcy. A unique set of rules can apply to farmers that file bankruptcy. Chapter 12 bankruptcy allows farmers to de-prioritize taxes. That can be a huge benefit. Knowing how best to utilize those rules is very beneficial.
Income tax. Tax and tax planning permeate daily life. Deferral contracts; depreciation; installment sales; like-kind exchanges; credits; losses; income averaging; reporting government payments; etc. The list could go on and on. Having a basic understanding of the rules and the opportunities available can add a lot to the bottom line of the farming or ranching operation.
Real property. Of course, land is typically the biggest asset in terms of value for a farming and ranching operation. But, land ownership brings with it many potential legal issues. Where is the property line? How is a dispute over a boundary resolved? Who is responsible for building and maintaining a fence? What if there is an easement over part of the farm? Does an abandoned rail line create an issue? What if land is bought or sold under an installment contract?
Estate planning. While the federal estate tax is not a concern for most people and the vast majority of farming and ranching operations, when it does apply it’s a major issue that requires planning. What are the rules governing property passage at death? Should property be gifted during life? What happens to property passage at death if there is no will? How can family conflicts be minimized post-death? Does the manner in which property is owned matter? What are the applicable tax rules? These are all important questions.
Business planning. One of the biggest issues for many farm and ranch families is how to properly structure the business so that it can be passed on to subsequent generations and remain viable economically. What’s the best entity choice? What are the options? Of course, tax planning is part and parcel of the business organization question.
Cooperatives. Many ag producers are patrons of cooperatives. That relationship creates unique legal and tax issues. Of course, the tax law enacted near the end of 2017 modified an existing deduction for patrons of ag cooperatives. Those rules are very complex. What are the responsibilities of cooperative board members?
Civil liabilities. The legal issues are enormous in this category. Nuisance law; liability to trespassers and others on the property; rules governing conduct in a multitude of situations; liability for the spread of noxious weeds; liability for an employee’s on-the-job injuries; livestock trespass; and on and on the issues go. It’s useful to know how the courts handle these various situations.
Criminal liabilities. This topic is not one that is often thought of, but the implications can be monstrous. Often, for a farmer or rancher or rural landowner, the possibility of criminal allegations can arise upon (sometimes) inadvertent violation of environmental laws. Even protecting livestock from predators can give rise to unexpected criminal liability. Mail fraud can also arise with respect to the participation in federal farm programs. The areas of life potentially impacted with criminal penalties are worth knowing, as well as knowing how to avoid tripping into them.
Water law. Of course, water is essential to agricultural production. Water issues vary across the country, but they tend to focus around being able to have rights to water in the time of shortage and moving the diversion point of water. Also, water quality issues are important. In essence, knowing whether a tract of land has a water right associated with it, how to acquire a water right, and the relative strength of that water rights are critical to understand.
Environmental law. It seems that agricultural and the environment are constantly in the news. The Clean Water Act, Endangered Species Act and other federal (and state) laws and regulations can have a big impact on a farming or ranching operation. Just think of the issues with the USDA’s Swampbuster rules that have arisen over the past 30-plus years. It’s good to know where the lines are drawn and how to stay out of (expensive) trouble.
Regulatory law. Agriculture is a very heavily regulated industry. Animals and plants, commodities and food products are all subject to a great deal of regulation at both the federal and state level. Antitrust laws are also important to agriculture because of the highly concentrated markets that farmers buy inputs from and sell commodities into. Where are the lines drawn? How can an ag operation best position itself to negotiate the myriad of rules?
The academic semesters at K-State and Washburn Law are about to begin for me. It is always encouraging to me to see students getting interested in the subject matter and starting to understand the relevance of the class discussions to reality. The Principles text is one that can be very helpful to not only those engaged in agriculture, but also for those advising agricultural producers. It’s also a great reference tool for Extension educators.
If you are interested in obtaining a copy, you can visit the link here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html
January 17, 2020 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, January 3, 2020
Today, I continue the journey through the most significant legal and tax developments of 2019 to impact the ag sector. The eighth and seventh biggest developments are in today’s commentary.
- SCOTUS Agrees To Hear Case Involving Groundwater Discharges into a WOTUS
Under the Clean Water Act (CWA), a National Pollution Discharge Elimination System (NPDES) permit is required to discharge a “pollutant” from a point source into the “navigable waters of the United States” (WOTUS). Clearly, a discharge directly into a WOTUS is covered. But, is an NPDES permit necessary if the discharge is directly into groundwater which then finds its way to a WOTUS? Are indirect discharges from groundwater into a WOTUS covered? If so, does that mean that farmland drainage tile is subject to the CWA and an NPDES discharge permit is required? The federal government has never formally taken that position, but if that’s the case it’s a huge issue for agriculture.
In 2018, three different U.S. Circuit Courts of Appeal decided cases on the discharge from groundwater issue.
- In Hawai’i Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018), the defendant owned and operated four wells at the Lahaina Wastewater Reclamation Facility (LWRF). Although constructed initially to serve as a backup disposal method for water reclamation, the wells became the defendant’s primary means of effluent disposal into groundwater and, ultimately, the Pacific Ocean. The defendant injected approximately 3 to 5 million gallons of treated wastewater per day into the groundwater via its wells. The wastewater seeped into the Pacific Ocean. The U.S. Court of Appeals for the Ninth Circuit held that the wells were point sources requiring NDES permits despite the defendant’s claim that NPDES permits were not required because the wells discharged only indirectly into the Pacific Ocean via groundwater.
- In Upstate Forever, et al. v. Kinder Morgan Energy Partners, LP, et al., 887 F.3d 637 (4th Cir. 2018), the plaintiffs claimed that the defendant violated the CWA by discharging “pollutants” into the navigable waters of the United States without a required discharge permit via an underground ruptured gasoline pipeline owned by the defendant’s subsidiary. The plaintiff claimed that a discharge permit was needed because the CWA defines “point source pollutant” (which requires a discharge permit) as “any discernible, confined and discrete conveyance, included but not limited to any…well…from which pollutants are or may be discharged.” The U.S. Court of Appeals for the Fourth Circuit determined that a pollutant can first move through groundwater before reaching navigable waters and still constitute a “discharge of a pollutant” under the CWA that requires a federal discharge permit. The discharge, the court concluded, need not be channeled by a point source until reaching navigable waters that are subject to the CWA. It is sufficient, the appellate court reasoned, that the discharge of pollutants from a point source through groundwater have a direct hydrological connection to navigable waters of the United States.
- In Tennessee Clean Water Network v. Tennessee Valley Authority, 905 F.3d 436 (6th Cir. 2018), the U.S. Court of Appeals for the Sixth Circuit held that the CWA does not apply to point source pollution that reaches surface water by means of groundwater movement. 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 “seeps in all directions, guided only by the general pull of gravity. Thus, it [groundwater] is neither confined nor discrete.” In addition, the appellate court noted that the CWA only regulates pollutants “…that are added to navigable waters from any point source.” In so holding, the court rejected the holdings of the Ninth and Fourth Circuits from earlier in 2018.
After the Ninth Circuit issued its opinion, the EPA, on February 20, 2018, requested comment on whether pollutant discharges from point sources that reach jurisdictional surface waters via groundwater may be subject to Clean Water Act (“CWA”) regulation. Specifically, the EPA sought comment on whether the EPA should consider clarification or revision of previous EPA statements regarding the Agency’s mandate to regulate discharges to surface waters via groundwater under the CWA. In particular, the EPA sought comment on whether it is consistent with the CWA to require a CWA permit for indirect discharges into jurisdictional surface waters via groundwater. The EPA also sought comment on whether some or all of such discharges are addressed adequately through other federal authorities, existing state statutory or regulatory programs or through other existing federal regulations and permit programs.
After receiving over 50,000 comments, on April 15, 2019, the EPA issued an interpretive statement concluding that the releases of pollutants to groundwater are categorically excluded from the NPDES regardless of whether the groundwater is hydrologically connected to surface water. The EPA reasoned that the Congress explicitly left regulation of groundwater discharges to the states and that the EPA had other statutory authorities through which to regulate groundwater other than the NPDES. The EPA, in its statement, noted that its interpretation would apply in areas not within the jurisdiction of the U.S. Circuit Courts of Appeal for the Ninth and Fourth Circuits.
In 2019, the U.S. Supreme Court agreed to hear the Ninth Circuit opinion. Hawaii Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018), pet. for cert. granted, County of Maui v. Hawaii Wildlife Fund, 139 S. Ct. 1164 (2019). Boiled down to its essence, the case turns on the meaning of “from.” As noted above, an NPDES permit is required for point source pollutants – those that originate “from” a point source that are discharged into a navigable water. But what if the pollutant originates from a point source, travels through groundwater, and then later reaches a WOTUS? Does the permit requirement turn on a direct discharge into a WOTUS, or simply a discharge that originated at a point source that ultimately ends up in a WOTUS? Clearly, the wells at issue in the case are point sources – on that point all agree. But, what about discharges from the wells that aren’t directly into a WOTUS? Are indirect discharges into a WOTUS via groundwater (which is otherwise exempt from the NPDES) subject to the permit requirement?
The case is very important to agriculture because of the ways that a pollutant can be discharged from an initial point and ultimately reach a WOTUS. For example, the application of manure or commercial fertilizer to a farm field either via surface application or via injection could result in eventual runoff of excess via the surface or groundwater into a WOTUS. No farmer can guarantee that 100 percent of a manure or fertilizer application is used by the crop to which it is applied and that there are no traces of the unused application remaining in the soil. Likewise, while organic matter decays and returns to the soil, it contains nutrients that can be conveyed via stormwater into surface water. The CWA recognizes this and contains an NPDES exemption for agricultural stormwater discharges. But, if the Supreme Court decides in favor of the environmental group, the exemption would be removed, subjecting farmers (and others) to onerous CWA penalties unless a discharge permit were obtained - at a cost estimated to exceed $250,000 (not to mention time delays).
What about farm field tile drainage systems? Seemingly, such systems would make it easier for “pollutants” to enter a WOTUS. Such drainage systems are prevalent in the Midwest and other places, including California’s Central Valley. Should the law discourage agricultural drainage activities? Thus, a ruling upholding the environmental group’s position would dramatically change agricultural production. In addition, while large operations would be better positioned to absorb the increased cost of production activities, many mid and small-sized operations would not be able to adjust based simply on the economics involved. The Court is expected to issue its ruling in 2020.
- Regulatory Takings
The power to “take” private property for public use (or for a public purpose) without the owner's consent is an inherent power of the federal and state governments. However, the United States Constitution limits the government's eminent domain power by requiring federal and state governments to pay for what is “taken.” The Fifth Amendment states in part “...nor shall private property be taken for public use without just compensation.”
Whether a taking has occurred is not an issue when the government physically takes the property, with the only issue being whether the taking is compensable and the amount of compensation due to the landowner. However, for non-physical (regulatory) takings, the issue is murkier. At what point does government regulation of private property amount to a compensable taking? Also, if the taking is by a state or local government, must the landowner “exhaust” state court remedies before seeking compensation for a regulatory taking? If so, it could result in a landowner having no real access to the federal court system on a constitutional taking claim. It’s an issue that the SCOTUS addressed in 2019.
For a landowner that has sustained a state/local regulatory (or physical) taking, can compensation be sought initially in federal court or must legal procedures be first pursued in state court with federal courts only available if compensation is denied at the state level? The U.S. Supreme Court answered this question in 1985. In Williamson Regional Planning Commission v. Hamilton Bank of Johnson City, 473 U.S. 172 (1985), the Court held that if a state provides an adequate procedure for seeking just compensation, there is no Fifth Amendment violation until the landowner has used the state procedure and has been denied just compensation. However, 28 U.S.C. §1738, would then be applied with the resulting effect that the failure to receive compensation at the state level generally meant that there was no recourse in the federal courts because of the preclusive effect of the landowner having already litigated the same issue(s) in the state courts. See, e.g., San Remo Hotel L.P., v. City and County of San Francisco, 545 U.S. 323 (2005). This “catch-22” was what the Court examined in 2019.
In Knick v. Township of Scott, 139 S. Ct. 2162 (2019), the plaintiff owned a 90-acre farm in Pennsylvania on which she grazed horse and other animals. The farm includes a small graveyard where ancestors of the plaintiff’s neighbors were buried. Such “backyard burials” are permissible in Pennsylvania. In late 2012, the defendant passed an ordinance requiring that “[a]ll cemeteries…be kept open and accessible to the general public during daylight hours.” The ordinance defined a “cemetery” as “[a] place or area of ground, whether contained on private or public property which has been set apart for or otherwise utilized as a burial place for deceased human beings.” In 2013, the defendant notified the plaintiff of her ordinance violation. The plaintiff sued in state court for declaratory and injunctive relief on the basis that the ordinance amounted to a taking of her property, but she did not seek compensation via an inverse condemnation action.
