Farm bankruptcies on the rise due to losses, court ruling

The type of bankruptcy designed to help family farmers restructure their debts is getting more use in Iowa because of mounting farm losses and a recent court decision.

An appeals court decision last September allows farmers who sell assets used in their farming operations to pay debts to discharge income taxes incurred because of the farm asset sale through Chapter 12 bankruptcy.

Cedar Rapids attorney Joe Peiffer sees a growing number of farmers stuck in a financial bind.

“I'm seeing loads of farmers,” Peiffer said. “The livestock industry has been kaputs.”

Peiffer said one farm client deeded a hog house back to the bank late last year. Another was deeding a dairy back to the bank this month.

Before Chapter 12 bankruptcy laws changed in 2005, many farmers had assets that could be liquidated to help get a bankruptcy plan approved to pay off creditors, Peiffer said. They would still have to pay off all the federal income taxes generated by the property sales under the pre-2005 law, making it much harder to get the bankruptcy plan approved.

“If he couldn't get his bankruptcy plan confirmed, the farmer was done,” Peiffer said. “He'd be stuck, hung out to dry, unable to pay his creditors and his taxes, so literally the IRS and state department of revenue could attach his assets or whatever else you could imagine.”

Peiffer represented a Mitchell County farmer in a Chapter 12 bankruptcy case that resulted in a different outcome for farmers. The U.S. Court of Appeals for the 8th Circuit handed down the decision on Sept. 16, 2009, in a case involving farmers from both Iowa and Nebraska. It is now law in Iowa, Minnesota, Missouri, Arkansas, Nebraska, North Dakota and South Dakota.

Under the decision, the repayment priority of the ag lender or other secured creditors is unchanged, but the tax collection agencies are moved to the back of the line, Peiffer said.

The decision couldn't have come at a better time, in Peiffer's view.

“We've kind of seen a perfect storm of bad things that can happen to the farmer: Low commodity prices, high input costs, and we're trying to figure out what to do so they can stay in business,” he said.

Peiffer believes some of the input costs became artificially high because of a temporary spike in commodity prices.

“Last year when the cost of corn got really high, many landlords canceled all their (farm land) leases,” Peiffer said. “With the leases canceled they could raise their cash rents, and we also had the situation where fertilizer, herbicide and seed costs all went up.”

In an article in AgLender magazine last September, Peiffer and Iowa State University Professor of Agriculture Neil Harl explained the ruling. The court decision tested the application of a 2005 law allowing a Chapter 12 debtor to treat obligations arising out of “claims owed to a governmental unit” as a result of “sale, transfer, exchange or other disposition of any farm asset used in the debtor's farming operation” to be treated as an unsecured claim.

The IRS argued the 2005 law didn't apply to ordinary income property, such as slaughter hogs or grain produced for sale, but only to property eligible for capital gain treatment, such as breeding stock, machinery and farmland.

The appeals court ruled the provision applied to income whether it came from ordinary income property or assets eligible for capital gains treatment.

The court also ruled that the amount of taxes to be treated as an unsecured claim would be calculated in the way most favorable to farm debtors.

The number of Chapter 12 bankruptcies in Iowa rose from one in 2008 to five in 2009, according to court records.