Copyright ©  2008  Regents of the University of Minnesota. All rights reserved.

A Chapter 7 bankruptcy is a liquidation proceeding. It is the most logical choice for a farmer who cannot continue to farm and who must terminate his or her farming operation. Under Chapter 7, a trustee is appointed to liquidate all nonexempt assets and distribute the proceeds to creditors. Secured creditors will receive either the value of their collateral or the collateral itself. The proceeds of the debtor's nonexempt assets will be used to satisfy claims according to the priorities established by the Bankruptcy Code. The farm debtor will be able to retain the property claimed exempt, although it may yet be subject to prebankruptcy liens.

As discussed in another fact sheet in this series, Bankruptcy: The Last Resort, farmers are exempt from involuntary bankruptcy proceedings. Thus, for farmers, a Chapter 7 proceeding is purely voluntary. Such a proceeding begins when the debtor files a voluntary Chapter 7 petition with the clerk of bankruptcy court.

The Trustee
Once a Chapter 7 petition has been filed, a trustee is appointed to wind up the business affairs of the debtor. This trustee generally is an attorney or someone familiar with the bankruptcy laws and the courts. The trustee will conduct a meeting of creditors, usually within 40 days after the filing date. The debtor must appear at this meeting and must submit to an examination under oath by both the trustee and interested creditors. The examination generally is limited to questions concerning the extent and whereabouts of the debtor's assets.

The trustee is charged with liquidating all property of the estate. The initiation of a case under the Bankruptcy Code creates an estate. The bankruptcy estate consists of all legal or equitable interests of the debtor in property as of the filing date. Thus, all real property, crops, livestock, machinery and equipment, interests in cooperatives, farm program entitlements, contract rights, and leases will be included in the bankruptcy estate. Besides property owned when the case is initiated, the property of the estate includes property recovered by the trustee from creditors or other third parties and property that the debtor becomes entitled to acquire within 180 days of the filing of the bankruptcy petition by inheritance, divorce decree, property settlement, life insurance policy, or death benefit plan.

The estate also includes income from other assets that are the property of the estate. Significantly, however, a debtor's earnings from services performed after the filing of a Chapter 7 petition but before the termination of the case are not included in the estate. Thus, income from a debtor's off-farm employment may not be looked to by his creditors once the bankruptcy petition has been filed.

Under the Bankruptcy Code, the trustee is granted a number of significant powers that enable him or her to deal with the debtor's property, debts, and creditors. In general, the trustee may use, sell, or lease property in the debtor's estate in the ordinary course of business. In addition, the bankruptcy court may authorize the trustee to operate the debtor's business for a limited period if continued operation is in the best interests of the estate and the creditors. For example, if the farm debtor is in the hog business and the estate consists of hogs of varying sizes, the trustee may be authorized to feed the hogs until they attain market weight so as to maximize the amount recovered by the estate. If the livestock owned by a farm debtor is subject to a valid, perfected security interest, however, the trustee will not, in most cases, undertake the continued care and feeding of the livestock. Rather, he or she will likely abandon the property so as to limit the estate's continued responsibility. The trustee may avoid, or set aside, certain of the debtor's transactions that were entered into prior to the filing of the bankruptcy case. The laws governing these avoidance powers are complex, but some general comments may be helpful. The trustee may avoid any transfers of property made by the debtor within 90 days before filing the bankruptcy petition to a creditor to repay a pre-existing debt if such a transfer allows the creditor to receive more than he or she otherwise would be entitled to. Such transfers are called "preferences" under the Bankruptcy Code. For purposes of these provisions, a transfer includes transferring ownership or possession of property or granting a security interest in property. This avoidance power can be used by the trustee to set aside any eleventh hour security interests that were obtained by zealous unsecured creditors. The 90-day period may be extended to one year for transfers made to insiders of the debtor.

Not all transfers made by the debtor within 90 days of filing are avoidable, however. Transfers made for new value, payments for debts incurred in the ordinary course of business, and the perfection of purchase money security interests within the time period required by the Uniform Commercial Code (UCC) do not constitute preferential transfers. In general, the philosophy of the law with respect to preferential transfers is to take away from creditors any transactions that might result in an improvement in their position on the eve of bankruptcy. This philosophy is in accord with the underlying policy of the Bankruptcy Code to foster equality of treatment among creditors.