While the case was pending, the defendant agreed to not enforce the ordinance. As a result, the trial court refused to rule on the plaintiff’s action. Without any ongoing enforcement of the ordinance, the plaintiff couldn’t show irreparable harm. Without irreparable harm, the court noted, the plaintiff couldn’t establish what was necessary for the equitable relief she was seeking. Frustrated at the result in state court, the plaintiff filed a takings claim in federal court. However, the federal trial court dismissed the case because she hadn’t sought compensation at the state level. Knick v. Scott Township, No. 3:14-CV-2223st, 2015 U.S. Dist. LEXIS 146861 (M.D. Pa. Oct. 29, 2015). The appellate court affirmed, citing the Williamson case. Knick v. Township of Scott, 862 F.3d 310 (3d Cir. 2017).
In a 5-4 decision, Chief Justice Roberts (joined by Justices Alito, Gorsuch, Kavanaugh and Thomas), writing for the majority, reversed. He pointed out that there is a distinction between the substance of a right and the remedy for the violation of that right. It’s the takings clause of the Fifth Amendment that establishes that the government can only take (either physically or via regulation) private property by paying for it. The government’s infringement on private property is what triggers possible compensation. The Constitutional violation has occurred and a state court decision that makes the landowner financially whole simply remedies that violation. It doesn’t redefine the property right. Thus, the majority opinion reasoned, laws confer legal rights and when those rights are violated there must be legal recourse. See, e.g., Marbury v. Madison, 5 U.S. 137 (1803). As the majority noted, “a government violates the Takings Clause when it takes property without compensation, and…a property owner may bring a Fifth Amendment claim [in federal court]… at that time.”
The Court’s decision is a significant win for farmers, ranchers, and other rural landowners that are impacted by state and local regulations impacting land use. A Fifth Amendment right to compensation accrues at the time the taking occurs.
Next week, I will continue working my way towards the most significant development in ag law and tax. Stay tuned.
Wednesday, January 1, 2020
2019 contained many legal and tax developments that were of importance to agricultural producers, rural landowners, agribusinesses and others tied to the business of agriculture. The legal and tax systems impact agriculture in many ways. From environmental and water issues to income tax and estate/business planning issues, to bankruptcy and contract issues, to financing and liability issues as well as others, there are many ways that legal and tax issues impact agriculture.
On Monday’s post, I highlighted what I viewed as significant developments but not significant enough to make my “Top 10” list for 2019. In today’s post, I start the journey through the ten biggest legal and tax developments of 2019 in terms of their impact (or potential impact) on the agricultural sector.
The “Top Ten” of 2019 – developments 10 and nine. It’s the topic of today’s post.
- The Relevance of Roundup Jury Verdicts
2019 saw more juries render verdicts in cases involving alleged damages by Roundup. The jury verdicts have been in the multi-millions of dollars. Presently, over 11,000 cases involving Roundup have been filed and are awaiting trial and adjudication. The basic claim in each case is that the use of Roundup caused some sort of physical injury to the plaintiff. In many of the cases, the claim is that physical injury occurred after usage (usually over a long period of time) of Roundup. While the temptation may be great to dismiss the recent verdicts as the result of raw emotion and passion by juries that don’t have much, if any, relation to agriculture, that temptation should be resisted. It is true that juries tend to react based on emotion to a greater degree than do judges (indeed, the judge in the 2018 case significantly reduced the jury verdict), but that doesn’t mean that there aren’t some “take-home” implications for farming and ranching operations at this early stage of the litigation.
Farming and ranching operations should at least begin to think about the possible implications of the Roundup litigation.
- What about lease agreements? Farmers and ranchers that lease out farmland and pasture may want to reexamine the lease terms. Consideration should be given as to whether the lease should incorporate language that specifies that the tenant assumes the risk of claims arising from the use of Roundup or products containing glyphosate. Relatedly, perhaps language should be included that either involves the tenant waiving potential legal claims against the landlord or provides for the landlord to be indemnified by the tenant for any and all glyphosate-related claims. Should language be included specifying that the tenant has the sole discretion to select chemicals to be used on the farm and that any such chemicals shall be used in accordance with label directions and any applicable regulatory guidance? How should the economics of the lease be adjusted to reflect this type of lease language? The tenant is giving up some rights and will want compensation for the loss of those rights. If the lease isn’t in writing, perhaps this is a good time to reduce it to writing.
- Is the comprehensive liability policy for the farm/ranch sufficient to cover glyphosate-related claims? Many farm comprehensive general liability policies contain “pollution exclusion” clauses. Do those clauses exclude coverage for glyphosate-related claims? How is “pollution” defined under the policy? Does it include pesticides and herbicides and associated claims? Does it cover loss to livestock that consume corn and/or soybeans that were grown with the usage of chemicals containing glyphosate? Can a rider be obtained to provide coverage, if necessary? These are all important questions to ask the insurance agent and an ag lawyer trained in reading farm comprehensive liability policies.
- If the farm employs workers, should that arrangement be modified from employer/employee to independent contractor status? If employee status remains and an employee sues the employer for alleged glyphosate-related damages, what can be done? Will enrolling the farm in the state workers’ compensation program provide sufficient liability protection for the farming/ranching operation?
What About Food Products?
To date, the cases have all involved the use of Roundup directly over a long period of time. At some point will there be cases where consumers of food products claim they were harmed by the presence of glyphosate in the food they ate? If those cases arise, given the use of production contracts in agriculture and the possibility of tracing back to the farm from which the grain in the allegedly contaminated food product was grown, does the farmer have liability? If you think this is far-fetched, remember that there is presently a member of the U.S. House that is proposing the regulation (if not elimination) of cows with flatulence. Relatedly, there are certain segments of the population that are opposed to the manner in which modern, conventional agriculture is conducted. These persons/groups would not hesitate in trying to pin liability all the way back down the chain to the farmer.
The Roundup litigation shouldn’t be ignored. It may be time to start thinking through possible implications and modifying certain aspects of the way the typical farm or ranch does business in order to provide the greatest liability protection possible.
- Ag Antitrust – The Ability of a Farmer To Sue For Anticompetitive Conduct
The markets for the major ag products in the U.S. are highly concentrated. This raises economic and legal questions as to whether the conduct that such concentration makes possible improperly denies farmers a proper share of the retail food dollar and simultaneously increase prices to consumers. In other words, does the conduct associated with market concentration at these various levels negatively impact commodity prices, and result in producers receiving less of the retail food dollar while consumers simultaneously pay more for food? If so, what can a farmer or rancher do about it? Does antitrust law provide a remedy? Does it matter that a farmer/rancher is not a directly injured party? In 2019, the U.S. Supreme Court decided a case involving the Apple Co. and IPhone users that involves some of these concepts. The Court’s decision has implications for agriculture.
In 1977, the U.S. Supreme Court held in Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977), that a plaintiff cannot claim damages when the plaintiff is not the party that was directly injured. In other words, even if an antitrust violation can be established that results, for example, in ag product prices being lower than a competitive market would produce, Illinois Brick bars the farmer/rancher from suing for damages due to lack of standing because they haven’t been directly injured – there is a processor in-between.
Note: Since 1977, most states have enacted laws or have judicial opinions that reject the Illinois Brick decision (which are not preempted by federal law – see California v. ARC America, 490 U.S. 93 (1989)). In these states, indirect purchasers can seek recovery under state antitrust laws.
In Apple Inc. v. Pepper, et al., 139 S. Ct. 1514 (2019), IPhone users sued Apple Inc. over its operations of the App Store. The trial court held that the consumers in the case were indirect purchasers that lacked standing due to Illinois Brick. The Ninth Circuit reversed (Pepper v. Apple Inc., 846 F.3d 313 (9th Cir. 2017)) and the U.S. Supreme Court agreed to hear the case (Apple Inc. v. Pepper, 138 S. Ct. 2647 (2018). On May 13, the Supreme Court affirmed the Ninth Circuit decision by a 5 to 4 vote. Thus, the plaintiffs could pursue their claims against Apple for allegedly monopolizing access to apps for Apple’s iPhones and imposing monopoly prices. Apple had constructed its arrangement with the app developers so that formally the developers set the prices charged to buyers and Apple took a 30 percent commission from that price before remitting the remainder to the developer. Thus, as a formal contract matter, Apple was only the agent of the developer although the customers could only deal with Apple to get apps. The majority took the view that Apple was a retailer of apps with an alleged monopoly over the supply. In this view the formal contract relationship between the developer and Apple was irrelevant to the question of whether the buyers were the first victim to Apple’s alleged monopoly.
Thus, the court was unanimous that the Illinois Brick rule should remain. However, the decision appears to reject the use of formal contracts to determine who is the first buyer. This is consistent with historic practice in antitrust where courts have looked to the substance and not the form of the conduct. However, to determine who is the first seller, the majority focused on transactional characteristics that seem very formal. But it repeatedly characterized Apple as a classic retailer that selected the goods it would sell, and generally controlled the marketing of the goods. In contrast, there are real “agents” who function as independent contractors to deliver goods for others and remit the payments. The decision does not make this distinction explicitly but its repeated characterization of Apple as a retailer suggests that the majority was taking a realistic, functional view of the relationship. A more nuanced analysis of this point would have been very helpful.
Peter Carstensen, antitrust expert and Professor Emeritus of the Wisconsin School of Law commented to me that because the decision leaves the Illinois Brick rule in place, it fails to give farmers any direct expansion of their right to damages under federal law. Of greater significance for agriculture where the concern is exploitation of monopsony or oligopsony power, Prof. Carstensen noted that the majority opinion is clear that both downstream customers and upstream suppliers (e.g., farmers) can sue the buyer/seller engaged in anticompetitive conduct causing harm. This is helpful with respect to poultry and (potentially) hog cases brought on behalf of farmers providing growing services. It confirms their independent right to claim damages. This declaration is also relevant to the continuing disputes over the interpretation of the Packers and Stockyards Act (PSA) condemnation of unfair and discriminatory conduct. 7 U.S.C. §§182 et seq. The courts have imposed an interpretation that holds that the PSA is an antitrust statute which requires competitive injury before there can be a violation. In addition, the decisions have required that there be an adverse effect on consumers and not just producers. Prof. Carstensen noted that the Pepper decision re-emphasizes the well-established antitrust principle that both upstream and downstream harms are independent antitrust injuries. In future PSA cases proof of harm to producers should establish “harm to competition.”
Another implicit but important underlying assumption of the case is that Illinois Brick applies to exploitive conduct (i.e., either excessive prices imposed on buyers, or under payment to sellers). The implication is that this rule has no bearing on cases involving exclusion or predation where the illegal conduct harms the victims but does not create a direct gain to the wrongdoer. Unlike the exploitation cases, the predatory wrongdoer is not sitting on a “pot of money” resulting from its illegal deeds; rather it has expended resources to exclude rivals or entrench its market position in some way. In such cases the measure of harm is the loss to the victim and not the gain to the wrongdoer. This is important because usually the harm results from some market manipulation or exclusionary practice in which the wrongdoer causes the harms without directly dealing with the victim. Where farmers are victims of such exclusionary practices even if the harm is inflicted indirectly, they would still have standing to seek damages as well as injunctions in federal court.
On the whole, Prof. Carstensen concluded that the Supreme Court reaffirmed the Illinois Brick rule. However, it employs a functional analysis to identify the first buyer (seller). This may improve slightly the chances of farmers getting damages in federal court when buyers engaged in unlawful exploitation have used agents or other specious means to avoid direct dealings. But the rule remains a major barrier to getting damages for farmers harmed indirectly by exploitive practices by downstream buyers. Where the farmers’ harm stems from exclusionary or predatory conduct, the decision reinforces the position that the rule does not apply to such damages. But, it also provides a further correction to the misinterpretations of competitive harm invoked in PSA cases. The Court’s opinion is a helpful one for agriculture.
In Friday’s post, I will continue the trek through the Top Ten of 2019.
Monday, December 30, 2019
It’s the time of year again where I sift through the legal and tax developments impacting agriculture from the past year, and rank them in terms of their importance to farmers, ranchers, agribusinesses, rural landowners and the ag sector in general.
