Chapter 12 of the Bankruptcy Code is used by financially distressed farmers to reorganize and remain in business. In 2005, Congress amended a key provision to allow farmers to have more control over tax debts caused by the sale of assets that may be necessary for successful reorganization. The intention was to simplify a bankruptcy court’s approval of a farmer’s reorganization plan and to allow the reorganizing farmer to hold on to more cash in the reorganization process by reducing the priority status of tax debts. However, the U.S. Supreme Court has confirmed that the Congressional amendment, as drafted, could not accomplish its helpful goals to farmers because of language that did not comport with existing bankruptcy law.
Chapter 12 of the Bankruptcy Code is a provision to help financially distressed farmers reorganize and stay in business. Originally legislated as a temporary measure, Chapter 12 was added to the Bankruptcy Code in 1986 as an emergency response to tightening agricultural credit in the wake of several bank failures. It was eventually made a permanent part of the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005. BAPCPA also served to amend Chapter 12 to allow a financially distressed farmer to treat a tax debt as an unsecured debt rather than have that tax debt considered a priority debt. This amendment is important because if the tax debt is a priority debt, the farmer must show the court that the debt can be paid in full before the court can approve the farmer’s reorganization plan. However, the tax debt as an unsecured claim only needs to be paid with funds if they are available and any unpaid balance is discharged. This is important for farmers that must sell substantial assets in the reorganization of their business since the asset sales frequently trigger substantial tax liability. Selling farm property or assets coupled with the obligation to pay the resulting taxes in full could leave the farmer without necessary farm assets or cash to continue as a viable family farm business. This can also make it impossible for the court to approve the farmer’s reorganization plan. Accordingly, this amendment allowing the farmer to “downgrade” the priority of an IRS tax debt in a Chapter 12 proceeding can be critical in the farmer’s successful use of Chapter 12 to keep the family farm in business.
Since the inception of this amendment in 2005, farmers and the IRS have engaged in significant litigation over the issues of the types and the timing of tax liabilities that will qualify for this downgrade of priority.