The bankruptcy trustee also may avoid fraudulent transfers made within one year before the filing. Under the Bankruptcy Code, a fraudulent transfer is a transfer that was made with the intent to hinder, delay, or defraud a creditor. It also includes transfers for which the debtor received less than a reasonably equivalent value in exchange for the transfer. Thus, gifts, assignments, or other transfers made to relatives to shelter certain assets from the claims of creditors in bankruptcy may be avoided by the trustee.

The trustee may reject or continue executory contracts and leases of the debtor. An executory contract is an agreement under which the obligations of both parties to the contract are unperformed. Common examples of such contracts in a farm setting include equipment leases and real property leases. Certain farm program contracts, such as Conservation Reserve Program contracts, are also executory contracts. If the trustee elects to assume an executory contract, he or she must either cure any defaults in the contract or provide the other party to the contract with adequate assurances that he or she will cure the defaults. In a Chapter 7 case, the trustee has 60 days from the filing of the bankruptcy petition to make a determination as to whether such contracts or leases should be assumed. A contract for deed in which the debtor is the buyer has been determined by the courts not to constitute an executory contract under the Bankruptcy Code. Therefore, the trustee need not determine whether to assume such contracts or cure all defaults under such contracts immediately.

The trustee also can avoid or set aside transfers not properly recorded or perfected under state law. If, for example, a creditor has failed to perfect a security interest under the UCC, his or her lien may be avoided by the bankruptcy trustee in its entirety. In addition, a trustee may avoid certain statutory liens or liens created by operation of law. Among these liens is any statutory lien for rent. As a result, any landlord who is relying upon statutory lien for rent will find that his lien can be avoided by a bankruptcy trustee.

Exempt Property
Exempt property includes both real and personal property of a debtor that cannot be seized or sold to satisfy the claims of creditors. Such exemptions are available only to individual debtors, not to partnerships or corporations. Such exemptions generally are intended to provide individuals with the minimal essentials for starting anew following bankruptcy.

In Minnesota, an individual debtor can select either exemptions that are provided by the Bankruptcy Code or exemptions that are provided by state law, whichever is most advantageous. As a result, it is important in the case of a Chapter 7 bankruptcy for the debtor to review carefully both the bankruptcy exemptions and the Minnesota exemptions to determine the correct course of action. The exemptions are listed in tables 1 and 2.

The value of the exemptions is determined by the fair market value of the various assets. If otherwise exempt property is subject to a lien, the debtor may claim as exempt the value of the property in excess of the lien amount (the "equity" in the property). In the case of a joint petition filed by a married couple, both spouses must claim the same exemptions, but the value limitations may be doubled. It is not, therefore, permissible for the husband to elect the Bankruptcy Code exemptions and the wife to elect the Minnesota exemptions.

If property is claimed by the debtor as exempt, it generally will remain subject to any voluntary liens that the debtor has granted. The Bankruptcy Code, however, grants the debtor the power to avoid certain consensual security interests that otherwise would attach to certain types of personal property including implements, tools of the trade, household goods, furnishings, and personal effects. It is thus possible to set aside a security interest in such items under the Bankruptcy Code, subject to the value limitations. Although some courts have held to the contrary, in Minnesota it has been held that this lien avoidance power can be applied to farm machinery.

If it appears that a bankruptcy may be required, Minnesota courts have held that it is perfectly proper and legal to plan for such an event. It may even be possible to convert nonexempt assets into exempt property before filing a bankruptcy petition. However, such bankruptcy planning is potentially dangerous and should be undertaken only with careful consideration of the ramifications of any such transactions.

Once the debtor in a bankruptcy case selects his or her exemptions, the trustee and creditors are given a period of time within which to object to such exemptions. If no one objects, the exemptions will stand.

Distribution Priorities
Once the trustee has collected all nonexempt assets and liquidated them, the estate is ready to be closed. Generally, property subject to a valid lien, and in which the debtor has no equity, is used to satisfy the lien. In the event such a creditor has a deficiency, he or she may file a claim as an unsecured creditor with the bankruptcy court.