As usual, 2019 contained many legal developments of importance. There were relatively fewer major tax developments in 2019 compared to prior years, but the issues ebb and flow from year-to-year. It’s also difficult to pair things down to ten significant developments. There are other developments that are also significant. So, today’s post is devoted to those developments that were left on the cutting table and didn’t quite make the “Top Ten” for 2019.
The “almost top ten of 2019” – that’s the topic of today’s post.
Chapter 12 Debt Limit Increase
To be eligible for Chapter 12 bankruptcy, a debtor must be a “family farmer” or a “family fisherman” with “regular annual income.” 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; have more than 50 percent of their debt be debt from a farming operation that the debtor owns or operates; and, the aggregate debt must not exceed a threshold amount. That threshold amount has only adjusted for inflation since enactment of Chapter 12 in 1986, even though farms have increased in size and capital needs faster than the rate of inflation. When enacted, 86 percent of farmers were estimated to qualify for Chapter 12. That percentage had declined over time due to the debt limit only periodically increasing with inflation and stood at $4,411,400 as of the beginning of 2019. Thus, fewer farmers were able to use Chapter 12 to deprioritize taxes associated with the sale of farm assets used in the farming operation and ultimately put together a reorganization plan that will allow the farmer to stay on the farm to continue production activities, make restructured loan payments and have some debt written off. However, as of August 23, 2019, the debt limit for a family farmer filing Chapter 12 was increased to $10,000,000 for plans filed on or after that date. H.R. 2336, Family Farmer Relief Act of 2019, signed into law on Aug. 23, 2019 as Pub. L. No. 116-51.
Which Government Agency Sues a Farmer For a WOTUS Violation?
In 2019, a federal trial court allowed the U.S. Department of Justice (DOJ) to sue a farmer for an alleged CWA dredge and bill permit violation without a specific recommendation from the Environmental Protection Agency (EPA). The farmer was alleged to have discharged “pollutants” into a “waters of the United States” (WOTUS) as a result of tractor tillage activities on his farmland containing or near to wetlands contiguous to a creek that flowed into a WOTUS. Staff of the U.S. Army Corps of Engineers (COE) saw the tilled ground and investigated. The COE staff then conferred with the EPA and referred the matter to the U.S. Department of Justice (DOJ). The DOJ sued (during the Obama Administration) for enforcement of a CWA §404 permit “by the authority of the Attorney General, and at the request of the Secretary of the Army acting through the United States Corps of Engineers.” The DOJ alleged that the equipment "constituted a 'point source'" pollutant under the CWA and "resulted in the placement of dredged spoil, biological materials, rock, sand, cellar dirt or other earthen material constituting “pollutants” (within the meaning of 33 U.S.C. § 1362(6)) into waters of the United States. The DOJ alleged that the defendant impacted water plants, changed the river bottom and/or replaced Waters of the United States with dry land, and "resulted in the 'discharge of any pollutant' within the meaning of 33 U.S.C. § 1311(a)." The farmer moved for summary judgment on the basis that the CWA authorizes only the EPA Administrator to file a CWA §404 enforcement action and that the court, therefore, lacked jurisdiction. The court disagreed and determined that the defendant could be sued by the U.S. Department of Justice upon the mere recommendation of the COE and without a specific recommendation from the EPA alleging a CWA violation, and in a situation where the CWA did not determine any CWA jurisdiction and only the COE did. This finding was despite a 1979 Attorney General opinion No. 197 determining that the EPA and not the COE has the ultimate authority to construe what is a navigable WOTUS. Ultimately, the parties negotiated a settlement costing the farmer over $5 million. United States v. Lapant, No. 2:16-CV-01498-KJM-DB, 2019 U.S. Dist. LEXIS 75309 (E.D. Cal. May 3, 2019). United States v. Lapant, No. 2:16-CV-01498-KJM-DB, 2019 U.S. Dist. LEXIS 93590 (E.D. Cal. Jun. 3, 2019).
USDA’s Swampbuster “Incompetence”
How does the USDA determine if a tract of farmland contains a wet area that is subject to the Swampbuster rules? That’s a question of key importance to farmers. That process was at issue in a 2019 case, and the court painted a rather bleak and embarrassing picture of the USDA bureaucrats. In fact, the USDA-NRCS was brutalized (rightly so) by the appellate court’s decision for its lack of candor and incompetence. I will skip the details here (I covered the case in a blog post earlier in 2019), but the appellate court dealt harshly with the USDA. The USDA uses comparison sites to determine if a particular site is a wetland subject to Swampbuster rules. In this case, the USDA claimed that 7 C.F.R. § 12.31(b)(2)(ii) allowed them to select a comparison site that was "on the same hydric soil map unit" as the subject property, rather than on whether the comparison site had the same hydrologic features as the subject tract(s). The appellate court rejected this approach as arbitrary and capricious, noting that the NRCS failed to try an "indicator-based wetland hydrology" approach or to use any of their other tools when picking a comparison site. In addition, the appellate court noted a COE manual specifies that, “[a] hydrologist may be needed to help select and carry out the proper analysis" in situations where potential lack of hydrology is an issue such as in this case. However, the NRCS did not send a hydrologist to personally examine the plaintiff’s property, claiming instead that a comparison site was not even necessary. Based on 7 C.F.R. §12.32(a)(2), the USDA claimed, the removal of woody hydrophytic vegetation from hydric soils to permit the production of an agricultural commodity is all that is needed to declare the area "converted wetland." The appellate court concluded that this understanding of the statue was much too narrow and went against all the other applicable regulatory and statutory provisions by completely forgoing the basis of hydrology that the provisions are grounded in. Accordingly, the appellate court reasoned that because hydrology is the basis for a change in wetland determination, the removal of trees is merely a factor to determine the presence of a wetland, but is not a determining factor. In addition, the appellate court pointed out that the NRCS never indicated that the removal of trees changed the hydrology of the property during the agency appeal process – a point that the USDA ignored during the administrative appeal process. The court’s decision is a step in the right direction for agriculture. Boucher v. United States Department of Agriculture, 934 F.3d 530(7th Cir. 2019).
No More EPA “Finger on the Scales”
During 2019, a federal trial court ruled that the EPA has the authority to bar persons currently receiving grant money from the EPA to serve on EPA scientific advisory committees. That’s an important development for the regulated community, including farmers and ranchers. The court’s opinion ended an Obama-era EPA policy of allowing EPA advisory committee members to be in present receipt of EPA grants. At issue in the case was a directive of the Trump-EPA regarding membership in its federal advisory committees. The directive specified “that no member of an EPA federal advisory committee be currently in receipt of EPA grants.” The directive reversed an Obama-era rule that allowed scientists in receipt of EPA grants to sit on advisory panels. That rule was resulting in biased advisory committees stacked with committee members that opposed coal and favored an expansive “Waters of the United States” rule among other matters. In defending its policy change, the EPA explained that “while receipt of grant funds from the EPA may not constitute a financial conflict of interest, receipt of that funding could raise independence concerns depending on the nature of the research conducted and the issues addressed by the committee.” Thus, the change was necessary “to ensure integrity and confidence in its advisory committees.” The trial court found the EPA’s explanation to be within the zone of reasonableness. Based on these findings, the trial court held that the EPA action was rational, considered the relevant factors and was within the authority delegated to the agency. The court granted the EPA’s motion to dismiss the case. Physicians for Social Responsibility v. Wheeler, 359 F. Supp. 3d 27 (D. D.C. 2019).
Coming-To-The-Nuisance By Staying Put?
Nuisance lawsuits filed against farming operations are often triggered by offensive odors that migrate to neighboring rural residential landowners. In these situations courts consider numerous factors in determining whether any particular farm or ranch operation is a nuisance. Factors that are of primary importance are priority of location and reasonableness of the operation. Together, these two factors have led courts to develop a “coming to the nuisance” defense. This means that if people move to an area they know is not suited for their intended use, they should be prohibited from claiming that the existing uses are nuisances. But, what if the ag nuisance comes to you? Is the ag operation similarly protected in that situation? An interesting Indiana court case in 2019 dealt with the issue. In the case, the defendants were three individuals, their farming operation and a hog supplier. Basically, a senior member of the family retired to a farm home on the premises and other family members established a large-scale confined animal feeding operation (CAFO) on another part of the farm nearby. The odor issue got bad enough that the retired farmer sued. However, the court determined that the CAFO was operated properly, had all of the necessary permits, and was within the zoning laws. The court noted that the plaintiff alleged no distinct, investment-backed expectations that the CAFO had frustrated. The court upheld the state right-to-farm law and also determined that a “taking” had not occurred because the plaintiff had not sold his home and moved away from the place where he grew up and lived all of his life. Himsel v. Himsel, No. 18A-PL-645, 2019 Ind. App. LEXIS 181 (Ind. Ct. App. Apr. 22, 2019).
Obamacare Individual Mandate Unconstitutional
In his decision in 2012 upholding Obamacare as constitutional, Chief Justice Roberts hinged the constitutionality of the law on the individual mandate (contained in I.R.C. §5000A) being a tax and, therefore, within the taxing authority of the Congress. Thus, if the tax is eliminated or the rate of the penalty tax taken to zero is the law unconstitutional? That’s a possibility now that the tax rate on the penalty is zero for tax years beginning after 2018. In late 2018, a federal district court noted that the payment was distinct from the individual mandate and determined that the individual mandate was no longer constitutional as of January 1, 2019 because it would no longer trigger any tax. In addition, because the individual mandate was the linchpin of the entire law, the court determined that the provision could not be severed from the balance of the law. As a result, the court reasoned, as of January 1, 2019, Obamacare no longer had any constitutional basis. Texas v. United States, 340 F.3d 579 (N.D. Tex. 2018). In 2019, the appellate court affirmed. Texas v. United States, No. 19-10011, 2019 U.S. App. LEXIS 37567 (5th Cir. Dec .18, 2019). The appellate court determined that the individual mandate was unconstitutional because it could no longer be read as a tax, and there was no other constitutional provision that justified that exercise of congressional power. Watch for this case to end up back before the Supreme Court. The case is of monumental importance not only on the health insurance issue. Obamacare contained many taxes that would be invalidated if the law were finally determined to be unconstitutional.
These were the developments that didn’t quite make the “Top 10” of 2019. In Wednesday’s post, I will start the trek through the Top 10 of 2019.
Friday, October 11, 2019
The power to “take” private property for public use (or for a public purpose) without the owner's consent is an inherent power of the federal and state governments. However, the United States Constitution limits the government's eminent domain power by requiring federal and state governments to pay for what is “taken.” The Fifth Amendment states in part “...nor shall private property be taken for public use without just compensation.”
Whether a taking has occurred is not an issue when the government physically takes the property, with the only issue being whether the taking is compensable and the amount of compensation due to the landowner. However, for non-physical (regulatory) takings, the issue is murkier. At what point does government regulation of private property amount to a compensable taking? In a previous post I addressed U.S. Supreme Court guidance on how to determine the property that the landowner claims has been taken.
If the taking is by a state or local government, must the landowner “exhaust” state court remedies before seeking compensation for a regulatory taking? If so, it could result in a landowner having no real access to the federal court system on a constitutional taking claim. It’s an issue that the U.S. Supreme Court addressed late in its last term this past June. It’s also the topic of today’s post – pursuing a “takings” remedy in federal court for a state/local-level regulatory taking
Regulatory (Non-Physical) Takings
A non-physical taking may involve the governmental condemnation of air space rights, water rights, subjacent or lateral support rights, or the regulation of property use through environmental restrictions. How is the existence of a regulatory taking determined? There are several approaches that the Supreme Court has utilized.
Multi-factor balancing test. In a key case decided in 1978, the U.S. Supreme Court set forth a multi-factored balancing test for determining when governmental regulation of private property effects a taking requiring compensation. In Penn Central Transportation Co. et al. v. New York City, 438 U.S. 104 (1978), the Court held that a landowner cannot establish a “taking” simply by being denied the ability to exploit a property interest believed to be available for development. Instead, the Court ruled that in deciding whether particular governmental action effects a taking, the character, nature and extent of the interference with property rights as a whole are the proper focus rather than discrete segments of the owner’s property rights. In 2005, the Court confirmed the multi-factor test and noted that the touchstone for deciding when a regulation is a taking is whether the restriction on property usage is functionally equivalent to a physical taking of the property. Lingle, et al. v. Chevron U.S.A., Inc., 544 U.S. 528 (2005).
