Chapter 12 Bankruptcy for Farmers

     When lawyers talk about the types of bankruptcy available, we usually focus on the three most common types of bankruptcy – Chapter 7, 11, and 13.  However, there are a few others, including Chapter 12, which is available for “family farmers” or “family fisherman.”  Although Arizona has few, if any, “family fisherman,” there are over 15,000 farms in Arizona, so Chapter 12 bankruptcies are filed in Arizona from time to time. 

     For purposes of the Bankruptcy Code, an individual or a married couple is a “family farmer” if they are engaged in a farming operation, their debts do not exceed $3,792,650, at least 50% of their debts are related to the farming operation, and more than 50% of the income from the previous tax year (or for each of the 2^nd and 3^rd prior tax years) came from the farming operation.  A corporation or partnership may qualify as a “family farmer” if more than 50% of the stock or equity in the corporation or partnership is owned by one family and that family operates the farm.  More than 80% of the value of the corporation or partnership assets and at least 50% of the corporation or partnership debts must be related to the farming operation and the total debt may not exceed $3,792,650.

     Chapter 12 is a reorganization with similarities to both Chapter 11 and Chapter 13.  As in a Chapter 13, a trustee is appointed whose job it is to evaluate the case, collect payments from the debtor, and make distributions to creditors.  Within 90 days after a Chapter 12 bankruptcy is filed, a plan of reorganization must be filed.  The plan will propose to make payments over a 3 to 5 year period and must be approved by the bankruptcy court.  How a creditor is to be treated in a Chapter 12 plan depends on the type of claim the creditor holds.  Priority claims, such as most taxes and the administrative costs of the bankruptcy, must be paid in full by the plan.  Secured claims must be paid at least the value of the collateral securing the claim, but such claims may be paid over a longer period than five years in some cases.  General unsecured claims must receive at least as much as they would receive in a Chapter 7 liquidation, which is often nothing.    

     After completion of all plan payments, the debtor will receive a discharge of all remaining debts, with limited exceptions.  For more information about the bankruptcy discharge, click here.

In re Skinner – Inference of Fraud in Nondischargeability Action

     On December 13, 2012, Judge Marlar issued a memorandum decision in In re Skinner, 2012 Bankr. LEXIS 5782 (Bankr. D. Ariz. 2012) in which he found that the debtors’ actions in failing to even attempt to make good on a promise to pay, coupled with the debtors’ clear inability to live up to the promise, warranted an inference of intent to deceive in an action to determine the non-dischargeability of a particular debt. 

     The debtors sold a classic car to the plaintiffs for $12,000 plus two lots of real property.  The debtors agreed to pay off the existing liens of $33,000 on the vehicle in order to convey clear title to the plaintiffs.  The debtors received the $12,000 from the plaintiffs and sold the two lots for $20,000, but did not use any of the money to pay down the liens.  In fact, the debtors increased the liens against the vehicle to $60,000.  The debtors eventually defaulted and the vehicle was repossessed.  The plaintiffs were awarded a default judgment in state court prior to the debtors’ bankruptcy filing and sought in the bankruptcy to have the debt declared non-dischargeable.

     Section 523(a)(2)(A) provides that a monetary debt is not dischargeable to the extent obtained by “false pretenses, a false representation, or actual fraud.”  A claim of non-dischargeability under section 523(a)(2)(A) requires the creditor to demonstrate five elements:  “(1) misrepresentation, fraudulent omission or deceptive conduct by the debtor; (2) knowledge of the falsity or deceptiveness of the statement or conduct; (3) an intent to deceive; (4) justifiable reliance by the creditor on the debtor's statement or conduct; and (5) damage to the creditor proximately caused by its reliance on  the debtor's statement or conduct.”   In re Slyman, 234 F.3d 1081, 1085 (9th Cir. 2000).

