By: Donald L Swanson
Chapter 12 is for farmers.
Subchapter V is for main street businesses.
But in many circumstances, a farmer could be eligible for relief under both Chapter 12 and Subchapter V. In such circumstances, the question is this:
- Which should the farmer choose—Chapter 12 or Subchapter V?
What follows is a three-part discussion on, (i) Chapter 12 is Better—Almost Always, (ii) Neutral Considerations, and (iii) When Subchapter V is the Only Option.
I. Chapter 12 is Better—Almost Always
The answer in the vast majority of such cases is this:
- Choose Chapter 12.
And it’s not a close call. Here’s why.
–Capital Gains Taxes
First and foremost, the Chapter 12 tax benefits in § 1232 cannot be matched in Subchapter V.
In its essence, § 1232 allows capital gains taxes from liquidation of farm assets to be treated under a Chapter 12 plan as a general unsecured claim that can be discharged—instead of as a priority claim or administrative claim that cannot.
Such a tax benefit for farmers is huge, especially since many farmers have, (i) farmland with a low tax basis, and (ii) fully depreciated equipment.
And the § 1232 tax benefit arises whether the liquidation of farm assets occurs pre-petition, post-petition, or under a confirmed Chapter 12 plan. And that beats the heck out of addressing those same capital gains taxes as pre-petition priority claims or post-petition administrative claims under Subchapter V.
–Time Length of Plan
Statutory language on the time length of a plan, for paying general unsecured claims, varies slightly between Chapter 12 and Subchapter V:
- Chapter 12—not longer than 3 years “unless the court for cause approves a longer period” that is less than 5 years, in § 1222(c); and
- Subchapter V—between 3 and 5 years “as the court may fix,” in § 1191(c)(2).
But the effects of those slight language variations can be huge:
- the same circumstance that would unquestionably limit the length of a Chapter 12 plan to 3 years could easily end up as a 5 years plan under Subchapter V.
–Filing Fees
The court fees for filing a Chapter 12 petition are much less than the corresponding court fees for filing a Subchapter V petition. The filing fees are:
- Chapter 12—$278; and
- Subchapter V—$1,738.
–Trustee Fees
Chapter 12 trustees are standing trustees under 28 U.S.C. § 586(b); whereas, Subchapter V trustees are case-by-case trustees.
And their compensation schemes are different too, with Chapter 12 trustee fees likely to be much less than Subchapter V trustee fees:
- Subchapter V trustees are compensated on an hourly basis, with no specific limitation; whereas,
- Chapter 12 trustees are compensated by a percentage of the debtor’s funds that they handle—and with a cap on fees in some districts.
The Bankruptcy Court for the District of Nebraska (where I am located), for example, has a Local Rule Appendix H on “Trustee Fees in Subchapter V of Chapter 11 and in Chapter 12 Cases.” Here are the differences it provides for compensating Chapter 12 trustees and Subchapter V trustees:
- Chapter 12—”debtor must pay the trustee a fee, for each year of the plan, equal to 10% of all payments under the plan . . . or $6,000, whichever is less,” and the debtor “must also pay an initial payment of $200.00” for the trustee’s fee; but
- Subchapter V—debtor must (i) pay $1,000 to the trustee “Within 5 days of the Petition Date” and must pay an additional $500 per month to the trustee “until the total amount held by the trustee is $3,000.”
–Debt Limit for Eligibility
The debt limit for Chapter 12 eligibility is $11,097,350 (adjusted for inflation from $10 million).
The debt limit for Subchapter V eligibility is currently at only $3,024,725 (adjusted for inflation from $2,750,000) with a likelihood of returning to its former $7,500,000 amount, if-and-when Congress can get around to acting on it.
–Voluntary Dismissal Opportunity
Chapter 12 grants an unfettered right, to a family farmer debtor, to voluntarily dismiss debtor’s Chapter 12 case. 11 U.S.C. § 1208(b) provides (emphasis added):
- “(b) On request of the debtor at any time, if the case has not been converted under section 706 pr 1112 of this title, the court shall dismiss a case under this chapter. Any waiver of the right to dismiss under this subsection is unenforceable.”
Subchapter V has no corresponding, unfettered right of dismissal for the debtor (see § 1112).
II. Neutral Considerations
Here are some considerations that may affect a debtor’s analysis on whether to file Chapter 12 or Subchapter V. But none of these considerations necessarily prefers one over the other. In other words, these considerations tend to be neutral.
–When Chapter 12 Tax Benefits Do Not Apply
Some Chapter 12 debtors are unable to take advantage of the § 1232 tax benefits. Examples include:
- when debtor’s plan does not involve a liquidation of farm assets beyond selling the farm products being produced—there are no capital gains taxes to be addressed by § 1232; or
- when debtor is solvent (or nearly so)—under the Chapter 7 liquidation standard for plan confirmation (§ 1225(a)(4)), the capital gains taxes will still have to be paid in a Chapter 12 plan.
