Chapter 12 and the New Capital Gains Tax Rule: More Upside for FSA Lenders in 2020?

Notwithstanding recent good news on China ag commodity purchase commitments, market experts are forecasting continued oversupply and difficult conditions for farmers through the first half of 2020, with the pipeline of new Chapter 12 filings expected to continue unabated, especially for dairy and protein producers. But there’s at least a hypothetical light at the end of the tunnel for agricultural lenders: a recent revision to a key tax provision in Chapter 12 of the Bankruptcy Code.

In October 2017, the Family Farmer Bankruptcy Clarification Act of 2017 (H.R. 2266) was signed into law. Broadly, the Act expands the ability of Chapter 12 debtors to deal with capital gains taxes in Chapter 12 plans of reorganization.

Specifically, the Act replaces Bankruptcy Code Section 1222(a)(2)(A) with new Section 1232, which now permits Chapter 12 debtors to treat capital gains taxes from post-bankruptcy asset sales as non-priority, general unsecured claims (i.e., a Chapter 12 plan can now be confirmed without paying 100% of post-petition capital gains taxes either in cash or over the life of the Chapter 12 plan).

Prior to this revision, under a Supreme Court ruling interpreting the 2005 version of Section 1222, only prepetition capital gains taxes could be classified as unsecured claims (and ultimately discharged under a Chapter 12 plan). This meant that some Chapter 12 debtors could not sell heavily depreciated assets post-bankruptcy without generating large, nondischargeble tax claims and effectively killing any chance for a viable exit from bankruptcy.

Theoretically, this revision could prove lucrative for secured lenders in Chapter 12 cases on two fronts. First, debtors will have the flexibility to sell/liquidate collateral under a plan without capital gains being an impediment to plan confirmation. Second, debtors who would otherwise be burdened with paying down 100% capital gains claims under a Chapter 12 plan will now have potentially greater free cash flow to support required plan payments to secured lenders and survive seasonal and/or unforeseen revenue swings.

The impact of the new Section 1232 remains to be seen, but the theoretical upside for lenders, servicers and the FSA itself lies in the opportunity for greater feasibility and flexibility as Chapter 12 debtors try to exit bankruptcy and stay in business. But at a minimum, the layered perils of depressed commodity prices and potential (constantly evolving) barriers to international commodities trade should serve to generate a pretty robust data pool for future analysis.

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Stuart Laven is a Cleveland, Ohio-based bankruptcy and restructuring attorney who focuses his practice on representing FSA lenders, producers, and other significant stakeholders in agricultural bankruptcies, out of court restructurings, and financings across much of the Midwest, including all U.S. Bankruptcy Courts in New York, Ohio, Michigan and Wisconsin. I can be reached at slaven@cavitch.com. Read my bio here.

Published by Stuart A. Laven, Jr., Esq.

Stuart Laven is a Cleveland, Ohio-based bankruptcy and restructuring attorney who focuses a significant portion of his practice on representing FSA lenders, producers, and other significant stakeholders in agricultural bankruptcies, out of court restructurings, and ag financings across much of the Midwest, including all U.S. Bankruptcy Courts in New York, Ohio, Michigan and Wisconsin.

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