     The court noted that proving knowledge and intent to deceive is inherently difficult, but that those elements “may be inferred by circumstantial evidence and from debtor’s conduct.”  The court found that the debtor “made a representation that was so far beyond his financial reality as to be deceptive, and that, when made, he knew that he either could not or would not perform his promise to quickly pay off the underlying . . . lien on the vehicle.”  That clear inability to pay, coupled with the fact that the debtor did not use even a single dollar to pay off the liens evidenced to the court the intent to deceive necessary for a finding of non-dischargeability under section 523(a)(2)(A).

In re Jones – Property acquired by “devise”

     In In re Jones, 2012 Bankr. LEXIS 5769 (Bankr. D. Ariz. 2012), decided by Judge Curley on December 13, 2012, the court held that real property that was acquired by the debtor through a beneficiary deed within 180 days after the bankruptcy was filed was property of the bankruptcy estate pursuant to section 541(a)(5) of the Bankruptcy Code.

     The debtor’s grandmother executed a beneficiary deed in favor of her grandson, which conveyed her home to the debtor effective upon her death.  The grandmother died just three days after the debtor filed bankruptcy.  The bankruptcy trustee filed a motion to sell the home free and clear of liens and the debtor objected, arguing that the home was not property of the bankruptcy estate.

     Section 541(a)(5)(A) of the Bankruptcy Code provides that property of the bankruptcy estate includes property that is acquired within 180 after the bankruptcy is filed “by bequest, devise, or inheritance.”  Neither party disputed the fact that the property was acquired within 180 after the bankruptcy was filed.  Nor did the parties dispute that the property was not acquired by bequest or inheritance.  The question for the court, therefore, was whether the property was acquired “by devise” pursuant to Arizona law.

     The Arizona Probate Code defines “devise” as follows:  “when used as a noun, means a testamentary disposition of real or personal property and, when used as a verb, means to dispose of real property by will.”  ARS § 14-1201.  Although the debtor argued that the word “devise” was used as a verb in section 541(a)(5)(A), the court found that it was clearly used as a noun, since it’s the subject of a prepositional phrase.  Thus, even though the property did not pass to the debtor through a will, the Court held that the beneficiary deed was a “testamentary disposition” and was therefore a “devise” under the broader meaning given to that term when used as a noun.     

     The court also found, as an alternative basis, that the property was property of the bankruptcy estate under section 541(a)(1), which defines property of the estate as including “all legal or equitable interests of the debtor in property as of the commencement of the case.”  The court reasoned that the debtor had a contingent interested in the property on the petition date, which was transformed into a full ownership interest upon the death of the debtor’s grandmother.

In re Sunnyslope Housing – Low Income Housing Tax Credits

     On December 12, 2012, Judge Haines issued a memorandum decision in In re Sunnyslope Housing Limited Partnership, 2012 Bankr. LEXIS 5726 (Bankr. D. Ariz. 2012) concerning the value of Low Income Housing Tax Credits.  The court had previously found the value of a secured creditor’s interest in its collateral for purposes of section 506(a) of the Bankruptcy Code, which provides that a creditor has a secured claim up to the value of the collateral and an unsecured claim to the extent the debt exceeds the value of the collateral.  In determining the value of the collateral, the court did not include the value of Low Income Housing Tax Credits (“LIHTCs”) to which the debtor was entitled.  On appeal, the District Court affirmed in part, but reversed and remanded for a determination of the value of the LHITCs to be included as part of the value of the collateral under section 506(a).

     The bank’s expert placed the value of the LIHTCs at $2.96 million, while the debtor’s expert placed the value at $26,144.  The court found that, while neither expert’s ultimate determination of value was persuasive, the best evidence of the value was $1.3 million, using the debtor’s expert’s discounted cash flow analysis.

     For more information about Low Income Housing Tax Credits, click here.

In re Cunningham – stating a non-dischargeability claim

     In a decision designated “for electronic publication only,” Judge Curley held on December 5, 2012 that a non-dischargeability complaint would survive a motion to dismiss where the plaintiff’s allegations related to the debtors’ alleged concealment of material facts, rather than actual representations.  In re Cunningham, 2012 Bankr. LEXIS 5655 (Bankr. D. Ariz. 2012).    