Total regulatory taking. In Lucas v. South Carolina Coastal Council, 505 U.S. 1003 (1992), the landowner purchased two residential lots with an intent to build single-family homes. Two years later, the state legislature passed a law prohibiting the erection of any permanent habitable structures on the Lucas property. The law's purpose was to prevent beachfront erosion and to protect the property as a storm barrier, a plant and wildlife habitat, a tourist attraction, and a “natural health environment” which aided the physical and mental well-being of South Carolina's citizens. The law effectively rendered the Lucas property valueless. Lucas sued the Coastal Council claiming that, although the act may be a valid exercise of the state's police power, it deprived him of the use of his property and thus, resulted in a taking without just compensation. The Coastal Council argued that the state had the authority to prevent harmful uses of land without having to compensate the owner for the restriction.
The Supreme Court ruled for Lucas and opined that the state's interest in the regulation was irrelevant since the trial court determined that Lucas was deprived of any economically viable alternative use of his land. The Lucas case has two important implications for environmental regulation of agricultural activities. First, the Lucas court focused solely on the economic viability of the land and made no recognition of potential noneconomic objectives of land ownership. However, in the agricultural sector land ownership is typically associated with many noneconomic objectives and serves important sociological and psychological functions. Under the Lucas approach, these noneconomic objectives are not recognized. Second, under the Lucas rationale, environmental regulations do not invoke automatic compensation unless the regulations deprive the property owner of all beneficial use.
Under the Lucas approach, an important legal issue is whether compensation is required when the landowner has economic use remaining on other portions of the property that are not subject to regulation.
Unconstitutional conditions. In Nollan v. California Coastal Commission,483 U.S. 825 (1987), the plaintiff owned a small, dilapidated beach house and wanted to tear it down and replace it with a larger home. However, the defendant was concerned about preserving the public's viewing access over the plaintiff's land from the public highway to the waterfront. Rather than preventing the construction outright, the defendant conditioned the plaintiff's right to build on the land upon the plaintiff giving the defendant a permanent, lateral beachfront easement over the plaintiff's land for the benefit of the public. Thus, the issue was whether the state could force the plaintiffs to choose between their construction permit and their lateral easement. The Court held that this particular bargain was impermissible because the condition imposed (surrender of the easement) lacked a “nexus” with, or was unrelated to the legitimate interest used by the state to justify its actions - preserving the view. The Court later ruled similarly in Dolan v. Tigard, 512 U.S. 374 (1994). These cases hold that the government may not require a person to give up the constitutional right to receive just compensation when property is taken for a public use in exchange for a discretionary benefit that has little or no relationship to the property. The rule of the cases does not apply to situations involving impact fees and other permit conditions that do not involve physical invasions, but it would apply to monetary exactions where none of the plaintiff’s property is actually taken. See, e.g., Koontz v. St. Johns River Water Management District, 133 S. Ct. 2586 (2013).
State/Local Takings – Seeking a Remedy
For a landowner that has sustained a state/local regulatory (or physical) taking, can compensation be sought initially in federal court or must legal procedures be first pursued in state court with federal courts only available if compensation is denied at the state level? The U.S. Supreme Court answered this question in 1985. In Williamson Regional Planning Commission v. Hamilton Bank of Johnson City, 473 U.S. 172 (1985), the Court held that if a state provides an adequate procedure for seeking just compensation, there is no Fifth Amendment violation until the landowner has used the state procedure and has been denied just compensation. However, 28 U.S.C. §1738, would then be applied with the resulting effect that the failure to receive compensation at the state level generally meant that there was no recourse in the federal courts because of the preclusive effect of the landowner having already litigated the same issue(s) in the state courts. See, e.g., San Remo Hotel L.P., v. City and County of San Francisco, 545 U.S. 323 (2005). This “catch-22” was what the Court examined earlier this year.
The 2019 Case
In Knick v. Township of Scott, 139 S. Ct. 2162 (2019), the plaintiff owned a 90-acre farm in Pennsylvania on which she grazed horse and other animals. The farm includes a small graveyard where ancestors of the plaintiff’s neighbors were buried. Such “backyard burials” are permissible in Pennsylvania. In late 2012, the defendant passed an ordinance requiring that “[a]ll cemeteries…be kept open and accessible to the general public during daylight hours.” The ordinance defined a “cemetery” as “[a] place or area of ground, whether contained on private or public property which has been set apart for or otherwise utilized as a burial place for deceased human beings.” In 2013, the defendant notified the plaintiff of her violation of the ordinance. The plaintiff sued in state court for declaratory and injunctive relief on the basis that the ordinance amounted to a taking of her property, but she did not seek compensation via an inverse condemnation action.
While the case was pending, the defendant agreed to not enforce the ordinance. As a result, the trial court refused to rule on the plaintiff’s action. Without any ongoing enforcement of the ordinance, the plaintiff couldn’t show irreparable harm. Without irreparable harm, the court noted, the plaintiff couldn’t establish what was necessary for the equitable relief she was seeking. Frustrated at the result in state court, the plaintiff filed a takings claim in federal court. However, the federal trial court dismissed the case because she hadn’t sought compensation at the state level. Knick v. Scott Township, No. 3:14-CV-2223st (M.D. Pa. Oct. 29, 2015). The appellate court affirmed, citing the Williamson case. Knick v. Township of Scott, 862 F.3d 310 (3d Cir. 2017).
In a 5-4 decision, Chief Justice Roberts (joined by Justices Alito, Gorsuch, Kavanaugh and Thomas), writing for the majority, reversed. He pointed out that there is a distinction between the substance of a right and the remedy for the violation of that right. It’s the takings clause of the Fifth Amendment that establishes that the government can only take (either physically or via regulation) private property by paying for it. The government’s infringement on private property is what triggers possible compensation. The Constitutional violation has occurred and a state court decision that makes the landowner financially whole simply remedies that violation. It doesn’t redefine the property right. Thus, the majority opinion reasoned, laws confer legal rights and when those rights are violated there must be legal recourse. See, e.g., Marbury v. Madison, 5 U.S. 137 (1803). As the majority noted, “a government violates the Takings Clause when it takes property without compensation, and…a property owner may bring a Fifth Amendment claim [in federal court]… at that time.”
The Court’s decision is a significant win for farmer’s, ranchers, and other rural landowners that are impacted by state and local regulations impacting land use. A Fifth Amendment right to compensation accrues at the time the taking occurs. It’s also useful to note that the decision would not have come out as favorably without the presence of Justices Gorsuch and Kavanaugh on the Court. That’s a point that agricultural interests also note.
Wednesday, September 11, 2019
This month’s installment of court developments concerning agriculture in the courts covers recent developments involving the valuation of a timber enterprise; obtaining a tax refund for an estate due to a financial disability; the calculation of a casualty loss; and the growing of hemp.
Ag law and tax developments in the courts – it’s the topic of today’s post.
Estate Tax Valuation
At issue in Estate of Jones v. Comr., T.C. Memo. 2019-101 were the proper valuations, as of May 28, 2009, of limited partner units in a timber business and stock shares in a sawmill. The decedent died in 2014, having established the sawmill business in 1954 and expanding it substantially since then. The decedent bought about 25,000 acres of timber in 1989 and an additional 125,00 acres in 1992. Later in 1992, the decedent formed the limited partnership to invest in, acquire, hold and manage timberlands and real estate and incur debt. The decedent transferred the timberland, which was considered to be the sawmill’s inventory, to the limited partnership in exchange for an interest in the entity.
The decedent began doing some succession planning in 1996 with the intent of keeping the business in the family as a successful operation. That plan included making gifts of interests in the businesses to family members, including significant blocks of stock. Upon the decedent’s death, the IRS challenged the valuation for gift tax purposes of the 2009 transfers of limited partnership interests and interests of the S corporation that owned the sawmill. Transfer of the limited partnership units was also restricted via a buy-sell agreement that contained a right-of-first refusal. Thus, the determination of fair market value of the 2009 transfers had to account for lack of marketability, lack of control, lack of voting rights of an assignee and reasonably anticipated cash distributions allocable to the gifted interests.
The IRS valued the transfers utilizing a net asset value approach and the estate’s expert used a discounted cash flow approach for both the timberland and the mill. The Tax Court agreed with the valuation arrived at by the estate’s expert, a far lower amount than what the IRS had arrived at.
There are many underlying details concerning the valuation approaches that I am not discussing here. The major point is, however, that taking care to follow well-established valuation procedures and keeping good records is essential. The Tax Court will often adopt the approach that is most precise and is substantiated.
Refund Claims Due To Financial Disability
I.R.C. §6511(h) establishes a statute of limitations for filing a claim for refund due to financial disability. The provision provides “an individual is financially disabled if such individual is unable to manage his financial affairs by reason of a medically determinable physical or mental impairment of the individual which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.” I.R.C. §6511(a)-(c) specifies that, “In the case of an individual, the running of the periods specified in subsections (a), (b), and (c) shall be suspended during any period of such individual’s life that such individual is financially disabled.” In Carter v. United States, No. 5:18-cv-01380-HNJ, 2019 U.S. Dist. LEXIS 134035 (N.D. Ala. Aug. 9, 2019) a decedent’s estate sought relief on the basis that the estate’s personal representative was financially disabled for a period of time entitling the estate to file a claim for refund after the time period set forth in I.R.C. §6511(a). The estate claimed that it should be treated as in individual for relief purposes. The estate sought a refund of federal estate tax tied to the value of bank stock that the decedent held at the time of death which made up 45 percent of the gross estate value. Unknown at the time of death was that a fraud had been committed against the bank which ultimately led to the bank being shut down and the stock rendered worthless. The personal representative was traumatized by the events, suffering emotional distress which rendered her unable to manage the estate which was substantiated by a physician who maintained that the representative’s disabilities triggered § 6511(h)’s equitable tolling provision so as to excuse the untimely filing of the refund claim.
The court disagreed with the estate’s position, holding that the term “individual” in I.R.C. §6511(h)(1) did not apply to an estate. The court pointed out that I.R.C. §7701(a)(1) defines a person as “an individual, a trust, estate, partnership, association, company or corporation.” The court reasoned that this made it clear that the Congress saw individuals and estates as distinct types of taxpayers, and the use of the term individual in IRC §6511(h) limited the relief to natural persons. The court also noted that even if the estate’s claim weren’t time-barred, it would fail on its own merits because estate tax value is based on the value as of the date of death or the alternate valuation date of six months after death. Simply because the fact of the bank fraud arose post-death didn’t change the fact that it wasn’t known at the time of death and the stock was being actively traded at death, the measuring date for federal estate tax purposes.
Calculating a Casualty Loss
While the casualty loss deduction rules have been modified for tax years beginning after 2017, the underlying manner in which a casualty loss is to be computed remains largely the same. Those rules involve documenting the value of the property before the casualty; determining the value after the casualty; income tax basis; and the amount of insurance proceeds received. It’s a big issue for agriculture particularly because of the exposure of agricultural property to weather. A recent Tax Court case illustrates how a casualty loss is computed.
In Taylor II v. Comr., T.C. Memo. 2019-102, the petitioner claimed a casualty loss on his 2008 return for damage from a hurricane. An insurance company paid over $2.3 million in claims, and the claimed deduction was $888,345. The petitioner reported a basis in the property of $6.5 million, insurance reimbursement of $2.3 million and a pre-casualty fair market value of $15,442,059 and a post-casualty fair market value of $12,250,000. The pre-casualty FMV was based on the 2009 listing price of the property reduced for time spent on the market. No testimony was provided as to post-casualty FMV.
The Tax Court (Judge Paris) noted that to compute a casualty loss deduction, the pre and post-FMV values of the impacted property must be computed and the property basis must be established. The Tax Court noted that decline in value can alternatively be established via the regulations under I.R.C. §165 if the taxpayer has repaired the property damage resulting from the casualty, the taxpayer may use the cost of repairs to prove the loss of value to the property from the casualty. In that instance, the taxpayer must show that (a) the repairs are necessary to restore the property to its condition immediately before the casualty, (b) the amount spent for such repairs is not excessive, (c) the repairs do not care for more than the damage suffered, and (d) the value of the property after the repairs does not as a result of the repairs exceed the value of the property immediately before the casualty. The Tax Court noted that the record did not establish that the valuations were based on competent appraisals, and didn’t indicate how the petitioner’s CPAs determined the pre or post-casualty FMV of the property, even though the pre-casualty FMV was consistent with the value reported to the insurance company. The Tax Court concluded that the appraisals were not reliable measures of the taxpayer's casualty loss and didn’t rely on them. In addition, the taxpayer received insurance payments that exceed the cost of repairs. That meant that a casualty loss deduction couldn’t be claimed based on the regulations. The Tax Court disallowed any casualty loss deduction.
