2019 Farm Bankruptcies: A 20% Increase Compounded by Record High Debt and Record Low Income

The 2019 year-end bankruptcy filing data is finally in, and not surprisingly, Chapter 12 filings increased significantly–almost 20%–from the previous year. Nationwide, there were 595 Chapter 12 filings in 2019, compared with 498 for calendar year 2018. The 2019 levels are the highest in eight years, with the last peak being 637 in 2011 (immediately following the financial crisis).

According to Farm Bureau data, almost half (273) of last year’s filings were in the Midwest, driven by Wisconsin’s decade-high 57 cases. Given the extraordinarily difficult state of the dairy market, this should not be surprising.

Perhaps even more alarming is the state of net farm income and outstanding farm debt: both point to a burgeoning crisis. If trade assistance (Market Facilitation Program) payments and crop insurance proceeds are subtracted, 2019 inflation-adjusted net farm income would have been $63.6 billion, the second lowest of the past decade. Meanwhile, 2019 farm debt hit a record high $415 billion (not adjusted for inflation).

The “Phase 1” China trade deal and USMCA theoretically offer a flicker of hope for leveraged producers in 2020. But headwinds like the coronavirus outbreak and other unknowns may dampen a recovery and force more producers into Chapter 12, especially now that Chapter 12 eligibility has been significantly expanded to allow producers with up to $10 million in debt to file).

The Pea Protein Market Shift: Why Producer Bankruptcies May Play a Big Role

If you are purely data driven in how you view near-term agriculture market trends, peas don’t seem to have a bright future: production is up 40 percent from a year ago, but prices (of the heavily exported commodity) are the lowest in 20 years, due largely to heavy tariffs imposed by China (35%) and India (50%).

But if you are more disposed to a longer-term, big-picture thesis, peas look like the cash crop of the future, with nothing but exponential growth and upside on the horizon. Demand for Beyond Meat and other meat substitutes has expanded rapidly and shows no signs of slowing down: 327 domestic pea protein products debuted in 2019, versus 11 a decade ago. Globally, the number is 1,300 products. (Source: CNBC.com)

For some producers who are stuck in long term contracts to raise depressed or low-margin crops (or purchase seed for those crops), bankruptcy (Chapter 12 for producers with less than $10 million of debt; Chapter 11 for larger balance sheet producers) presents an opportunity to literally walk away from those contracts/crops and immediately take advantage of more lucrative pea crops.

Bankruptcy Code section 365 (which applies to farm/ag debtors the same way it does to non-ag business debtors) gives debtors in bankruptcy broad ability to “reject” burdensome ongoing “executory” contracts and unexpired leases. When a contract or lease is formally rejected (via a motion and bankruptcy court order, or as part of a Chapter 12/Chapter 11 plan), any remaining contract payment obligations (e.g., long term purchasing quotas or rents) are treated as unsecured claims against the bankruptcy estate, and the debtor is completely relieved of any go-forward commitments. There are subtle exceptions to this rule for payment or other obligations that arise after the bankruptcy is filed (post-bankruptcy payments/obligations have “administrative” priority status), but the substantial benefit to the reorganizing producer is the ability to walk away from long-term contracts.

The same section of the Bankruptcy Code also gives debtors the right, if certain conditions are met (like curing any past payment defaults), to “assume” an ongoing contract and continue performing under it after its exit from bankruptcy, even if the bankruptcy filing itself would have been a technical default/breach of the contract that would give the other party the right to cancel the contract. This Bankruptcy Code device may prove strategically lucrative for those producers who want to move forward with an existing pea seed/bulk pea sale or other profitable/promising long-term contract as they refocus their operations and right-size their balance sheets.

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.

What Happens to Market Facilitation Program Payments in Farm Bankruptcies?

