Extension of family farmer bankruptcy provisions : hearing before the Subcommittee on Economic and Commercial Law of the Committee on the Judiciary, House of Representatives, One Hundred Third Congress, first session on H.R. 416 ... March 10, 1993 online

reflected in their reluctance to extend credit to "marginal" borrowers for fear of a future
Chapter 12 filing.

For this reason, the ABA is encouraged by Section 2 of H.R. 416 which seeks to
clarify the extent to which Chapter 12 filings can be extended. Specifically, Section 2 of
H.R. 416 amends the current Chapter 12 statute by allowing for an extension only if the
need is attributable to circumstances for which the debtor should not be held responsible,
and so long as the extension does not unduly delay the administration of the case. The
ABA believes that such a change will help to reinstate the original intent of the law - that
is to expedite the filing of an appropriate bankruptcy plan.

Unfortunately, constant delays are not the only problem with the current law. For
instance, because creditors are precluded from exercising many of the rights established
under Chapter 11 (such as shared appreciation and lost opportunity), the availability of
credit for beginning and undercapitalized farmers remains adversely affected. Clearly,
this was not the original intent of Chapter 12.

Funhermore, currently under Chapter 12, bankers and individual creditors are
forced-again without the participatory vote provided under Chapter ll-to "cramdown"
to current market levels the value of secured loans. While cramdowns exist under



12



Chapter 11, the option for creditors to elect "shared appreciation" also exists, allowing
bankers to recover some of their losses. Conversely, under Chapter 12, the banker can
recoup nothing. As the market value for agricultural land tumbled during the mid-1980s,
bankers, other creditors, and individuals who had extended credit to those who filed for
bankruptcy suffered large, irrevocable losses. While the value of this land has rebounded
in recent years, and while farms and ranches have returned to profitability, these
creditors have been precluded from sharing in the appreciation of these assets.

Moreover, bankers are not the only people adversely effected by the loss of
shared appreciation under Chapter 12; individual creditors often face similar, if not more
devastating, fates. Last year before this subcommittee, a colleague of mine from
Nebraska related a tragic Chapter 12 case involving a husband and wife who sold their
farm to support their retirement. Upon selling their farm, this couple took back a note
from the borrower on contract, structured with a ten-year balloon payment. During this
ten-year period, the husband died, leaving his wife with minimal social security and the
annual farm payments as her sole source of income. In the last year of the contract, the
contract holder filed for protection under Chapter 12. For three years, this widow's
banker advanced monies for legal fees for Chapter 12 and for general living expenses. In
addition to the fact that the proceeding took more than three years to complete, when
completed, instead of receiving the approximately $80,000 to which she was originally
entitled, she was "crammed down" approximately $20,000. In addition, the contract was
rewritten for another twenty years at the same rate of interest that was negotiated ten



13

years prior to bankruptcy.

As a result, instead of living comfortably, this widow must contend with an
installment payment that was rewritten by the courts. Furthermore, the farm has
appreciated by 1/3 since it was renegotiated during the Chapter 12 proceedings, and
neither she, nor her family, is allowed to enjoy any of the appreciation. This situation is
blatantly unfair and painfully unjust. We recommend that Chapter 12 be further
amended to allow creditors to share in the appreciated value of an asset up to the
original amount lost during bankruptcy. Such a provision would also greatly reduce the
current reluctance of lenders to provide loans to financially marginal borrowers due to
fear of losses in a potential Chapter 12 bankruptcy.

Bankers are not alone in expressing the unfairness of this situation. Last June,

before this subcommittee, Richard Bohanon, the Chief Judge for the United States

Bankruptcy Court for the Western District of Oklahoma suggested that some form of

shared appreciation would improve the current Chapter 12 statute:

The obvious pain to the banks in this procedure is that they must realize
their deficiency and absorb that loss now rather then at some later time.
Additionally, they normally are not in a position to benefit from some
future increase in the value of the farm, should that ever occur, for the face
amount of their note is "written down" to the present fair market value of
the collateral. Given time for thoughtful study I believe that a solution
could be found to the predicament of the banks and allow for an effective
farm reorganization.

A clear comparison is with section 1111(b) (2) of Chapter 11 which allows
secured creditors to elect to waive their deficiency claim and retain their



67-706 0-93-2



14



lien for the full amount.'