Growing of Hemp
The 2018 Farm Bill allows for hemp (not marijuana) production and allows states and Indian tribes to opt for either primary regulatory authority, or USDA authority over any proposed hemp production. Under the primary authority option, a state may submit its own plan to the U.S. Secretary of Agriculture (Secretary). Once a plan is submitted, the Secretary has 60 days to approve or deny the plan. Under the “USDA option,” hemp can be produced under a plan established by the USDA, but the plan must still be submitted to and approved by the Secretary. The Farm Bill provides that the Secretary has explicit authority to set regulations and guidelines that relate to the implementation to both the primary regulatory authority option or the USDA option. On February 27, 2019, the USDA issued a notice that the agency had begun gathering information to promulgate rules and regulations related to the 2018 Farm Bill and the production of hemp in the United States.
In Flandreau Santee Sioux Tribe v. United States Department of Agriculture, No. 4:19-CV-04094-KES, 2019 U.S. Dist. LEXIS 95188 (D. S.D. Jun. 6, 2019), the plaintiff, an Indian tribe, submitted its own proposed hemp production plan in March of 2019. The Secretary issued a letter in stating that the plan would be approved or denied within 60 days after hemp production regulations were finalized – likely in the fall of 2019. On May 6, the plaintiffs submitted a letter to USDA requesting a waiver of regulatory requirements so that the plaintiff could plant hemp during the 2019 growing season. A meeting was held to discuss the waiver. Later that month the plaintiff sued for a temporary restraining order or preliminary injunction seeking to force the USDA to grant the hemp planting waiver.
A hearing on the temporary restraining order was held in June. After the hearing, the court denied the plaintiff’s motion. The court determined that the plaintiff’s motion was not yet ripe and that the plaintiff was not likely to ultimately succeed on the merits of its claim. The court noted that the Farm Bill gave the Secretary broad discretion with respect to hemp production. In addition, the 60-day window to approve or reject plans did not begin until the USDA finalized regulations. The court also noted that there was no monetary remedy built into the law because the USDA was not required to pay compensation for economic losses. The court also determined that the plaintiff’s potential economic losses did not outweigh the impact on the USDA if the injunction were to be granted. The court noted that the issuance of an injunction would force the USDA to act before it could carefully lay out the regulations on hemp production. Such haste in allowing production could have detrimental long-term effects.
There’s never a dull moment in ag law and tax.
Friday, August 16, 2019
The conservation-compliance provisions of the 1985 Farm Bill introduced the concept of “swampbuster.” Swampbuster was introduced into the Congress in January of 1985 at the urging of the National Wildlife Federation and the National Audubon Society. It was originally presented as only impacting truly aquatic areas and allowing drainage to continue where substantial investments had been made. Thus, there was virtually no opposition to Swampbuster.
But, the “dirt is in the details” as it is often said. Just how does the USDA determine if a tract of farmland contain a wet area that is subject to regulation? That’s a question of key importance to farmers. That process was also the core of a recent court opinion, in which the court painted a rather bleak and embarrassing picture of the USDA bureaucrats.
Swampbuster and the USDA’s process for determining land subject to the Swampbuster rules – that’s the topic of today’s post.
The legislation charged the soil conservation service (SCS) with creating an official wetland inventory with a particular tract being classified as a wetland if it had (1) the presence of hydric soil; (2) wetland hydrology (soil inundation for at least seven days or saturated for at least 14 days during the growing season); and (3) the prevalence of hydrophytic plants under undisturbed conditions. In other words, to be a wetland, a tract must have hydric soils, hydrophytic vegetation and wetland hydrology. The presence of hydrophytic vegetation, by itself, is insufficient to meet the wetland hydrology requirement and the statute clearly requires the presence of all three characteristics. B&D Land & Livestock Co. v. Schafer, 584 F. Supp. 2d 1182 (N.D. Iowa 2008).
Under the June 1986 interim rules, wetland was assumed to be truly wet ground that had never been farmed. In addition, “obligation of funds” (such as assessments paid to drainage districts) qualified as commenced conversions, and the Fish and Wildlife Service (FWS) had no involvement in ASCS or SCS decisions. In September of 1986, a proposal to exempt from Swampbuster all lands within drainage districts was approved by the chiefs of the ASCS, SCS, FmHA, FCIC and the Secretary of Agriculture. However, the USDA proposal failed in the face of strong opposition from the FWS and the EPA.
The final Swampbuster rules were issued in 1987 and greatly differed from the interim rules. The final Swampbuster rules eliminated the right to claim prior investment as a commenced conversion. Added were farmed wetlands, abandoned cropland, active pursuit requirements, FWS concurrence, a complicated “commenced determination” application procedure, and special treatment for prairie potholes. Under the “commenced conversion” rules, an individual producer or a drainage district is exempt from Swampbuster restrictions if drainage work began before December 23, 1985 (the effective date of the 1985 Farm Bill). If the drainage work was not completed by December 23, 1985, a request could be made of the ASCS on or before September 19, 1988, to make a commencement determination. Drainage districts must satisfy several requirements under the “commenced conversion” rules. A project drainage plan setting forth planned drainage must be officially adopted. In addition, the district must have begun installation of drainage measures or legally committed substantial funds toward the conversion by contracting for installation or supplies.
The final rules defined “farmed wetlands” as playa, potholes, and other seasonally flooded wetlands that were manipulated before December 23, 1985, but still exhibited wetland characteristics. Drains affecting these areas can be maintained, but the scope and effect of the original drainage system cannot be exceeded. 7 C.F.R. § 12.33(b). Prior converted wetlands can be farmed, but they revert to protected status once abandoned. Abandonment occurs after five years of inactivity and can happen in one year if there is intent to abandon. A prior converted wetland is a wetland that was totally drained before December 23, 1985. Under 16 U.S.C. §3801(a)(6), a “converted wetland” is defined as a wetland that is manipulated for the purpose or with the effect of making the production of an agricultural commodity possible if such production would not have been possible but for such action. See, e.g., Clark v. United States Department of Agriculture, 537 F.3d 934 (8th Cir. 2008). If a wetland was drained before December 23, 1985, but wetland characteristics remain, it is a “farmed wetland” and only the original drainage can be maintained.
Identifying a Wetland – The Boucher Saga
The process that the USDA uses to determine the presence of wet areas on a farm that are subject to the Swampbuster rules (known as the “on-site” wetland identification criteria) are contained in 7 C.F.R. §12.31. The application of the rules was at issue in the most recent opinion in a case involving an Indiana farm family’s longstanding battle with the USDA.
Facts and administrative appeals. The facts of the litigation reveal that the plaintiff (and her now-deceased husband) owned the farm at issue since the early 1980s. The farmland has been continuously used for livestock and grain production for over 150 years. The tenants that farm the land participated in federal farm programs. In 1987, the plaintiffs were notified that the farm might contain wetlands due to the presence of hydric soils. This was despite a national wetland inventory that was taken in 1989 that failed to identify any wetland on the farm. In 1991, the USDA made a non-certified determination of potential wetlands, prior converted wetlands and converted wetlands on the property. In 1994, the plaintiff’s husband noticed that passersby were dumping garbage on a portion of the property. To deter the garbage-dumping, the plaintiff’s husband cleaned up the garbage, cleared brush, and removed five trees initially and four more trees several years later. The trees were upland-type trees that were unlikely to be found in wetlands, and the tree removal impacted a tiny fraction of an acre. The USDA informed the landowners that the tree removal might have triggered a wetland/Swampbuster violation and that the land had been impermissibly drained via field tile (which it had not).
Because the land at issue was farmed, the USDA’s Natural Resources Conservation Service (NRCS) used an offsite comparison field to compare with the tract at issue for a determination of the presence of wetland. The comparison site chosen was an unfarmed depression that was unquestionably a wetland. In 2002, an attempt was made to place the farm in the Conservation Reserve Program, which triggered a field visit by the NRCS. However, a potential wetland violation had been reported and NRCS was tasked with making a determination of whether a wet area had been converted to wetland after November 28, 1990. The landowners requested a certified wetland determination, and in late 2002 the NRCS made a “routine wetland determination” that found all three criteria for a wetland (hydric soil, hydrophytic vegetation and hydrology) were present by virtue of comparison to adjacent property because the tract in issue was being farmed. The landowners were notified in early 2003 of a preliminary technical determination that 2.8 acres were converted wetlands and 1.6 acres were wetlands. The NRCS demanded that the landowners plant 300 trees per acre on the 2.8 acres of “converted wetland.”
The landowners requested a reconsideration and a site visit. Two separate site visits were scheduled and later cancelled due to bad weather. The landowners also timely notified NRCS that they were appealing the preliminary wetland determination and requested a field visit, asserting that NRCS had made a technical error. A field visit occurred in the spring of 2003 and a written appeal was filed of the preliminary wetland determination and a review by the state conservationist was requested. The appeal claimed that the field visit was inadequate. The husband met with the State Conservationist in the fall of 2003. No site visit occurred, and a certified final wetland determination was never made. The landowners believed that the matter was resolved.
The husband died, and nine years later a new tenant submitted a “highly erodible land conservation and wetland conservation certification” to the FSA. Permission was requested from the USDA to remove an old barn and house from a field to allow farming of that ground. In late 2012, the NRCS discovered that a final wetland determination had never been made and a field visit was scheduled for January of 2013 shortly after several inches of rain melted a foot of snow on the property. At the field visit, the NRCS noted that there were puddles in several fields. The NRCS used the same comparison field that had been used in 2002, and also determined that underground drainage tile must have been present (it was not).
Based on the January 2013 field visit, the NRCS made a final technical determination that one field did not contain wetlands, another field had 1.3 acres of wetlands, another field had 0.7 acres of converted wetlands and yet another field had 1.9 acres of converted wetlands. The plaintiff (the surviving spouse) appealed the final technical determination to the USDA’s National Appeals Division (NAD). At the NAD, the plaintiff asserted that either tile had been installed before the effective date of the Swampbuster rules in late 1985 or that tiling wasn’t present (a tiling company later established that no tiling had been installed on any of the tracts); that none of the tracts showed water inundation or saturation; that none of the tracts were in a depression; and that the trees that were removed over two decades earlier were not hydrophytic, were not dispositive indicators of wetland, and that improper comparison sites were used. The NRCS claimed that the tree removal altered the hydrology of the site. The USDA-NAD affirmed the certified final technical determination. The plaintiff appealed, but the NAD Director affirmed. The plaintiff then sought judicial review.
Trial court decision. The trial court affirmed the NAD Director’s decision and granted summary judgment to the government. Boucher v. United States Department of Agriculture, No. 1:13-cv-01585-TWP-DKL, 2016 U.S. Dist. LEXIS 23643 (S.D. Ind. Feb. 26, 2016). The court based its decision on the following:
- The removal of trees and vegetation had the “effect of making possible the production of an agricultural commodity” where the trees once stood and, thus, the NRCS determination was not arbitrary or capricious with respect to the converted wetland determination.
- The NRCS followed regulatory procedures found in 7 C.F.R. §12.31(b)(2)(ii) for determining wetland status on the land that was being farmed by comparing the land to comparable tracts that were not being farmed.
- Existing regulations did not require site visits during the growing season.
- “Normal circumstances” of the land does not refer to normal climate conditions but instead refers to soil and hydrologic conditions normally present without regard to the removal of vegetation.
- The ten-year timeframe between the preliminary determination and the final determination did not deprive the plaintiff of due process rights.
The appellate court reversed the trial court decision and remanded the case for entry of judgment in the plaintiff’s favor and award her “all appropriate relief.” Boucher v. United States Dep’t of Agric., No. 16-1654, 2019 U.S. App. LEXIS 23695 (7th Cir. Aug. 8, 2019). On the comparison site issue (the USDA’s utilization of the on-site wetland identification criteria rules), the USDA claimed that 7 C.F.R. § 12.31(b)(2)(ii) allowed them to select a comparison site that was "on the same hydric soil map unit" as the subject property, rather than on whether the comparison site has the same hydrologic features as the subject tract(s). The appellate court rejected this approach as arbitrary and capricious, noting that the NRCS failed to try an "indicator-based wetland hydrology" approach or to use any of their other tools when picking a comparison site. In addition, the appellate court noted a COE manual specifies that, “[a] hydrologist may be needed to help select and carry out the proper analysis" in situations where potential lack of hydrology is an issue such as in this case. However, the NRCS did not send a hydrologist to personally examine the plaintiff’s property, claiming instead that a comparison site was not even necessary. Based on 7 C.F.R. §12.32(a)(2), the USDA claimed, the removal of woody hydrophytic vegetation from hydric soils to permit the production of an agricultural commodity is all that is needed to declare the area "converted wetland."