When the special tax benefits of Chapter 12 do not apply, § 1232 becomes a neutral factor in the choice between Chapter 12 and Subchapter V.
–Discharge Timing & Plan Amendment
In a Chapter 12, (i) discharge does not occur until all payments under a confirmed plan are completed (§ 1228(a)), and (ii) a confirmed plan can be modified at any time before all payments are completed thereunder (§ 1229).
Subchapter V is more complicated on both items—depending on whether the plan confirmation is:
- consensual under § 11921(a)—i.e., with all classes of claims voting for the plan; or
- non-consensual under § 1191(b)—i.e., not all classes of claims have voted for the plan.
If the Subchapter V plan confirmation is consensual:
- discharge happens upon confirmation (§ 1141(d)); but
- under § 1193(b) the confirmed plan cannot be modified after substantial consummation (which typically occurs soon after confirmation—see § 110(2)).
Whereas, if the Subchapter V plan confirmation is non-consensual:
- discharge happens only after all plan payments are made (§ 1192); but
- the confirmed plan can be modified at any time before all plan payments are made (§ 1193(c)).
Since creditors control whether a plan confirmation is consensual or not, a debtor cannot count upon receiving either type of confirmation. That’s why the discharge timing and plan amendment considerations are neutral.
III. When Subchapter V is the Only Option
You’d think that every career farmer and his/her farming entity would qualify for Chapter 12. But that’s not the case.
There are many circumstances when such a person can’t qualify for Chapter 12—in which case, the debtor will be hoping that Subchapter V is a viable option.
Here are some of those circumstances.
–“Engaged in” Eligibility
The “engaged in” eligibility standards are materially different between Chapter 12 and Subchapter V. Here is the operative language for each:
- Subchapter V—“engaged in commercial or business activities” (§ 1191(1)(A)); and
- Chapter 12—an individual “engaged in a farming operation” or an entity in which family members “conduct the farming operation” (§ 109(18)(A)&(B)).
The effect of such differing language is that Chapter 12 eligibility requires a farming “operation,” while Subchapter V does not:
- the difference is in the statutory words “operation” (Chapter 12) and “activities” (Subchapter V); and
- the practical difference might be huge for a debtor whose business operations are already shutting down but the debtor is still engaged in shut down activities—it might be that only Subchapter V is available for this debtor.
–Debt Limit
While the difference in debt limit numbers for eligibility is currently huge ($11+ million for Chapter 12, compared to $3+ million for Subchapter V), there is another difference that can entirely flip the analysis.
Here is the statutory language difference:
- Chapter 12—“whose aggregate debts do not exceed $11,097,350” (§ 101(18)(A)&(B)); and
- Subchapter V—“that has aggregate noncontingent unliquidated secured and unsecured debts . . . in an amount not more than [whatever the current statutory amount might be] . . . (excluding debts owed to 1 or more affiliates or insiders) . . .” (§ 1182(1(A)).
Such differences in debt limit language can have huge practical implications.
It’s entirely possible, for example, that a farmer with too much “aggregate” debt for Chapter 12 eligibility can still be eligible for Subchapter V—such as, when large debt amounts are owed to “affiliates or insiders” or when a large debt amount is contingent (e.g., a guaranteed debt that is not yet in default) or unliquidated (e.g., a tort claim is being asserted in a pending lawsuit).
–Other Eligibility Limitations
Chapter 12 has eligibility standards that simply do not exist in Subchapter V. Examples include:
- an individual farmer must “receive from such farming operation more than 50 percent of such individual’s or such individual and spouse’s gross income” in certain prior taxable years (§ 101(18)(A)); and
- at least 50% of the ownership of a farming entity must be “held by one family, or by one family and the relatives of the members of such family, and such family or such relatives conduct the farming operation” (§ 101(18)(B)).
So, it is entirely possible that a career farmer and his/her farming entity could be, (i) disqualified from Chapter 12 eligibility by non-farm income or by a lack of family-purity in farm ownership or operation, but (ii) still eligible for relief under Subchapter V.
Conclusion
If a family farmer is eligible for both Chapter 12 and Subchapter V, that farmer will want (in the vast majority of cases) to proceed under Chapter 12—not under Subchapter V.
Some differences exist between Chapter 12 and Subchapter V that are neutral on the question of which is better for a debtor.
And then there are circumstances where a career farmer and his/her farming entity cannot qualify for Chapter 12. In such circumstances, the debtor will be hoping for Subchapter V eligibility instead.
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