     In In re Cunningham, the debtors purchased a home and executed a promissory note and deed of trust, but later sold the home to a third party using carry-back financing in which the buyer made payments to the debtors and the debtors used the payments to pay the original lender.  Two years later, the third party refinanced the property and the debtors were paid in full, but the debtors did not use the funds to pay off the original lender.  Rather, they retained the funds and continued to make payments on their note.  Eventually, both the debtors and the third-party defaulted on their obligations and a title company was required to pay off the original lender in order to release the lien.  The title company filed a complaint against the debtors to have the debt declared non-dischargeable in the debtors’ bankruptcy.  The debtors filed a motion to dismiss the complaint for failure to state a claim upon which relief could be granted.

     Section 523(a)(2)(A) provides that a monetary debt is not dischargeable “to the extent obtained by false pretenses, a false representation, or actual fraud.”  The plaintiff alleged that the debtors committed fraud by concealing two material facts:  (1) that the debtors concealed the transfer of the property from the original lender and (2) that the debtors failed to disclose and concealed the refinancing and the debtors' subsequent receipt of funds. The plaintiff argued that a concealment of material facts is no different than a misrepresentation. The court held that the plaintiff had met its burden and denied the motion to dismiss.

     The court examined two cases.  The first was Field v. Mans, 157 F.3d 35 (1^st Cir. 1998), in which the court reasoned on very similar facts that, while the original granting of credit was not fraudulently induced, the debtor had obtained an “extension of credit” because an acceleration clause gave the creditor the right to call the note due or demand payment from the debtor after the unauthorized sale. The second opinion examined by the court was In re Demarest, 176 B.R. 917 (Bankr. W.D. Wash. 1995) aff’d 124 F.3d 211 (9^th Cir. 1997).  In that case, the title company mistakenly failed to pay off a lender at closing and the debtors received $65,000 in excess of what they should have received.  The debtors deposited the check and continued making monthly payments.  The court in Demarest reasoned that  silence may create a false impression, providing the basis for a misrepresentation that is actionable under section 523(a)(2)(A).

In re Schayes – principal residence of Chapter 11 debtors

     Section 1123(b)(5) of the Bankruptcy Code prevents a debtor from modifying claims that are secured only by the debtor’s “principal residence.”  In In re Schayes, 2012 Bankr. LEXIS 5598 (Bankr. D. Ariz. 2012), decided by Judge Haines on December 4, 2012, the court held that a home that the debtors purchased for investment purposes but which was their only residence on the petition date was the debtors’ “principal residence” for purposes of section 1123(b)(5). 

     The debtors purchased the subject property in 2007 and lived in the property for one year as required by the original financing contract.  The home was vacant from 2008 until February 2011 when the debtors moved back into the property.  The debtors filed their Chapter 11 bankruptcy petition in July 20, 2011.  The debtors continued to live in the home.

     The debtors argued that the property should not be deemed their principal residence for purposes of § 1123(b)(5) because they never intended to use it as their principal residence. They argued that their only intended use of the property was to rent it out to generate income and that they moved into the property solely for the business purpose of putting the property into a rentable condition and protecting it from further deterioration until it could be rented. Their proposed Chapter 11 plan provided that they would move out of the property and the property would then be rented. The debtors argued that that their intention rather than their actual use should be determinative for purposes of § 1123(b)(5).

     However, the court noted that the Bankruptcy Code does include a definition for a principal residence. Section 101(13A) defines the term "debtor's principal residence" as: "a residential structure if used as the principal residence by the debtor, including incidental property without regard to whether that structure is attached to real property.”  The court concluded that “the definition of ‘principal residence’ in § 101(13A) unambiguously hinges on how the debtor actually uses the structure, not the debtor's intentions at any point in time.”