The ABA is in total agreement with Judge Bohanon's assertion concerning shared
appreciation. A shared appreciation provision seems particularly justified because these
same creditors have suffered not only from a lack of shared appreciation, but also from
"lost opportunity." Under Chapter 11, the principle of adequate protection includes
protection of the secured value of a creditor's interest in collateral - the lost opportunity
to reinvest the secured value of an asset. This protection is not provided in Chapter 12,
leaving creditors with frozen loans receiving no interest from the date the bankruptcy
petition is filed until the plan goes into effect. The cumulative result of lost opportunity
and foregone shared appreciation is that many bankers and Main Street creditors have
become reluctant to extend credit to new, beginning farmers as well as to financially-
marginal farmers who otherwise might have received credit. Moreover, the inability of
these creditors to share in the appreciation of these assets results directly in the loss of
funds available for all borrowers in rural America.

Statistically, findings concerning the actual impact of Chapter 12 filings have not
been surprising to rural lenders. According to a September 1992 study released by
USDA's Economic Research Service (ERS) titled: "Bankruptcy Costs Under Chapter 12,"
the average total bankruptcy cost under Chapter 12 at the time of bankruptcy is between
90 and 100 percent of the asset value of the farm at the time of bankruptcy (this number



'Siatemeni of Richard L Bohanon, Chief Judge. United States Bankruptcy Coun for the Western
District of Oklahoma, before the House Judiciary Subcommittee on Economic and Commercial Law, June
24, 1992.



15



compares to between 54 to 60 percent historically for agricultural bankruptcies previously
filed under Chapter 11). Because creditors forced into Chapter 12 bankruptcy are
precluded froin recovering any of these losses when the value of a borrowers' assets
appreciates, one can readily see that this lack of shared appreciation amounts to millions
of dollars no longer available to lend to other rural borrowers.

Additionally, ERS findings indicate that lost opportunity income-interest income

foregone on frozen assets-has cost creditors around $25,000 per Chapter 12 filing.

Given roughly 10,000 Chapter 12 filings to date, one can quickly see that lost opportunity

alone has lessened credit availability by $250 million. The ERS study concludes that

conservatively the incremental impact of Chapter 12 over Chapter 11 is that it raises

indirect bankruptcy cost by about one-fourth. The study shows the impact this cost has

on the borrower, not the banker:

To offset the costs Chapter 12 imposes on creditors, interest rates to farm
borrowers will have to be 0.25 and 1.0 percent higher on average. Much
higher costs will be borne by financially weaker farm borrowers, either in
the form of increased interest or other charges or in their inability to obtain
loans at any price.^

Further, the ERS concurs with the statements of Judge Bohanon that allowing a

secured creditor to share in some form of asset appreciation under a plan similar to

those currently provided under Chapter 11 should work to "mitigate the negative

efficiency consequences of Chapter 12" for the lender and borrower alike.



Robert N. CoUender, 'Banknipicy Costs Under Chapter 12," U.S. Department of Agriculture,
Economic Research Service, September 1992 (Report No. AGES 9210) p 16.



16



In the end, because of the threat of Chapter 12, young farmers and ranchers, as
well as marginal borrowers-those most in need of funding-often have a difficult time
finding lenders who are willing to extend credit. When they do find a willing lender, they
must pay an interest rate premium on their loans. This increase in interest rates is the
result of "risk pricing" that lenders must utilize to protect depositors and to satisfy the
regulators. In conclusion, Chapter 12 bankruptcy has had two major effects on fanners
and ranchers in rural America: the availability of credit has been lessened and the cost
of credit has increased because of its existence.

Mr. Chairman, while the ABA appreciates the efforts made in H.R. 416 to
address the problems associated with needless delays in the Chapter 12 process, we
would encourage this committee to address the other concerns which have made Chapter
12 so difficult for bankers attempting to lend to borrowers in rural America. Again, I
appreciate the opportunity to appear before the Committee today, and will be pleased to
answer any questions.



17

Mr. Brooks. Mr. Synar.

Mr. Synar. Thank you, Mr. Chairman. I apologize, everybody,
my voice is gone.

Mr. Plagge, in your testimony, you cite Department of Agri-
culture figures stating that chapter 12 filing costs of around
$25,000 in lost opportunity income. Then you talk about multiply-
ing that by the number of chapter 12 filings since 1986, and con-
clude that in lost opportunity income alone, credit availability has
been decreased by $250 million; is that correct?

