October 02, 2014

I. THE PROBLEM

Corn, soybean, sugar beets and other farm commodities have taken a drastic decline in price. This has led to steady or dropping land values, particularly in the Red River Valley in sugar beet growing areas. As of a month or two ago, it was not possible for a sugar beet grower to project a profit for beets in 2015 at current prices. fu fact, owning beet stock has become a detriment. Not only can the stockholder not deliver beets at a profit, but might be obligated to deliver beets at a loss. Not surprisingly, beet stock values have also significantly and quickly declined in value.

Complicating all of this is a rail car shortage made worse by competition with oil shipments. Corn prices have been as much 60 cents per bushel less in the Red River Valley than in, for example, Iowa where the rail car sh011age is less severe and there still is a very strong ethanol market. The first cellulosic ethanol plant, using com stover, has just opened in Emmetsburg, Iowa.

Meanwhile, the bright spots in our area are beef and hog prices, and a correlative increase in pasture land values, range land values and pasture land and range land rents.

II. THE EXPECTED REACTION

Grain producers are busy cutting expenses, sharpening their pencils for a 2015 budget, and might still need to spend some of the profits earned in 2012 and 2013 to break even in 2015. They might also sell land, but will be reluctant to do so in a falling land market. Ifinterest rates increase, that will be an additional stressor. Some grain producers might try to borrow more, perhaps on what they view as increased value of their farmland holdings. But how long can this continue, and will lenders want to shift from cash flow and anticipated profits lending to asset based lending?

Some borrowers will tty to ignore the problem, as long as possible. Some lenders might do the same.

III. LIQUIDATION OR CHAPTER 12?

Some grain producers might simply spend down profits from earlier years, as long as possible, hoping for the best, but perhaps finding themselves in the worst position of all, with no options left other than a Chapter 7 bankruptcy or a liquidation. Some might react the way they did in the 1980s by filing reorganizational bankruptcy cases. In the 1980s, that meant Chapter 11 cases for substantial farming operators.

In 2005 Chapter 12 was reenacted and has been a permanent part of the Bankruptcy Code ever since. It is meant to provide relief for family farmers. It is one of the few areas of the Bankruptcy Code that have not been substantially tightened up over the last several years for the benefit oflenders.

HOW TO PREPARE FOR A LIQUIDATION OR BANKRUPTCY FILING?

While things are still relatively good and calm, is the time for lenders to prepare for possible future difficulties. There is no time like the present. These are the minimum steps to take if you anticipate a problem with an ag loan:

1. Make sure you have current, complete and accurate financial statements prepared by the borrower and any guarantors and signed by the borrower and any guarantors and that there is an obligation to periodically provide borrower/guarantor updates
2. Verify the financial information and double check values;
3. Do not allow a borrower or guarantor to be able to say that the financial statements were simply prepared by the bank and signed by the borrower or guarantor without much review;
4. When in doubt appraise the value of collateral and make sure there is no confusion about ownership of the collateral and don't give credit for unencumbered exempt assets;
5. Make sure that all loan agreements, and especially security agreements and mortgages, are signed by the party that actually owns the collateral;
6. Double check all loan documents to make sure they will stand up under difficult times and in court;
7. Double check that all security interests have been perfected by proper financing statement filings and continuations;
8. Make sure that security interests in titled vehicles are perfected by having your lien noted on the title, and better, having possession of the title as well;
9. Make sure all mortgages have been properly recorded and are supported by title opinions or title insurance
10. If you need to perfect a prior security interest or mortgage, do so at least 90 days before any bankruptcy filing; and
11. Try to take additional collateral and get additional guarantees of payment. Perfecting liens in additional collateral should also be done at least 90 days before any bankruptcy filing.
    
    

IV. WHAT CAN HAPPEN IN A CHAPTER 12 BANKRUPTCY CASE?

As long as the lender got fully secured when the loan was funded and has kept fully secured, losses will be minimal in Chapter 12. In Chapter 12, if a lender is fully secured, unless the lender agrees otherwise, a Chapter 12 plan cannot be confirmed that proposes to do anything other than pay the loan in full, although perhaps over a longer period of time and at a different interest rate than stated in the loan documents.

Trouble begins when the collateral is worth less, or becomes worth  less than the loan balance. Under these circumstances, the lender's claim will be split into an allowed secured claim, equal to the value of the  collateral, as of the date the Chapter 12 bankruptcy case was filed, and an allowed unsecured claim for the difference between the value of the collateral and the loan balance as of the date the Chapter 12 case was filed.

Unsecured claims in Chapter 12 might be paid from disposable earnings not needed to service payment of allowed secured claims, reasonable family living expenses, operating expenses and other things, but no full payment is assured. It might take years to get even partial payment.

An over secured creditor in a bankruptcy case can also include, as part of its claim, reasonable attorney's fees, as long as the loan documents so provide, despite the North Dakota state law to the contrary.

The key thing in any Chapter 12 bankruptcy case is the value of the collateral and the loan balance as of the date the case is filed.

V. WHAT WILL BE THE DEBTOR'S STRATEGY IN CHAPTER 12?

The best time for a debtor to file a Chapter 12 bankruptcy case is when the value of collateral is at its lowest. Thus, if there is a declining real estate market and machinery and equipment market, the longer the debtor can wait, the better, because the allowed secured claim (based on collateral values as of the date of filing) will be at its lowest, and the allowed unsecured claim, which might not be paid in full, will be at its highest. Also, the best time for a debtor to file a Chapter 12 case is when projected disposable earnings will be at their lowest, because that value largely determines what will be paid on allowed unsecured claims.

The lender's reaction to this strategy might be to force the issue earlier, before collateral values decline further, unless the borrower is able to refinance or provide additional or replacement collateral.

But remember that if new collateral is taken to better secure old debt, the new security interest or mortgage interest could be invalidated as a preferential transfer, if there were a bankruptcy filed within 90 days after the security interest was perfected or the mortgage was recorded.

VI. LEASES?

Lessors are treated very well in Chapter 12, and other chapters of the Bankruptcy Code. Generally, if a true lease is involved, the debtor's choice will be to either assume or reject the lease. If the debtor assumes the lease, all lease defaults must be cured, the debtor must give adequate assurance that there will be no further defaults, and the debtor must pay any damages caused by the breach of the lease.

If the debtor rejects a lease, the debtor must return the leased items to the lessor, but any damages will be treated as an allowed unsecured claim.

The challenge is to try to shorten the time for the debtor to decide if it will assume or reject the lease.