     The court noted the suggestion of an uncodified “multi-use exception” to section 1123(b)(5).  See In re Scarborough, 461 F.3d 406, 411 (3d Cir. 2006) (“the real property that secures the mortgage must be only the debtor’s principal residence in order for the anti-modification provision to apply”). However, the court distinguished Scarborough and similar cases, noting that, “[t]he basis for the uncodified exception in each of these cases was a multiple actual use of the property, not a single actual use as the debtor's principal residence coupled with another intended or hypothetical use.”

In re Assyrian Babylon, LLC – feasibility of Chapter 11 plan

     In In re Assyrian Babylon, LLC, 2012 Bankr. LEXIS 5589 (Bankr. D. Ariz. 2012), decided by Judge Marlar on December 3, 2012, the court held that a chapter 11 plan of reorganization was feasible despite the fact that the debtor business had to essentially start over at a new location. 

     The debtor operated a sports bar in Yuma, Arizona.  A fire had occurred prior to the bankruptcy that left a portion of the premises uninhabitable.  During the bankruptcy proceeding, a remodeling dispute arose between the debtor and its landlord and major creditor which ultimately lead to the court ordering the debtor to vacate the premises in June 2012.  Just a few weeks later, on August 2, 2012, the debtor filed a plan of reorganization to which the creditor objected based on feasibility grounds.

     The court noted the six factors to be considered when evaluating the feasibility of a plan:  (1) the adequacy of the capital structure; (2) the earning power of the business; (3) economic conditions; (4) the ability of management; (5) the probability of the continuation of the same management; and (6) any other related matters which determine the prospects of a sufficiently successful operation to enable performance of the provisions of the plan.  The court also noted that there was no operating history at the new location to which the debtor intended to relocate and that the amount of new capital being infused into the venture was “thin.”  However, the court found that the debtor had met its burden of proof on feasibility.  The court stated that, “we are dealing with a fairly small business that has successfully operated in the past” and, “[a]lthough legitimate differences of opinion exist over the thin amount of new capital being infused, and recognizing that, while more may be better, less is not fatal to feasibility.”    

Avoidance Actions

     One of the primary goals of the Bankruptcy Code is to provide for an orderly distribution of funds to creditors.  In order to accomplish this goal, the Bankruptcy Code gives the trustee power to bring assets into the bankruptcy estate through the avoidance of certain transfers that occurred prior to the bankruptcy filing.  This is accomplished by the trustee filing a lawsuit against those who received the transfers.  These avoidance actions generally fall into two categories:  fraudulent transfers and preferences.

Fraudulent Transfers

     Two different provisions in the Bankruptcy Code grant the trustee the right to avoid fraudulent transfers.  First, section 544(b) provides that the trustee may avoid a transfer that is voidable by a creditor under state law.  Second, section 548 provides that the trustee may avoid transfers that were made with the actual intent to hinder, delay or defraud creditors.  That section also gives the trustee the power to avoid a transfer if the debtor "received less than a reasonably equivalent value" in exchange for the transfer if the transfer occurred while the debtor was insolvent or if the debtor was rendered insolvent by the transfer.

Preferences

     Section 547 of the Bankruptcy Code allows the trustee to avoid transfers:

• to a creditor
• on behalf of an antecedent debt (a debt that existed before the transfer)
• made while the debtor was insolvent
• made within 90 days before the bankruptcy (or one year if the recipient was an insider), and
• that permit the creditor to receive more than he would receive in a chapter 7 liquidation.

It is important to note that neither the debtor nor the creditor did anything wrong in entering into the transfer. Defendants in preference lawsuits are often very frustrated and angry at being sued when they have done nothing wrong, and for good reason.  But the Bankruptcy Code allows the trustee to undo otherwise unobjectionable transactions to make sure that similarly-situated creditors are treated equally in the bankruptcy process.  Preference actions ensure that the debtor cannot frustrate the purposes of the Bankruptcy Code by paying certain creditors and not others on the eve of bankruptcy.