Mr. Plagge. Could you repeat that?

Mr. Synar. The figure that you use in your testimony of lessened
credit availability of $250 million on page 7, that $250 million fig-
ure doesn't come from the agriculture report, does it, that is a num-
ber you all made up?

Mr. Plagge. This is a number from — right.

Mr. Synar. The fact is that that data that the agriculture report
was based upon comes fi-om two States, South Dakota and North
Carolina. Mr. Plagge, is it fair to extrapolate those figures from two
States for the entire country?

Mr. Plagge. The figures themselves, I don't know if you can ex-
trapolate them from just two States, but I think that overall

Mr. Synar. But that is basically what you did in your testimony,
isn't it?

Mr. Plagge. These figures come from those two States according
to this.

Mr. Synar. Isn't it imfair to conclude also that all that lost inter-
est income would have been lent in the ag sector, in fact, banks
like yours don't just make ag loans, do they?

Mr. Plagge. No, they don't.

Mr. Synar. So that number is a little bit exaggerated, isn't it?

Mr. Plagge. I guess I don't believe it is overall. I think it is a
figure that is hard to relate back to lost opportunity.

Mr. Synar. You also say that we should have an included shared
appreciation provision similar to section 1111(b)(2) of chapter 11.
Could you tell us how often 1111(b)(2) is used?

Mr. Plagge. Not very often.

Mr. Synar. No, it isn't.

Mr. Plagge. I think it is still important that the opportunity be
there in the presenting of the plan in order to

Mr. Synar. So do you think shared appreciation should be all the
way through the Bankruptcy Code?

Mr. Plagge. No. What I am talking about is chapter 12.

Mr. Synar. Why are you picking on 12?

Mr. Plagge. Because that is the one that applies to family farm-
ers particularly.

Mr. Synar. If it is such a good idea, why don't you apply it across
the board?

Mr. Plagge. I am not here to testify across the board.

Mr. Synar. Mr. Underwood, how do you feel about Mr. Plagge's
contention that chapter 12 has hurt the availability of farmers on
the marginal credit risk in getting loans?

Mr. Underwood. I respectfully disagree with that statement. As
early as 1981-82, I believe it was, if you used the word "agri-



18

culture" and "loan" in the same sentence in the State of Oklahoma
or Texas, the bankers weren't dodging, they were digging foxholes.

Agricultural lending was gone, chapter 12 hadn't even been con-
templated at that point in time. I have several lenders who will
lend into chapter 12 because they know how they are going to be
treated, they know what the rules are.

So they are more willing to lend to someone who is in chapter
12. But right now agricultural lending in my experience is dead
anyway.

Mr. Synar. Why don't you tell us about the general attitude of
bankers during negotiated settlements on chapter 12?

Mr. Underwood. One of the strongest things we have in chap-
ter — in negotiating is that we can go to the creditor prior to ever
filing bankruptcy and say, look, in the event we have to file chapter
12, here's what we can accomplish and here's what we can do.

In 1986 and 1987 they weren't very receptive. Chapter 12 has
been very strong because we've been able to settle a lot of cases
short of filing bankruptcy or we've had to file bankruptcy and then
been able to dismiss the cases. And I would say 95 percent of the
cases that I have filed has been successful even if they show up as
having converted to a 7 or dismissed because the creditors then
agreed to the treatment and we said, OK, let's stop the costs from
accruing. So it has been a very strong tool for settling the case.
And I don't know if that was responsive or not.

Mr. Synar. Talk to me about your thoughts about shared appre-
ciation since the judge you practice in front of has been in favor
of it.

Mr. Underwood. I have a lot of respect for Judge Bohanon. I
disagree, again, respectfully with Judge Bohanon on shared appre-
ciation and the reason I disagree on shared appreciation is one of
the tools chapter 12 has given us is the ability to restructure short-
term debt and turn it into long-term debt and the debtor — the
farmer — knows exactly what he's going to have to pay each year.
When you interject something like shared appreciation or fluctuat-
ing fees, which is another issue that Judge TeSelle wanted me to
raise — I m sorry

Mr. Synar. Make sure you get all of these judges taken care of
today.

Mr. Underwood. Anyway, when you interject something like
shared appreciation the farmer no longer — the debtor no longer
knows what nut he has to crack each year. How much does he have
to pay each year? And that's been one of the big values of chapter
12 is how much, you know, here I've got to pay $10,000 a year. And
I tell you what, these guys scramble and they find it. I mean, thev
work hard to find it. So I don't care for shared appreciation, I think
it would be a mistake.

