Chapter 12 Bankruptcy: An Overview

Chapter 12 of the U.S. Bankruptcy Code helps family farmers and family fishermen relieve their debt burdens and reorganize their finances. At the same time, it allows them to continue operating their businesses and to keep the equipment they need to do their jobs. This relatively new kind of bankruptcy is necessary because farmers and fishermen have income that doesn’t fit the layout of other bankruptcy chapters.

This article gives an overview of how Chapter 12 bankruptcy works, who’s eligible to file it, and how it benefits family farmers and family fishermen.

What Is Chapter 12 Bankruptcy?

Chapter 12 was created to address the unique concerns and financial hardships facing family farmers and fishermen. It gives family fishermen and family farmers a way to avoid foreclosure. It also provides them with an opportunity to create a plan to repay their debts without losing their businesses or their belongings. 

The early-to-mid 1980s dealt a series of harsh blows to family farmers. Bad weather, plummeting commodity prices, and stricter rules for agricultural loans caused farm incomes to drop and farm debt to increase dramatically. In 1986, Congress passed Chapter 12 as an emergency measure to help save family farms. 

Chapter 12 was modeled after Chapter 13 bankruptcy. Chapter 13 is a type of bankruptcy that lets individuals create repayment plans to manage their debts. Because farmers often had large equipment loans and income that changed with the seasons, Chapter 13 wasn’t usually much help to farmers. Chapter 12 was written with farmers in mind and specifically addressed those kinds of problems. 

Chapter 12 was initially supposed to be a temporary measure, but Congress kept extending it. In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). BAPCPA made Chapter 12 a permanent part of the Bankruptcy Code. It also expanded the chapter’s protections to include family fishermen as well.

Many farmers took advantage of Chapter 12 in late 1986 and 1987. Historically, though, Chapter 12 cases have only been a tiny fraction of all U.S. bankruptcies. For instance, from 2009 to 2018, only 0.05% of bankruptcy cases were filed under Chapter 12. 

That said, the number of Chapter 12 bankruptcies has been steadily increasing in recent years. Record temperatures, very active hurricane seasons, and farm tariffs led to a 20% jump in Chapter 12 cases from 2018 to 2019. As a result, Congress passed the Family Farmer Relief Act of 2019, which raised the debt limits for Chapter 12 cases.

Benefits of Chapter 12 for Family Farmers and Fishermen

Bankruptcy laws provide debt relief options for a variety of situations. Chapter 7 helps people or businesses seeking a fresh start. Businesses that need to reorganize their debts while continuing to operate can do so under Chapter 11. Chapter 13 offers individuals the chance to create a repayment plan to get out of debt. And Chapter 12 was created to extend the benefits of Chapters 11 and 13 to family farmers and family fishermen. 

Like a Chapter 13 bankruptcy, a debtor in a Chapter 12 case proposes a reorganization plan to catch up on delinquent debts and repay creditors over 3-5 years. This plan must meet the Chapter 12 requirements. Like a Chapter 13 plan, creditors don’t have to approve the plan. But Chapter 12 offers benefits to family farmers and fishermen that go beyond the benefits available in a Chapter 13 case.

Flexible Payments

In a Chapter 13 bankruptcy, a debtor must pay the same amount each month throughout the entire repayment plan. This would be difficult for most family farmers and fishermen, whose income tends to change with the season. Chapter 12’s rules allow debtors to make seasonal payments or balloon payments that line up with the agricultural or fishing season. 

Cramdown

Another benefit of Chapter 12 is the ability to use a concept called “cramdown.” Cramdown is based on the idea that a secured creditor isn’t entitled to get more money in a Chapter 12 case than it would get in a Chapter 7 (liquidation) case. In a liquidation scenario, a secured creditor is only entitled to the market value of its collateral. The market value is however much the collateral is worth when the debtor files bankruptcy. 

To illustrate this idea, say a fisherman finances a boat. The boat becomes collateral for the loan, meaning the creditor can repossess the boat if the fisherman doesn’t make the payments. Later, the fisherman files Chapter 7 bankruptcy. When he files, he still owes $40,000 on the boat, but the boat is only worth $25,000. Under the Chapter 7 rules, the creditor is only entitled to whatever the Chapter 7 bankruptcy trustee could get for selling the boat — in this example, $25,000. The other $15,000 that the fisherman owed becomes unsecured debt.

If that same fisherman filed a Chapter 12 case instead of Chapter 7, he can keep the boat, but he doesn’t have to pay the full loan balance ($40,000) through his Chapter 12 plan. Instead, he can cram down the boat loan and just pay what the boat is worth ($25,000). Chapter 12 debtors can cram down all secured claims, including mortgages. Chapter 12 is the only chapter of bankruptcy that allows this. 

Other Advantages

Because family fishermen and family farmers are trying to run their businesses, Chapter 12 lets them keep, sell, or lease their property as part of their normal course of business. They don’t need to get court approval, which would be required in other kinds of bankruptcies. Chapter 12 also lets debtors sell their property without having to pay off any tax liens on that property. Under Chapter 12, those tax claims are treated as unsecured debts. This means the debtor may only have to pay part of these debts or may not have to pay them at all.