     The two most common defenses to a preference action are (1) that the transaction occurred in the "ordinary course of business" and (2) that the creditor gave "subsequent new value" to the debtor after the transfer in question was made.  If a creditor is required to turn over money or property as a result of an avoidance action, he will have a claim against the bankruptcy estate under section 502(h) for the amount that he was required to turn over.  

   

Involuntary Bankruptcy

     Many people that I talk to are not aware that a bankruptcy of an individual or business can be commenced involuntarily.  An involuntary bankruptcy is commenced by the filing of an involuntary petition by one or more creditors of the debtor.  If the debtor has more than 12 creditors, an involuntary petition must be filed by three or more creditors holding noncontingent claims that are not disputed as to amount or liability.  The aggregate amount of their claims must be at least $14,425.  If there are fewer than 12 creditors, then a single creditor may file the involuntary petition.  A petitioning creditor bears the burden of showing that (1) its claim is not contingent as to liability or subject to a bona fide dispute as to amount or liability and (2) the debtor is not generally paying debts as they become due.
   
     When an involuntary petition is filed, a summons will be issued and the petition and the summons must be served on the debtor.  The debtor then has 20 days to file an answer.  A hearing will then be held and if the court determines that the requirements for an involuntary bankruptcy have been met, an "order for relief" will be entered, and the case will proceed as any other bankruptcy would.

Warning!

     Section 303(i) provides for damages against a petitioning creditor for an improper petition.  That section provides that if an involuntary petition is dismissed by the court without an order for relief being entered, the court may order the petitioning creditor to pay the debtor's costs and attorneys' fees whether or not the petition was filed in bad faith.  If the court determines that the petition was filed in bad faith, the petitioning creditors may be exposed to awards of compensatory and punitive damages.

The Bankruptcy Discharge

     Bankruptcy is intended to be a "fresh start for the honest but unfortunate debtor."  In order to grant that "fresh start," the Bankruptcy Code provides a "discharge" of certain debts for individual debtors.  The discharge acts as a permanent injunction for all dischargeable debts.  The discharge replaces the temporary injunction of the automatic stay.  

     A bankruptcy discharge releases the debtor from personal liability for all but certain specified types of debts.  In other words, the debtor is no longer legally required to pay any debts that are discharged.  The discharge is a permanent order prohibiting the creditors of the debtor from taking any form of collection action on discharged debts, including legal action and communications with the debtor, such as telephone calls, letters, and personal contacts.

     Although a debtor is not personally liable for discharged debts, a valid lien that has not been avoided in the bankruptcy case will remain after the bankruptcy is concluded.  Therefore, a secured creditor may enforce a lien to recover the property secured by the lien.   

Objections to Discharge

     Section 727 of the Bankruptcy Code provides several circumstances under which a debtor is not entitled to receive a discharge in bankruptcy.  For example, a debtor may not be entitled to a discharge if he destroyed or falsified records or transferred property prior to the bankruptcy filing "with intent to hinder, delay, or defraud a creditor.  An objection to the debtor's discharge under section 727 is, in effect, an objection to the bankruptcy as a whole.

     Creditors may also file a complaint to determine the dischargeability of a particular debt.  Section 523(a) of the Bankruptcy Code specifically excepts certain categories of debts from the discharge granted to individual debtors.  In most cases, the exceptions to discharge apply automatically if the language prescribed by section 523(a) applies.  The most common types of nondischargeable debts are certain types of tax claims, debts not listed on the debtor's schedules, debts for spousal or child support, and certain school loans.

    Other types of debt may be discharged unless a creditor files a lawsuit in the bankruptcy case (called an "adversary proceeding") seeking to except the debt for the discharge.  These debts include debts obtained by false pretenses or fraud, debts "for fraud or defalcation while acting in a fiduciary capacity," embezzlement or larceny, and debts "for willful and malicious injury by the debtor."