Mr. Synar. And it's not used that much in chapter 11, is it? How
many times have you used it?

Mr. Underwood. Oh, in all the chapter 11 cases I've been in-
volved with I used 1111(b)(2) I think is what you all are referring
to. I used 1111(b) one time. I've only seen it used one time.

Mr. Synar. How many years have you been practicing?

Mr. Underwood. In Oklahoma I've been since 1985. So it's only
been about 8 years.



19

Mr. Synar. Mr. Plagge, one final question. If chapter 12 is al-
lowed to expire, then the banks will basically foreclose on the prop-
erties and they will get the liquidation value of the property, and
they will be ineligible for any shared appreciation; isn't that true?

Mr. Plagge. If they take possession of it they would be.

Mr. Synar. That's right. So they don't get any, do they?

Mr. Plagge. Well, yes, they would, if thev held the asset.

Mr. Synar. Oh, they have to manage and hold the asset?

Mr. Plagge. Right. The appreciation would increase. Let me —
could I respond to one thing?

Mr. Synar. Sure. That's what we are here for.

Mr. Plagge. All right. Thank you. I guess I would like to touch
base back on the delay issue and then also just the credit — the
credit to those borrowers not in chapter 12 or any chapter of bank-
ruptcy in general. Lenders as a whole — I mean, we are talking ap-
proximately 2,900 filings, I believe, was the number of the recent
filings on chapter 12 and you apply that to the total number of bor-
rowers in general, our agricultural producers out there in general,
you know, I guess we are talking both sides of that issue. When
we talk

Mr. Synar. How many filings did you say there were?

Mr. Plagge. I believe I saw the number — in the most recent
year, 2,900 or something like that.

Mr. Synar. Our numbers say 1,600, but go ahead.

Mr. Plagge. OK. I'm sorry. Relatively whatever the number is,
when we look at things from a — when I look at loans personally
from a lending stand point or I look at loans as the lead lender in
our institution, we look at them from various perspectives, but
when we take a look at things like chapter 12, chapter 7, whatever
the bankruptcy chapter is, we factor those things into the decision.
For instance, if we

Mr. Synar. And you factor other Bankruptcy Code section in
other loans you make too, don't you?

Mr. Plagge. That is correct. That is correct. I am talking to the
issue of loans to those people who are trying to get started farming
or loans to those people that are not in a position necessarily where
they are going to benefit from a chapter 12 in general, but because
of the threat of those factors of bankruptcy, credit is either reduced
or shut off or they are forced to go to other areas.

Mr. Synar. Mr. Plagge, you know, I do not mean to interrupt
you, but you have a dual responsibility other than being a small
town banker here. You are representing the ABA.

Mr. Plagge. Yes, I am.

Mr. Synar. I have been begging them on bended knees, for years
to show me statistics, show me this dried up credit attributed to
chapter 12. We are now at the last hearing we are going to have
before we mark this legislation up. This study that you gave me,
if that is the best you can do, very frankly, you do not have an ar-
gument. I mean, the same threat of bankruptcy throughout the
code is there when anybody applies for a loan. Are you telling me
that one-quarter to 1 percent of all costs of loans are always be-
cause of the threat of bankruptcy or is it unique to chapter 12?

Mr. Plagge. The study that ERS did applied it directly to chap-
ter 12.



20

Mr. Synar. Well, what about the other ones? Isn't that the case
across the code?

Mr. Plagge. There's a risk factor in all credit.

Mr. Synar. Right. And so this argument that it costs more to do
a chapter 12, well, if it's taken into account everywhere else, it
costs you to loan any money anywhere; does it not?

Mr. Plagge. That's part of the

Mr. Synar. And bankruptcy is taken into account. So why are
you picking on 12?

Mr. Plagge. The testimony we have talks to certain elements.
The delays in chapter 12.

Mr. Synar. Which I agree with you.

Mr. Plagge. Right and which you have made provisions for that
and then the shared appreciation in general. And the shared appre-
ciation is obviously a factor from the mideighties when you had
massive increases or massive decrease in land and then through
the period of 8 to 10 years back up again, and not to the similar
levels they started at, out a substantialincrease in general.