Finally, if a natural disaster or an illness makes it impossible for a family farmer or fisherman to finish making payments under their Chapter 12 plan, they may be eligible for a hardship discharge. A hardship discharge is only available in limited circumstances, but it effectively wipes out the debtor’s obligation to pay whatever debts are left in the plan.

Eligibility for Chapter 12 Bankruptcy

In the fishing and agricultural industries, filing for bankruptcy is often viewed as a last resort. Many times, fishermen (or farmers) and their creditors try to work together to find creative ways to repay or refinance debts to delay or avoid bankruptcy.

Also, not every farmer or fisherman qualifies to file Chapter 12 bankruptcy. Chapter 12 is available to individuals (single or married) who are engaged in a farming or commercial fishing operation if they meet these requirements:

• They have “regular annual income.” Seasonal income is OK as long as it tends to be about the same every year. Generally, the income just needs to be predictable enough for the debtor to be able to create and carry out a payment plan.

• More than half of their gross income (before deductions) from the past year came from their fishing or farming business. This is usually based on the past year’s tax return, but family farmers can also use information from earlier tax years to provide a clearer picture of their ordinary income.

• For farmers, at least 50% of their total debt amount, not counting home mortgages, is related to the farming operation. For fishermen, at least 80% of their total debt amount, not counting home mortgages, is related to the commercial fishing operation. 

• The total of all debts that they owe, including home mortgages, is less than $4,153,150 (for farmers) or $1,924,550 (for fishermen).

Partnerships or corporations that own farming or fishing operations can also file for Chapter 12 if one family owns more than 50% of the partnership or corporation. That family and its relatives must be actively involved in the farming or fishing operation. There are other eligibility requirements for partnerships or corporations seeking Chapter 12 relief.

Chapter 12 Bankruptcy Cases: A Timeline 

A Chapter 12 bankruptcy, like all chapters of bankruptcy, begins with the debtor filing the bankruptcy paperwork with the court. Filing the case triggers the automatic stay provision, which stops all collection actions against the debtor. Most farmers and fishermen continue operating their businesses throughout the bankruptcy proceedings.

When the case is filed, the court appoints a bankruptcy trustee. The trustee is responsible for:

• Reviewing the proposed repayment plan and other documents.

• Advising the bankruptcy judge.

• Collecting plan payments from the debtor.

• Sending payments to creditors. 

The Chapter 12 Repayment Plan

Under Chapter 12, debtors must file a proposed repayment plan within 90 days after filing the bankruptcy petition. The court can extend this deadline if necessary. The plan must meet Chapter 12’s “best interest of the creditors” test. Under this test, the payments each creditor receives through the proposed Chapter 12 plan must be at least as much as that creditor would get if the debtor had filed a Chapter 7 case. As long as the plan passes this test, it’s OK if the plan proposes to pay unsecured creditors pennies on the dollar — or nothing at all.

The Chapter 12 trustee reviews the proposed plan and any claims or objections filed by creditors. A plan confirmation hearing is typically held around 45 days after the debtor submits the proposed plan. At the hearing, the bankruptcy judge either confirms (approves) or rejects the plan. The judge usually relies heavily on the trustee’s recommendations in making this decision. Once the plan is confirmed, it becomes a court order that the debtor and creditors must obey.

After the Plan Is Approved

A Chapter 12 plan must be completed within 3-5 years. Three years is the minimum plan length unless the debtor can pay all their debts sooner (including unsecured debts). Five years is the maximum plan length. If a Chapter 12 debtor owes past-due child support or alimony, the plan period must be five years. That is unless the debtor can pay these debts in full in less than five years.

During the plan period, the debtor must give all their disposable income to the Chapter 12 trustee. Chapter 12 defines disposable income as:

• All of the debtor’s income, including the income from their farm or fishing operation,

• Minus any necessary business expenses and other deductions, such as taxes,

• Minus reasonable living expenses for the debtor and the debtor’s family. 

Living expenses include things like groceries, utilities, insurance, and current child support or alimony payments.

The trustee keeps a certain amount as a fee. The trustee’s fee amount is set by the bankruptcy court. The trustee uses the rest of the money received to pay creditors according to the Chapter 12 plan terms. After all the required payments are made under the plan, the court grants the debtor a discharge and closes the Chapter 12 case. 

A Chapter 12 discharge typically wipes out all of the debtor’s remaining debts, with some exceptions. Certain types of debts, such as child support, alimony, federal income tax debts, and—in some cases—student loan debt aren’t dischargeable in bankruptcy. Also, the Chapter 12 plan may include debts that will remain after the discharge. For example, long-term secured debts, like mortgages, often can’t be paid in full during the plan period.

During the plan period, if the debtor can’t or doesn’t want to continue with the Chapter 12 plan, they can choose to dismiss the case or convert the case to a Chapter 7 (liquidation) bankruptcy.

Let's Summarize...

Chapter 12 bankruptcy is designed to extend bankruptcy relief and protections to family fishermen and farmers while taking these debtors’ unique financial affairs into account. Chapter 12 allows eligible debtors to create a repayment plan to take control of their finances while they continue to operate their businesses. 

Chapter 12 is similar to other kinds of bankruptcy, but it has several advantages that specifically benefit farmers and fishermen. Examples of these benefits include increased flexibility, the ability to cram down debts, and the chance to sell property free of tax liens.