The appellate court concluded that this understanding of the statue was much too narrow and went against all the other applicable regulatory and statutory provisions by completely forgoing the basis of hydrology that the provisions are grounded in. Accordingly, the appellate court reasoned that because hydrology is the basis for a change in wetland determination, the removal of trees is merely a factor to determine the presence of a wetland, but is not a determining factor. In addition, the appellate court pointed out that the NRCS never indicated that the removal of trees changed the hydrology of the property during the agency appeal process – a point that the USDA ignored during the administrative appeal process. The appellate court rather poignantly stated, “Rather than grappling with this evidence, the hearing officer used transparently circular logic, asserting that the Agency experts had appropriately found hydric soils, hydrophytic vegetation, and wetland hydrology…”.
The USDA-NRCS was brutalized (rightly so) by the appellate court’s decision for its lack of candor and incompetence. Those same agency characteristics were also illustrated in the Eighth Circuit decision of Barthel v. United States Department of Agriculture, 181 F.3d 934 (8th Cir. 1999). Perhaps much of the USDA/NRCS conduct relates to the bureaucratic unilateral decision in 1987 to change the rules to include farmed wetland under the jurisdiction of Swampbuster. That decision has led to abuse of the NAD process and delays that have cost farmers untold millions. Hopefully, the clean-out of some USDA bureaucrats as a result of the new Administration that began in early 2017 will result in fewer cases like this in the future.
Tuesday, August 6, 2019
In 2018, the U.S. Supreme Court, in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), handed South Dakota a narrow 5-4 win in its quest to collect taxes from online sales. The Court held that the Constitution’s Commerce Clause did not bar South Dakota from statutorily requiring remote sellers without a physical presence in the state to collect and remit sales tax on goods and services that are sold to buyers for delivery inside the state of South Dakota. In so doing, the Court distinguished and at least partially overruled 50 years of Court precedent on the issue.
But, did the Court open the floodgates for the states to tax every dollar of sales in a state from an out-of-state seller? That’s a hard case to make because the Court ruled specifically on a South Dakota statute that contained a de minimis sales requirement before state sales tax kicked-in. However, the Kansas Department of Revenue (KDOR) has now taken the position that any amount of sales by a remote seller (a seller without any physical presence in Kansas) to a Kansas buyer triggers the need of the remote seller to register with the state and pay Kansas sales tax.
The Kansas position concerning sales taxation of remote sellers and implications – the focus of today’s blog post.
Online Sales - Historical Precedent
The core constitutional issues concerning a state’s ability to impose sales (and/or use) tax on a seller with no physical presence in the state involve interstate commerce and due process. In 1967, the U.S. Supreme Court determined that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States” in holding that Illinois could not subject a mail order seller located in Missouri to use tax where the seller had no physical presence in Illinois. National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967). In holding the law unconstitutional, the Court reasoned that subjecting the seller’s interstate business to local “variations in rates of tax…and record-keeping requirements” would violate the purpose of the Commerce Clause “to ensure a national economy free from…unjustifiable local entanglements.”
Twenty-five years later, the Court reaffirmed the limitations of the Commerce Clause on state regulatory authority in Quill Corporation v. North Dakota, 504, U.S. 298 (1992). In Quill, the Court held that a mail order house with no physical presence in North Dakota was not subject to North Dakota use tax for “property purchased for storage, use, or consumption within the State.” The Court followed closely its holding in National Bellas Hess, Inc. because doing so “encourage[d] settled expectations and …foster[ed] investment by businesses and individuals.” As applied to internet sales, Quill (which predated the internet) does not exempt all internet sales from state sales taxes – just sales by sellers who don’t have a physical presence in a particular state. National retailers have a presence in many states.
More recently, in 2015, the Court examined a Colorado “tattletale” law that required out-of-state sellers with no physical presence in the state “to notify…customers of their use tax liability and to report” sales information back to Colorado. Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2013). The trial court enjoined enforcement of the law on Commerce Clause grounds. On appeal, the Tenth Circuit held that it couldn’t hear the challenge to the law because the Tax Injunction Act (28 U.S.C. §1341) divested it of jurisdiction and the matter belonged in state court and, ultimately, the U.S. Supreme Court. The Tenth Circuit remanded the case for dismissal of the Commerce Clause claims and dissolution of the permanent injunction. The U.S. Supreme Court reversed and remanded the decision of the Tenth Circuit on the jurisdiction issue and, on remand, the Tenth Circuit, invalidated the Colorado law on Commerce Clause grounds. Direct Marketing Association v. Brohl, 814 F.3d 1129 (10th Cir. 2016).
In the U.S. Supreme Court’s reversal and remand of the Tenth Circuit’s decision in Direct Marketing Association, Justice Kennedy wrote a concurring opinion that essentially invited the legal system to find an appropriate case that would allow the Court to reexamine the Quill and National Bellas Hess holdings. Hence, the South Dakota legislation.
South Dakota Legislation and Litigation
S.B. 106 was introduced in the 2016 legislative session of the South Dakota legislature. It requires the collection of sales taxes from certain remote sellers – those with “gross revenue” from sales in South Dakota of over $100,000 per calendar year or with 200 or more “separate transactions” in the state within the same timeframe.
S.B. 106 was signed into law on March 22, 2016, and the state Department of Revenue soon thereafter began issuing notices to sellers that it thought were in violation of the law. Several out-of-state sellers that received notices did not register for sale tax licenses as the law required. Consequently, the state brought a declaratory judgment action against the sellers in circuit court, and sought a judicial declaration that the S.B. 106 requirements were valid and applied to the sellers. The state also sought an order enjoining enforcement of S.B. 106 while the action was pending in court, and an injunction that required the sellers to register for licenses to collect and remit sales tax.
The sellers tried to remove the case to federal court based on federal question jurisdiction, but the federal court rejected that approach and remanded the case to the South Dakota Supreme Court. South Dakota v. Wayfair, Inc., 229 F. Supp. 3d 1026 (D. S.D. 2017). On remand, the South Dakota Supreme Court invalidated S.B. 106 on Commerce Clause grounds based on the U.S. Supreme Court precedent referenced above. State v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. 2017). The state of South Dakota filed a petition for certiorari with the U.S. Supreme Court and the Court granted the petition.
U.S. Supreme Court Decision – The Importance of “Substantial Nexus”
Article I, Section 8 of the U.S. Constitution says that, “The Congress shall have the power...to regulate commerce…among the several states…”. That was the key point of the Court’s 1967 Bellas Hess, Inc. decision. As noted above, in that case the Court stated that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States.” In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the Court ruled that a state tax would be upheld if it applied to an activity having a substantial nexus with the state; was fairly apportioned; did not discriminate against interstate commerce; and, was fairly related to the services that the state provided. Later, in the Quill case, the Court determined that a physical presence in the taxing jurisdiction was what satisfied the Brady “substantial nexus” requirement.
In Wayfair, the Court determined that a “substantial nexus” could be present without the party subjected to tax having a physical presence in the taxing jurisdiction. But, the key point is that the “substantial nexus” test of Brady remains. Likewise, the other three requirements of Brady remain. A state can only impose sales (or use) tax on a remote seller without a physical presence in the state if the tax is fairly apportioned; does not discriminate against interstate commerce; and is fairly related to services that the state provides. In other words, taxing a business without a physical presence in the state cannot unduly burden interstate commerce. The Wayfair majority determined that the South Dakota law satisfied these tests because of the way it was structured – it had only a limited application due to the requirement of a de minimis a dollar amount of sales or transactions in the state; it was not applied retroactively; South Dakota was a member of the Streamlined Sales and Use Tax Agreement (SSUTA); the sellers at issue were national businesses with a large online presence; and South Dakota provided tax software to ease the administrative burden.
On August 1, 2019, the KDOR issued Notice 19-04 designed to provide “guidance” to remote sellers doing business in Kansas. https://www.ksrevenue.org/taxnotices/notice19-04.pdf In the Notice, the KDOR noted that Kansas law (Kan. Stat. Ann. §79-3702(h)(1)(F)) defines a “retailer doing business in this [Kansas]” as: “any retailer who has any other contact with this state that would allow this state to require the retailer to collect and remit tax under the provisions of the constitution and the law of the United States.” The KDOR also noted that the Kansas requires online (and other remote) sellers with no physical presence in Kansas to collect and remit “the applicable” sales and use tax on sales delivered into Kansas. KDOR indicated that remote sellers are to register and begin collecting and remitting Kansas sales and/or use tax by October 1, 2019.
The Notice, as strictly construed, is correct. The state can require a remote seller to register with the state and collect and remit sales and/or use tax “under the provisions of the constitution and the laws of the United States.” That would mean as the applicable law has been defined by the U.S. Supreme Court, including the Court’s most recent Wayfair decision – which involved a state law that contained a de minimis requirement based on amount of sales or number of transactions. However, the KDOR Notice did not specify any level of de minimis sales before sales tax was triggered. Indeed, the Director of Research and Analysis for KDOR was quoted in the Bloomberg Daily Tax Report (online) on August 1 as stating that KDOR “does not believe it needs a de minimis threshold” based on Kan. Stat. Ann. §79-3702. This is an inaccurate statement that will likely invite a legal challenge to the KDOR’s position. There simply is no protection in the Wayfair decision for KDOR’s position. The “substantial nexus” test still must be satisfied – even with a remote seller. Indeed, during the 2019 session of the Kansas legislature, a major tax bill contained de minimis requirements that mirrored the South Dakota legislation, but the Governor vetoed the bill and the Kansas House failed to override the veto. Presently, no other state has taken the position that the KDOR has taken.
The KDOR’s position amounts to a frontal assault on the Commerce Clause post-Wayfair. Presently, 23 states are “full members” of the SSUTA. For those states, Wayfair at least implies that membership in the SSUTA has the effect of minimizing the impact on interstate commerce. But, that doesn’t mean that SSUTA membership eliminates the “substantial nexus” requirement. Indeed, South Dakota was an SSUTA member and the Court still went through the “substantial nexus” analysis. Thus, it appears that any state legislation must have exceptions for small businesses with low volume transactions and sales revenue. Whether a series LLC (in some states such as Iowa) or subsidiaries of a business could be created, each with sales below the applicable threshold, remains to be seen.
On a related note, could the KDOR (or any other state revenue department) go after a portion of business income of the out-of-state business via income tax? That seems plausible. However, the Interstate Income Act of 1959 (15 U.S.C. §381-384), requires that a business (or individual – the business form does not matter because corporations have long held personhood status under the Constitution (see, Bank of the United States v. Deveaux, 9 U.S. 61 (1809); Burwell v. Hobby Lobby Stores, Inc., 134 S. Ct. 2751 (2014)) have some sort of connection with a state before its income can be taxed (at least with respect to the solicitation of orders for tangible personal property). Is that legislation now unconstitutional too? Or, is there a distinction remaining between taxing receipts as opposed to income? That may be at issue in a future Supreme Court case.
For now, it’s practically a sure bet that, unless the Kansas legislature passes a bill containing de minimis thresholds that can withstand the Governor’s veto, the state will be devoting taxpayer resources to defending a lawsuit that will challenge the state’s (as of now) unsupportable position.
Friday, August 2, 2019
It’s been about a month since I devoted a blog post to court litigation involving agricultural producers and businesses. So, it’s time to devote another post to the matter as an illustration of how often the law and the business of agriculture intersect. These posts have proven to be quite popular and instructive.
“Ag in the Courtroom” – the most recent edition. It’s the topic of today’s post.
More Bankruptcy Developments
As I have noted in numerous posts over the past couple of years, the difficult economic conditions in much of agriculture in the Great Plains and the Midwest have made bankruptcy law rise in importance. Fortunately, legislation is headed to the President’s desk that will increase the debt limit in Chapter 12 bankruptcy to $10 million and place some of the existing Chapter 12 provisions in Chapter 11 for use by non-farm small businesses. Those were needed pieces of legislation.