The Automatic Stay

     The automatic stay is an injunction that automatically stops all lawsuits, foreclosures, garnishments, and all collection activity against a debtor the moment a bankruptcy petition is filed.  A chapter 13 bankruptcy even protects co-debtors who are liable with the debtor on consumer debts.  The automatic stay remains in effect until (1) a judge grants relief from the stay at the request of a creditor, (2) the debtor receives a discharge, or (3) the item of property to be repossessed or foreclosed upon is no longer property of the bankruptcy estate.

     The automatic stay does not stop any criminal action against the debtor, nor does it stop a tax audit, a demand for tax returns, or the assessment of a tax (although the collection of taxes is stayed).  The automatic stay also does not stop actions for a domestic support order or the modification of such an order or actions to collect domestic support from property that is not property of the estate.

     A creditor who willfully violates the automatic stay may be liable for actual damages caused by the violation and sometimes for punitive damages.  Since the court usually takes several days to mail creditors notice of the bankruptcy, it is incumbent on the debtor or debtor's attorney to give actual notice to creditors who might take action without knowledge of the stay.  Creditor actions taken after the stay is in place are generally void or voidable.

     

The Bankruptcy Code

     Article I, Section 8 of the United States Constitution authorizes Congress to enact "uniform Laws on the subject of Bankruptcies."  Under this grant of authority, Congress enacted the "Bankruptcy Code" in 1978.  The Bankruptcy Code, which is found in title 11 of the United States Code, has been amended several times since its enactment, most notably in 2005 with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).

     The Bankruptcy Code consists of nine chapters - numbered 1, 3, 5, 7, 9, 11, 12, 13, and 15.  Chapters 1, 3, and 5 contain provisions that apply to all chapters.  Chapter 1 contains definitions, Chapter 3 sets forth rules for the administration of the bankruptcy estate, and Chapter 5 provides for the creditors' rights and claims, the avoidance powers of the Trustee, the effect of a discharge, objections to discharge, and property of the estate.  Chapters 9, 12, and 15 are rare and will not be discussed at length here.  Chapter 9 provides for the reorganization of a municipality.  Chapter 12 provides for a family farmer or family fisherman rehabilitation, and Chapter 15 is for cross-border bankruptcy proceedings.  The remaining chapters - 7, 11, and 13 - provide for the three most common types of bankruptcy cases and are explained in greater detail below.

     Chapter 7 is a straight liquidation and is usually what people think of when they think of bankruptcy.  A trustee is appointed who is charged with collecting and liquidating the debtor's non-exempt assets and distributing any funds to creditors.  Most individual chapter 7 cases are "no asset" cases, meaning that the Debtor does not own anything that the trustee can legally take, so the debtor will receive a discharge without having to pay anything to unsecured creditors.  If the debtor does have non-exempt assets, those assets will be sold and the proceeds will be distributed to creditors.  An individual debtor will then generally receive a discharge of remaining debts, while a business debtor will simply be shut down.

     Chapter 11 is a reorganization in which the debtor proposes a plan to repay creditors.  It is usually for corporations or wealthy individuals.  The debtor has a 120-day period during which it has the exclusive right to file a plan of reorganization.  After that, a creditor or the case trustee, if one has been appointed, can file a plan.  In the case of a small business, the "exclusivity period" is 180 days.  Any party in interest may file an objection to confirmation of a plan.  The Bankruptcy Code Requires the court, after notice, to hold a hearing on confirmation of a plan.  In order to confirm a plan, the court must find, among other things, that: (1) the plan is feasible; (2) it is proposed in good faith; and (3) the plan and the proponent of the plan are in compliance with the Bankruptcy Code.

     Chapter 13 is a rehabilitation that is available only to individuals with regular income and no more than $360,475 in unsecured debt and no more than $1,081,400 in secured debt.  Chapter 13 involves a plan to make payments to the trustee over 3 to 5 years.  Unless the court grants an extension, the debtor must file a repayment plan with the petition or within 15 days after the petition is filed.   A plan must be submitted for court approval and must provide for payments of fixed amounts to the trustee on a regular basis, typically monthly.  The trustee then distributes the funds to creditors according to the terms of the plan, which may offer creditors less than full payment on their claims.