The news in early November that a second round of $7.8 billion in 2019 Market Facilitation Program (MFP) payments would get underway—news that comes at a time when farm bankruptcy filings are on the rise—raises a potentially significant question for both agricultural lenders and struggling producers alike: what happens to MFP payments in bankruptcy?

The answer ultimately turns on whether the producer’s MFP entitlement is part of the secured lender’s collateral when the bankruptcy is filed: if it isn’t, it may serve as the primary (or only) source of cash to fund a Chapter 12 plan and/or working capital for operations while the bankruptcy is pending.

Of course, a secured lender who expects to capture inbound MFP entitlements should make sure that they are included in the security agreement’s collateral description—which sounds simple enough. But MFP payments—which don’t fit squarely into the time-tested categories of crop insurance, disaster relief, or margin coverage payments —present some unique and untested technical questions that make that task a bit nuanced.

The threshold question—especially for lenders with security agreements that predate the inception of the MFP—is what existing category of UCC Article 9 collateral MFP payments fall into. Are MFP payments “proceeds” of crops (as crop insurance payments and disaster relief subsidies have generally been treated under UCC 9-102(a)(64))? Or are the payments more in the nature of “general intangibles” (UCC 9-102(a)(42))? And if MFP payments are specifically described in the collateral description—either in a new loan or a loan/security agreement amendment—can a lender perfect an Article 9 security interest in a producer’s rights to future MFP payments via the usual state-law UCC Article 9 perfection process, or is it preempted by federal regulations/procedures altogether?

These questions have never been tested in the courts, which is to be expected with a program as new as the 2019 MFP. With the 2018 MFP in the rearview mirror (and, presumably, all 2018 MFP payments now long since disbursed into the ether), it’s the specific provisions of the 2019 program that matter. The 2019 MFP is controlled by the federal regulations in 7 C.F.R. 1409, which are pretty detailed in terms of producer eligibility, application procedures, and the mechanics and formula for payments. But they are silent on the questions posed above.

However, another USDA regulation, 7 C.F.R. 1404, gives guidance on the broad question of assignability of the 2019 payments: if an MFP payment to a producer has been authorized by FSA, the producer and lender need to execute an FSA-prescribed form CCC-251/252 (and file the form with the producer’s county FSA office) in order to effectuate and perfect the assignment of the payment to the lender.

But if MFP payments haven’t been officially approved for a given producer—i.e., they are still only a contingent “entitlement” or potential source of producer cash income—the federal regs don’t offer any insight on the procedure for perfecting a security interest in the payments (contrast this with security interests in federal crop insurance program payments, which, under the Federal Crop Insurance Act, can only be perfected via a form assignment accepted by the crop insurer). And in the absence of any case law specifically addressing the question, we are left to make an educated guess as to whether future MFP entitlements can be captured as “proceeds,” “general intangibles,” or otherwise.

Given this lack of clarity, the prudent path for lenders is to review and, if necessary, update their security agreements and UCC filings to ensure that the collateral descriptions capture “all proceeds [of the producer’s crop/product/herd/etc.], including without limitation any Market Facilitation Program Payments or other government payments,” as well as all “general intangibles.”

If there is any hint of a defect in the lender’s perfection in inbound MFP payments, there is a good chance they will be fair game in the producer’s bankruptcy case. This holds especially true in cases where the producer is “under water” with its senior lender(s)—i.e., it doesn’t have any unencumbered accounts receivable or other assets to fund any distributions to junior creditors (which can make confirmation of a plan difficult or impossible under the plan confirmation rules in the Bankruptcy Code). If there is a window to challenge an alleged lien on any asset of a producer’s under-water Chapter 12 estate, it is a certainty that either the trustee or a junior creditor will take advantage of it.

If recent agribusiness indicators are to be believed, these questions may present themselves in ag bankruptcies with increasing frequency in the near term. According to Farm Bureau statistics, 2019 net farm income has increased to $88 billion this year, the highest since 2014. But nearly 40% ($33 billion) of that income is derived from some form of government assistance (Market Facilitation Program payments) or insurance/disaster relief proceeds.