A recent Alabama bankruptcy case illustrates the peril of selling loan collateral without the creditors notice and consent. It’s a unique set of facts because the debtor sold the collateral, a tractor, to bail her boyfriend out of jail. In In re Reid, 598 B.R. 674 (Bankr. S.D. Ala. 2019), the Farm Service Agency (FSA) attached itself as a creditor in the debtor’s chapter 7 bankruptcy proceeding. In March of 2016 the debtor took out two FSA loans for a total of $50,000. A security agreement was also executed at the same time granting the FSA a security interest in "All farm equipment . . . and inventory, now owned or hereafter acquired by the Debtor, together with all replacements, substitutions, additions, and accessions thereto, including but not limited to the following which are located in the State of Alabama." A specific list of assets was attached, including a New Holland tractor, ten beef breeding cows, and nine calves. The debtor used the loan proceeds to purchase the equipment and livestock that was listed as collateral.
In June of the same year, the debtor was notified that she could not have cattle on the land she purchased with another loan not at issue in the case. However, the debtor was never notified of the restriction and it was not stated in the purchase contracts. Ultimately, the debtor was given thirty days to vacate the premises. Around this time, the debtor’s equipment and cattle started to go missing. The debtor was also becoming aware that her boyfriend (and father of her children) had a drug problem, and she began to suspect that he was selling the equipment and cattle for drugs. Later, the debtor attempted to stop a man from taking cattle from the property and the man said to take it up with her boyfriend. The debtor did not report the cattle or equipment as stolen. The debtor’s boyfriend was arrested about the same time for drug crimes and eluding the police. The debtor vacated the property with the only collateral remaining at the property being the New Holland tractor, which the debtor listed for sale on Facebook. The debtor testified that she sold the New Holland tractor to an unknown purchaser for between $6,000.00 and $8,000.00. But the exact price and identity of the purchaser could not be found as the debtor deleted her Facebook account. The proceeds of the tractor sale were put towards bail money for the boyfriend. The debtor never made a payment on the loans and vacated the property before the first payment was due.
The FSA attempted to recover the tractor but was unsuccessful. The FSA sought to have the bankruptcy court find the debt owed to the FSA in the amount of $52,048.56 plus interest to be non-dischargeable for fraud; fiduciary defalcation; embezzlement; and willful and malicious injury. The court averaged the alleged selling price of the tractor and rendered $7,000 non-dischargeable. The court also determined that the debtor did not fraudulently obtain the FSA loans, and did not embezzle the collateral because fraud wasn’t present. Because willful and malicious injury was present upon the debtor’s sale of the tractor without notice to the FSA and use of the proceeds for the debtor’s personal benefit, the $7,000 that the debtor received upon sale of the tractor was non-dischargeable.
The Intersection of State and Federal Regulation
Agriculture is a heavily regulated industry. Sometimes that regulation is apparent and sometimes it occurs an a rather unique manner. Sometimes it comes from the federal government and sometimes it is purely at the state and local level. In yet other situations, the regulation is an interesting (and frustrating for those subject to it) blend of federal and state/local regulation.
In 2009, the defendant in Carroll Airport Comm'n v. Danner, No. 17-1458, 2019 Iowa Sup. LEXIS 57 (May 10, 2019), planned to construct a grain leg (bucket elevator) and grain bins. In 2013, the defendant obtained the proper county zoning permits but was told of the need to comply with the airport zoning ordinances. The grain leg stands within 10,000 feet horizontally from the end of plaintiff’s runway. The structure reaches a height of 127 feet off the ground. The parties agree the grain leg intrudes within the airport's protected airspace by approximately sixty feet. After construction began it was evident that there would be issues with the airport zoning ordinances and the plaintiff asked the Federal Airport Administration (FAA) to perform an aeronautical study of the grain leg and its impact on aviation safety. The FAA issued a letter stating, "This aeronautical study revealed that the structure does exceed obstruction standards but would not be a hazard to air navigation." It also warned, “This determination concerns the effect of this structure on the safe and efficient use of navigable airspace by aircraft and does not relieve the sponsor (i.e., the defendant) of compliance responsibilities relating to any law, ordinance, or regulation of any Federal, State, or local government body.” Lastly the FAA requested that the defendant paint the structure and add red lights to the top of it. The defendant did so. The FAA also adjusted the flight patterns in and out of the airport to accommodate this structure. The plaintiff did not seek review under this determination.
Two years later, the plaintiff (the local airport commission) sued alleging the grain leg violated certain building ordinances; city and county zoning ordinances; airport commission regulations; and constituted a nuisance and hazard to air traffic. The plaintiff sought equitable relief—an injunction requiring the defendant to modify or remove the grain leg. The defendant raised an affirmative defense of federal preemption. In June 2017, the trial court found that the grain leg violated state and local zoning ordinances and constituted a nuisance and an airport hazard. The trial court found that the grain leg did not fall within the agricultural exemption to certain zoning laws and rejected the defendants’ affirmative defense that the no-hazard letter preempted state and local zoning ordinances. The appellate court affirmed, concluding that the doctrines of express, implied, and conflict preemption did not apply to the FAA no-hazard determination. On further review, the state Supreme Court affirmed. The Supreme Court concluded that the FAA no-hazard determination did not preempt local zoning ordinances, was not legally binding, and contained language notifying the defendant that compliance with local rules was required.
Rights involving surface water vary from state-to-state. In some parts of the U.S., however, a party owning land adjacent to a watercourse has what are known as “riparian” rights to the water. But, do those rights apply to man-made lakes, or just natural lakes? The issue came up recently in Incline Village Board of Trustees v. Edler, No. SC97345, 2019 Mo. LEXIS 178 (Mo. Sup. Ct. Apr. 30, 2019).
The defendants owned properties in subdivisions around a lake. One of the properties of the second subdivision abutted the lake. The properties they owned in the first subdivision did not abut the lake. During the creation of the first subdivision, restrictions were added to the land. One such restriction stated, “No structures or other improvements shall be made on or to any common area, including any body of water, other than such structures or improvements which are made by the trustees for the benefit of all lot owners. Except that, the owner of each lot which abuts any body of water, may construct one boat dock on such body of water, provided that, said boat dock extends from said lot and is first approved in writing by the trustees.” All landowners in the first subdivision were entitled to use the lake, even if they did not abut the lake. The second subdivision was not joined with the first one, but it was clear that the second subdivision was excluded from use rights on the lake. Lots in the first subdivision were subject to assessments to maintain the lakes.
The defendants built a dock on the property on the second subdivision. The trustees of the first subdivision defendants sued seeking a declaratory judgment, damages for trespass, and the removal of the dock. The district court ordered removal of the dock and determined that special circumstances existed supporting the award of attorney's fees of $70,000 in favor of the trustees.
On appeal, the appellate court determined that the lake was clearly artificial and, thus, the defendants were not riparian owners. Riparian rights are only extended to landowners adjacent to natural lakes. The appellate court also rejected the defendants’ reliance-based argument. The appellate court noted that the defendants had never had use of the lake for dock purposes or paid assessments for its maintenance. In addition, the defendants’ predecessor in title's deed to the adjacent land explicitly excepted the lake from the transfer. In addition, the plaintiffs had told the defendants of the property restrictions before the dock was built. As for attorney fees, the appellate court determined that there was not any special circumstance to merit an award of attorney fees. The plaintiff had not given any formal warning about not building the dock and the defendants had sought legal advice.
It’s never a dull moment in ag law involving ag producers, agribusinesses and rural landowners. The cases keep on rolling in.
Thursday, July 25, 2019
Agriculture is a heavily regulated industry. Land ownership; production activities; marketing of ag products; and food products that are in the consumer (and livestock) food supply are subject to federal and state regulations. What are the major federal rules? How do they apply to producers of food products?
The regulation of food products – it’s the topic of today’s post.
The government agencies with primary responsibility for ensuring the safety of the U.S. food supply are the USDA (through the Food Safety and Inspection Service (FSIS)) and the Food and Drug Administration (FDA). While neither agency has the authority to mandate a recall of unsafe food, they have developed general oversight procedures and protocol for voluntary food recalls by private companies. The USDA is generally responsible for the regulation of meat, poultry and certain egg products, while the FDA has responsibility for the regulation of all other food products including seafood, milk, grain products, fruits and vegetables, and certain canned, frozen and otherwise packaged foods that contain meat, poultry and eggs that USDA does not otherwise regulate.
Food Adulteration and Misbranding
The regulations generally proscribe the adulteration and misbranding of food. In general, a food is considered adulterated if it contains a harmful substance that may pose a safety risk, contains an added harmful substance that is acquired during production or cannot be reasonably avoided, contains a unapproved substance that has been intentionally added to the food, or if it has been handled under unsanitary conditions that presents a risk of contamination that may pose a safety threat. Under the Federal Food, Drug, and Cosmetic Act (FFDCA) (21 U.S.C. §§ 301-399), the manufacture, delivery, receipt or introduction of adulterated food into interstate commerce is prohibited. However, the USDA regulations did not prevent the introduction into the human food chain of meat from downed livestock. In Baur v. Veneman, 352 F.3d 625 (2d Cir. 2003), a beef consumer argued that the USDA should label all downed livestock as “adulterated,” and that the consumption of meat from downed animals created a serious health risk of disease transmission and that elimination of downed cattle from the human food stream was necessary to protect the public health. In late 2003, the United States Court of Appeals for the Second Circuit held that the beef consumer had standing to challenge the USDA policy. Shortly thereafter, the presence of “Mad-Cow” disease was discovered in the U.S., and the USDA announced on December 30, 2003, that it was changing its regulations to ban the meat from downed animals from the human food chain. FSIS issued a series of three interim rules in early 2004. The final rule is effective October 1, 2007, and prohibits the slaughter of non-ambulatory cattle in the United States (except that veal calves that cannot stand due to fatigue or cold weather may be set apart and held for treatment and re-inspection). 72 Fed. Reg. 38699 (July 13, 2007). Also, the final rule specifies that spinal cord must be removed from cattle 30 months of age and older at the place of slaughter, and that records must be maintained when beef products containing specific risk materials are moved from one federally inspected establishment to another for further processing. Under the final rule, countries that have received the internationally recognized BSE status of “negligible risk” are not required to remove specific risk materials.
While neither the USDA nor the FDA can order a private company to recall unsafe food products, they can issue warning letters, create adverse publicity, seize unsafe food products, seek an injunction or begin prosecuting criminal proceedings.
For food products over which the FSIS has jurisdiction, upon learning that a misbranded or adulterated food item may have entered commerce, the FSIS will conduct a preliminary investigation to determine whether a voluntary recall is warranted. If a recall is deemed necessary, a determination is made as to the degree of the recall and the public is notified. For food products subject to the FDA’s jurisdiction, a similar procedure is utilized.
Organic foods are produced according to certain production standards. For crops, “organic” generally means they were grown without the use of conventional pesticides, artificial fertilizers, human waste, or sewage sludge, and that they were processed without ionizing radiation or food additives. For animals, “organic” generally means they were raised without the use of antibiotics and without the use of growth hormones. In most countries, organic produce must not be genetically modified.
Historically, organic farms have been relatively small family-run farms with organic food products only available in small stores or farmers' markets. More recently, organic foods have become much more widely available, and organic food sales within the United States have grown by 17 to 20 percent a year in recent years while sales of conventional food have grown at only about 2 to 3 percent annually. This large growth is predicted to continue, and many companies (including Wal-Mart) are beginning to sell organic food products.
An organic food producer must obtain certification in order to market food as organic. Under the Organic Food Production Act (OFPA) of 1990 (7 U.S.C. §§ 6501-23), the USDA is required to develop national standards for organic products. USDA regulations are enforced through the National Organic Program (NOP) governing the manufacturing and handling of organic food products. As enacted, the statute provides that an agricultural product must be produced and handled without the use of synthetic substances in order to be labeled or sold as “organic”. But, under USDA regulations, a “USDA Organic” seal can be placed on products with at least 95% organic ingredients. The 95 percent rule was challenged by a Maine organic blueberry farmer as being overly tolerant of non-organic substances and inconsistent with the statute, and the United States Court of Appeals for the First Circuit agreed, invalidated several of the regulations while scaling back the scope of other regulations. Harvey v. Veneman, 396 F.3d 28 (1st Cir. 2005). In response to the court’s opinion (and while the case was on appeal) the Congress amended OFPA. Upon further review, the court determined that OFPA, as amended, permitted the use of synthetics as both ingredients in and processing aids to organic food. Harvey v. Johanns, 494 F.3d 237 (1st Cir. 2007).