Mr. Synar. Respond to Mr. Underwood and I'll conclude this Mr.
Chairman. When he tells you that one of the benefit of not having
shared appreciation is that the farmer knows exactly what his re-
sponsibility is and that he can by hook or crook, innovative think-
ing, harder work, extra jobs, putting his wife in — or spouse into the
workplace, will come up with the money. But if you do shared ap-
preciation he'll never know. And secondly, shared appreciation may
not just be the value of the land. This farmer may bust his hump
making this thing more productive. He may switch crops. He may
find a new way to do things. Why should you get the benefit of his
innovation?

Mr. Plagge. The shared appreciation, I think, reflects right back
to the original asset in this case, you know, specifically in the testi-
mony as the farm asset. And that share appreciation may not have
an impact for a period of years on his cash-flow. I mean, that's all
in the negotiations of how that shared appreciation is put into the
plan. It may come at some point down the road after the farmer
is through the process of bankruptcy or through the problems of his
cash-flow and so forth. So it may not have an impact at all in the
front side of getting back to the point — because I know that's im-
portant. They have to know what they have for an obligation every
year because of the unsureties on the other side of the desk when
they don't know for sure what's coming in on the grain side and
so forth. So we don't disagree with that. It's the matter of when
you see the situation like you saw in the 1980's, when a massive
amount of appreciation comes back afler the filing, there ought to
be some right to negotiate on the front side of that situation for
shared appreciation of that drastic change.

Mr. Synar. Mr. Underwood, any comments?

Mr. Brooks. Mr. Fish.

Mr. Fish. Mr. Underwood, both H.R. 6020, as passed by the
House October 3, 1992, and S. 1985, as passed by the Senate Octo-
ber 7 last year, included a provision facilitating access to Bank-
ruptcy Code chapter 13 by raising the ceiling on debt. A similar
provision may be included in major bankruptcy reform legislation
in the 103d Congress. My question is, to what extent would greater



21

access to chapter 13 obviate the need for family farmers to file
under chapter 12?

Mr. Underwood. I don't think it would relieve the need for chap-
ter 12. The raising of the ceiling for chapter 13, I think, is very im-
portant. I feel that the ceiling on chapter 12 needs to be raised as
well, due to the Coleman v. Block years, and it's my understanding
that as of last Friday, Mr. Espy also stopped foreclosures on farm-
ers and what we have is we have a situation where the interest
continues to accrue and sometimes we've busted the limits — the ju-
risdictional limits for chapter 12.

Chapter 13 and chapter 12 are different enough that I don't
think just raising the limits on chapter 13 would obviate the need.

Mr. Fish. OK. Thank you. Mr. Plagge, Bankruptcy Judge A.
Thomas Small pointed out in his written statement submitted to
our subcommittee last year, and I quote, "[0]ne of the virtues of
chapter 12 has been its positive influence, together with state farm
credit mediation laws, on resolving disputes outside of court."

What is your assessment of chapter 12's impact on the willing-
ness of lenders and borrowers to work together to obviate the ne-
cessity of a bankruptcy filing?

Mr. Plagge. Well, speaking from an Iowa standpoint, we have
mediation there as well and I think that has been very effective in
getting people to the table. Our complaint with chapter 12 in that
same impact of getting people to the table to talk to is that the
roles — the main complaint of the farm sector beforehand is that the
lender has all the cards in the negotiation when they are outside
of chapter 12. Our contention is that that almost totallv shifts to
the other side because of the "cramdown" features of cnapter 12.
It truly almost 100 percent goes the other way in the negotiation.
What we're saying is that in a true negotiation of impact of success
let's find a middle ground and that, again, is the delay and shared
appreciation comments.

Mr. Fish. Your written statement, Mr. Plagge, provides a gen-
erally negative assessment of chapter 12. I'm sure you will agree,
however, that many farmers cannot meet the eligibility require-
ments for chapter 13 and find the chapter 11 process expensive and
cumbersome. My question is, do you believe that chapter 12 has
permitted a significant number of family farmers to keep their
farms who otherwise would have lost them, and if so, isn't this de-
sirable?

Mr. Plagge. Yes, I think in a lot of areas it has had a very sig-
nificant impact and in other areas not so significant. But — and
we're not arguing the case of chapter 12 as an effective tool, we're
arguing the case that's there's features of chapter 12 that we'd like
to see changed.

I think in any lending situation, as Congressman Synar stated,