Sources: “MFP Payments Coming Before Thanksgiving,” Progressive Farmer/DTN, Todd Neeley, November 13, 2019; “Farm Bankruptcies Rise Again,” Farm Bureau Market Intel (fb.org), John Newton, October 30, 2019.

About the Author:

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.

Chapter 12’s New $10 Million Debt Limit: Will Farm Bankruptcy Filings Spike?

Following the enactment of the Family Farmer Relief Act of 2019 in August, there has been endless speculation as to whether the Act’s dramatic increase in the Chapter 12 maximum debt limit—from about $4.4 million to $10 million—would catalyze a spike in Chapter 12 farm bankruptcy filings. Recent agricultural lending and other economic data indicate the answer is probably “yes,” especially within certain ag commodities and regions (hint: dairy and the Midwest).

According to Farm Bureau statistics, 2019 farm debt is projected to hit a record-high $416 billion, with $257 billion of that being secured by mortgages on agricultural real estate. Perhaps more significantly, ag loan maturities have been stretched to all-time highs in a number of categories, with the average maturity of non-real estate loans being stretched to an average of 15.4 months.

And while net farm income has also risen—$88 billion this year, the highest since 2014—some 40% ($33 billion) of that income is derived from some form of government/trade assistance (Market Facilitation Program payments) or insurance proceeds.

But the question remains: do these ominous numbers indicate that a spike in Chapter 12 filings is just around the corner, especially now that the debt limit has more than doubled? Broad-brush, national statistics might suggest otherwise. For the 12-month period ended September 2019, Chapter 12 filings nationwide were up 24% versus the prior 12-month period, to 580 cases. But that’s well short of the 676 cases filed in 2011, the last year Chapter 12 filings peaked. And nationwide filings actually decreased 2% from 2Q to 3Q 2019—a period that includes the first month following the August 23 effective date of the Family Farmer Relief Act and the new $10 million debt cap.

But if we drill down on the available statistics (which are rather scant; the Office of the U.S. Courts doesn’t track or aggregate Chapter 12 filings by debt levels, for example) and take stock of recent headlines and other anecdotal data, there seems to be only one, reasonable conclusion to draw: a Chapter 12 bankruptcy boom is on the horizon, with dairy producers being the highest risk candidates to file.

First, if you compare Chapter 12 filings from the month of June 2019 with the month of September 2019 (the most recent one-month periods available), there’s a dramatic 44% uptick in filings (from 36 to 52). Of course, filings in Nebraska (10 new cases) accounted for the lion’s share of this move, and are probably largely attributable to record flooding in the state this past spring. But it’s still a notable upward move in such a short timeframe—especially if you bear in mind that September was the first full month following the effective date of the new $10 million debt limit.

Second, participation in the dairy-specific crop insurance program, Dairy Revenue Protection (DRP), has been aggressively expanding: in just its first year of existence, more than 50 billion pounds of milk have been covered, with significant concentrations of coverage blanketing all of the major Midwest dairy-producing states/regions of, Wisconsin, Michigan and Western New York.

Third, the recent bankruptcy of Dean Foods—the country’s largest dairy processor—is certain to have a domino effect on a huge swath of the country’s dairy producing regions. Long before filing Chapter 11, the company canceled more than 100 producer contracts, and there may be significantly more to come.

If the Chapter 12 boom does happen, a number of interesting and unique issues are sure to be raised for farmers, lenders, and other ag stakeholders. I will consider these issues in subsequent posts.

About the Author:

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.

Sources: Office of the United States Courts (bankruptcy filing data); “Farm Bankruptcies Rise Again,” Farm Bureau Market Intel (fb.org), John Newton, October 30, 2019; “Dean Foods, America’s biggest milk producer, files for bankruptcy,” CNBC.com, Amelia Lucas, November 12, 2019.