Produce Safety Rule
In early 2011, the President signed into law the Food Safety Modernization Act (FSMA) of 2010. 21 U.S.C. §301, et seq. The FMSA gives the FDA expansive power to regulate the food supply, including the ability to establish standards for the harvesting of produce and preventative control for food production businesses. Beginning in 2018, the new rules will significantly impact many growers and handlers of fresh produce.
The FMSA also gives the FDA greater authority to restrict imports and conduct inspections of domestic and foreign food facilities. To implement the requirements of the FMSA, the FDA had to prepare in excess of 50 rules, guidance documents, reports under a short time constraint. Indeed, the timeframe was so short FDA complained that they didn’t have enough time to do the job appropriately. That led to lawsuits being filed by activist groups to compel the FDA to issue several rules that were past-due. A federal court agreed with the activists in the spring of 2013 and, as a result, the FDA issued four proposed rules with comment periods that ended in November of 2013. Center for Food Safety v. Hamburg, 954 F. Supp. 2d 965 (N.D. Cal. 2013). One of the most contentious issues involved the rule FDA was supposed to develop involving intentional adulteration of food. FDA said it needed two more years to develop an appropriate rule, but the Court ordered them to develop it immediately. The hope, at that time, was that the Congress would step in and modify the deadlines imposed on the FDA so that reasonable rules could be developed rather than being simply rushed through the regulatory process for the sake of meeting an arbitrary deadline.
In late 2015, the FDA issued its Final Produce Safety Rule that has application to growers and fresh produce handlers (those that pack and store fresh produce). The rule is designed to reduce the instances of foodborne illnesses. Effective, January 16, 2016, the rule generally covers the use of manure or compost as fertilizer, allowing (at least for the present time) a 90 to120-day waiting period between the application of untreated manure on land and the time of harvest. That timeframe is in accordance with USDA National Organic Program Standards. Relatedly, the rule requires that raw manure and untreated biological soil amendments of animal origin must be applied without contacting produce and post-application contact must be minimized. Also, the rule addresses water quality and establishes testing for water that is used on the farm such as for irrigation or handwashing purposes. Under the rule, there must be no detectible generic E coli in water that has the potential to contact produce. The rule establishes a timeframe for noncompliant growers to come into compliance with the water requirements. The rule also addresses scenarios that could involve contamination of food products by animals, both domestic and wild, and establishes standards for equipment, tools and hygiene. As for potential contamination by wild animals, the rule requires farmers to monitor growing areas for potential contamination by animals and not harvest produce that has likely been contaminated. In addition, the rule establishes requirements for worker training, health and hygiene, and particular rules for farms that grow sprouts.
Under the rule, farms that sell an average of $25,000 or less of produce over the prior three years are exempt. Similarly, exempt are farms (of any size) whose production is limited exclusively to food products that are cooked or processed before human consumption. For producers whose overall food sales average less than $500,000 annually over the prior three years where the majority of the sales are directly to consumers or local restaurants or retail establishments, a limited exemption from the rule can apply. However, these producers must maintain certain required documentation (effective Jan. 16, 2016) and disclose on the product label at the time the product is purchased the name and location of the farm where the food product originated. In addition, the rule also allows commercial buyers to require that the farms from which they purchase produce follow the rule on their own accord.
Food products – yet another aspect of agriculture that is substantially regulated.
Thursday, June 27, 2019
A significant amount of governmental regulation of agricultural activities is conducted by and through administrative agencies that promulgate regulations and make decisions. The rules for and scope of regulations is determined by unelected bureaucrats and often has the force of law. In addition, much of administrative law involves the administrative agency that developed the regulation at issue serving as judge and jury over disputed matters involving those same regulations. This raises fundamental questions of fairness.
In theory, governmental administrative agencies cannot exceed the authority provided by the legislative body. Ultimately, the courts serve as the check on the exercise of authority. But, how? Under what standard do the courts review administrative agency decisions? It’s an issue that was addressed by the U.S. Supreme Court yesterday, and it didn’t turn out the way that many in agriculture had hoped.
Today’s post takes a deeper look at administrative agencies, how farmers and ranchers can best deal with them, and review of administrative agency determinations by the courts. The deference provided to administrative agency decisions – that’s the topic of today’s post.
Administrative Agency Basics
At the federal level, the Congress enacts basic enabling legislation, but leaves the particular administrative departments (such as the USDA) to implement and administer congressionally created programs. As a result, the enabling legislation tends to be vague with the administrative agencies (such as the USDA) needing to fill in the specific provisions by promulgating regulations. The procedures that administrative agencies must follow in promulgating rules and regulations, and the rights of individuals affected by administrative agency decisions are specified in the Administrative Procedures Act (APA). 5 U.S.C. §§ 500 et seq. The provisions of the APA constitute the operative law for many of the relationships between farmers and ranchers and the government.
Administrative Agency Procedure
Usually, a farmer or rancher's contact with an administrative agency is in the context of participation in an agency-administered program, or being cited for failure to comply with either a statutory or administrative rule. So, it’s helpful for farmers and ranchers to have a general understanding of how administrative agencies work and the legal effects of their decisions. In general, disputed matters involving administrative agencies must first be dealt with in accordance with the particular agency's own procedural rules before the matter can be addressed by a court of law. This is known as exhausting administrative remedies. 7 U.S.C. §6912(e). See also Johnston v. Patterson, No. 4:14-CV-210-BO, 2014 U.S. Dist. LEXIS 172224 (E.D. N.C. Dec. 12, 2014). About the only exception to the rule of exhaustion occurs when a facial challenge is made to the regulation itself. See Gold Dollar Warehouse, Inc. v. Glickman, 211 F.3d 93 (4th Cir. 2000). Thus, participating carefully in administrative proceedings can be vitally important to a farmer or rancher, especially in terms of properly preserving a record for subsequent court review.
Going through the administrative process is critical because, typically, an appeal to a court of law is made only on the basis of the record generated in the administrative proceeding. Courts are limited in the extent to which they can substitute their judgment for that of an administrative agency regarding the facts of the dispute. Thus, it is critical to preserve all disputed factual and legal issues in the record of the administrative proceeding so that they can later be considered by a court. The exhaustion of administrative remedies, as a general rule, also requires that legal issues must be raised during the administrative process so as to be preserved for judicial review. If they are raised in the administrative process, then they will likely be precluded. Also, exhaustion is required as to each legal issue. See, e.g., Ballanger v. Johanns, 495 F.3d 866 (8th Cir. 2007).
What’s the Standard For Reviewing Agency Action?
Courts generally consider only whether the administrative agency acted rationally and within its statutory authority. Consequently, a particular farmer or rancher bears the burden of insuring that the record is adequate for the appeal of the issues involved before the matter leaves the administrative process. Otherwise, an appeal of an administrative agency's decision must be based solely on arguments that the agency acted arbitrarily, capriciously, beyond legal authority or that it abused its discretion.
In general, when dealing with administrative appeals from a federal agency such as the USDA, the court generally defers to the agency’s interpretation of its regulations as contained in the agency’s interpretive manuals. Prevailing in court on this type of a claim can be quite difficult. However, in Christensen v. Harris County, 529 U.S. 576 (2000), the U.S. Supreme Court ruled that statutory interpretations made by governmental agencies in pronouncements that do not have the force of law, such as opinion letters, policy statements, agency manuals, and enforcement guidelines, are not entitled to such great deference. Christensen is a significant case for the agricultural sector because the USDA often makes interpretations of the laws they administer in formats that do not have the force of law. Similarly, in Meister v. United States Department of Agriculture, 623 F.3d 363 (6th Cir. 2010), the court noted than an agency is not entitled to deference simply because it is a governmental agency. The case involved a claim that the U.S. Forest Service had failed to comply with its own regulations and a federal statute in developing its 2006 management plan for national forests in northern Michigan. The trial court granted the government’s motion for summary judgment, but the appellate court reversed. The appellate court noted that it was insufficient for the government to only identify the lands on which a particular activity (such as snowmobiling) could occur. Instead, the government had to identify the supply of lands on which participants in particular activities would experience a quality recreational experience. As a result, the issuance of the agency’s plan was arbitrary because the estimates of snowmobile and cross-country visitors to the forests were entirely arbitrary and there was no coordination with Michigan's recreational planning, and the agency did not minimize conflicts between off-road vehicle use and other uses and interests of the forests. The court specifically noted that agency deference was not automatic. Instead, the agency must apply the relevant statutory and regulatory authority.
On the deference issue, it was believed that a change might be in the wind. In 1997, the U.S. Supreme Court again reiterated the principle of agency deference. Auer v. Robbins, 519 U.S. 452 (1997). This so-called “Auer deference” involves a court deferring (or give “controlling weight”) to agency interpretations of its own ambiguous regulations. Another type of deference, known as “Chevron deference” involves a court deferring to an agency interpretation of ambiguous statutes that the agency administers. Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). However, the Court, in 2013 criticized the Court’s 1997 decision and suggested that it might be time to reconsider principles of agency deference. Decker v. Northwest Environmental Defense Center, 133 S. Ct. 1326 (2013).
The amount of deference a court gives to agency interpretations of its own regulations is important to agriculture. For example, the USDA administers the Packers and Stockyards Act (PSA). The PSA, bars packers (and others) from engaging in any “unfair, unjustly discriminatory, or deceptive practice.” 7 U.S.C. §192(a). The PSA also prohibits the making or giving of any “undue or unreasonable preference or advantage” to any person. 7 U.S.C. §192(b). The courts have construed this language to require harm to competition be shown to establish a violation. In late 2016, the USDA published an interim final rule removing the requirement to show harm to competition to establish a violation. But, the USDA later withdrew the rule. The withdrawal of the rule was challenged as arbitrary and capricious (the standard for overturning agency action). But, the Eighth Circuit denied the plaintiffs’ claims. Organization for Competitive Markets v. United States Department of Agriculture, 912 F.3d 455 (8th Cir. 2018). The court determined that the USDA, in abandoning the proposed rule, had provided a reasoned analysis based on principles that were “rational, neutral, and in accord with the agency’s proper understanding of its authority” – the USDA didn’t want to get sued. The case is an example of deference toward a governmental agency’s actions.
Yesterday, the U.S. Supreme Court addressed the issue of deference again in Kisor v. Wilkie, No. 18-15, 2019 U.S. LEXIS ___ (U.S. Sup. Ct. Jun. 26, 2019). The facts of the case didn’t involve agriculture. That’s not the important part. What is important is that the Court again reaffirmed (5-4, thanks to Chief Justice Roberts) Auer deference. However, the Court did appear to place some limitations on Auer deference for future cases. I say “appear” because the Court created a new multi-part test for review of agency action that could prove difficult for lower courts to apply and relatively easy for administrative agencies to skirt. According to the Court, a court that reviews agency action is to review the regulatory language at issue to determine whether the regulation is ambiguous. If it is, the court is to then apply Auer deference in determining whether the agency reached a reasonable conclusion resulting from the agency’s careful consideration and expertise after giving affected parties reasonable notice of the agency’s interpretation. From agriculture’s perspective, it was hoped that the Court would jettison Auer deference. That would have been the approach of Justice Gorsuch who would have eliminated the binding agency deference of Auer.
So, the battle between agriculture and administrative agencies will continue on numerous fronts, and the arguments over the reasonableness of agency interpretations will continue with the courts largely deferring to agency determinations. While there might be a dent in Auer deference, it still is a very functional defense to agency action.
The Equal Access to Justice Act (EAJA) (5 U.S.C. §§504 (2008); 28 U.S.C. §2412(d)(2)(A)) provides that a party who prevails administratively against government action can recover fees and expenses if the administrative officer determines that the government’s position was not substantially justified. However, the USDA’s longstanding position is that the EAJA does not apply to administrative hearings before the USDA’s National Appeals Division (NAD) because NAD proceedings are not adversarial adjudications that are held “under” the APA. But, the United States Court of Appeals for the Eighth Circuit rejected the USDA’s position in 1997. Lane v. United States Department of Agriculture, 120 F.3d 106 (8th Cir. 1997). The Ninth Circuit ruled similarly in 2007. Aageson Grain and Cattle, et al. v. United States Department of Agriculture, 500 F.3d 1038 (9th Cir. 2007). The Seventh Circuit ruled likewise in 2008. Five Points Road Venture, et al. v. Johanns, 542 F.3d 1121 (7th Cir. 2008).
Dealing with administrative agencies is a reality for the typical farmer or rancher. While ag didn’t get the clear victory it sought in Kisor, perhaps it’s a baby-step in the right direction. Only time will tell.