The Bankruptcy Code establishes a detailed priority system for payment of claims. They are:

1. Expenses of the administration of the bankruptcy case, including costs and expenses of preserving the estate taxes incurred by the estate, trustee's fees, and attorney's fees for the trustee.
2. Unsecured claims for wages, salaries, and commissions up to $4,300 per creditor.
3. Unsecured claims for contributions to employee benefit plans up to $4,300 per employee, less any amount paid to an employee for wages, salaries, or commissions.
4. In the case of a grain elevator bankruptcy, unsecured claims of farmers against the elevator for grain up to $4,300 for each creditor.
5. Up to $1,950 per claim on unsecured claims for money deposited with the debtor for purchase or lease of property or for services contemplated for the personal, household, or family use of the debtor that were not provided.
6. Unsecured claims of governmental units for taxes and penalties.

After these priority claims, the next parties in line are general unsecured creditors who filed claims in a timely fashion or who were excused for late filing. Next in line are those creditors whose claim is for a fine, penalty, or damages that are not compensation for direct monetary losses suffered by the claim holder. If property remains after these claimants, all unsecured creditors receive interest at the legal rate from the date the bankruptcy petition was filed. Any funds or property remaining after the payment of interest is paid to the debtor. If the debtor's assets are insufficient to pay in full all of the claims within a particular classification, all creditors share on a pro-rata basis.

Because there may be numerous disputes between the debtor and creditors or among creditors, complete administration of the estate may take several months. In the absence of any disputes directly involving the debtor, the debtor's involvement with the administration of the case usually will be completed within 120 days from the date the petition was filed. By that time, the debtor will have received a discharge from all liabilities listed on the bankruptcy petition. The discharge does not, however, release any property that the debtor retains from any lien that may have been granted prior to filing bankruptcy. Only those liens that may be avoided will be extinguished by the bankruptcy court. All other liens remain intact following bankruptcy.

Conclusion
Chapter 7 bankruptcy is designed for farmers who have decided to stop farming. Once a Chapter 7 bankruptcy petition has been filed, the debtor cannot continue to operate business. All property passes to the trustee upon filing of the bankruptcy petition. The trustee then collects all the debtor's nonexempt property and uses it to pay unsecured creditors. To the extent that this property is insufficient, the debtor generally will be discharged from any further indebtedness.

Table 1. Minnesota Exemptions

^* In a joint case, these exemptions other than the homestead exemptions are available to each spouse.

Table 2. Federal Bankruptcy Code Exemptions^* (11 U.S.C. Section 522(d))

^* In a joint case, these exemptions other than the homestead exemptions, are available to each Unlimited

To order other publications in this series, contact the University of Minnesota Extension Store, 20 Coffey Hall, 1420 Eckles Avenue, St. Paul, MN 55108-6069, e-mail: shopext@umn.edu or credit card orders at 800-876-8636 or (612) 624-4900 (local calls).

• Security Interests in Personal Property (FO-7292).
• Mortgages and Contracts for Deed (FO-7293).
• Termination of Contracts for Deed (FS-7294).
• Bankruptcy: Chapter 7 Liquidations (FO-7295).
• Bankruptcy: Chapter 11 Reorganizations (FS-7296).
• Mortgage Foreclosures (FO-7297).
• Termination of Security Interests in Personal Property (FO-7298).
• Rights of Unsecured Creditors (FO-7299).
• Tax Considerations in Liquidations and Reorganizations (FO-7300).
• Bankruptcy: Chapter 12 Reorganizations (FO-7301).
• Agricultural Production Contracts (FO-7302).
• Financing the Farm Operation (FS-2589).
• Contracts, Notes and Guaranties (FS-2590).
• Farm Leases (FS-2593).
• Bankruptcy: The Last Resort (FO-2598).

The fifteen publications are also available as a package: Farm Legal Series (PC-7291).

This publication is designed to provide accurate information in regard to the subject matter covered. It is published with the understanding that the authors and the University of Minnesota are not engaged in rendering legal, accounting or other professional services. If legal advice or other professional assistance is required, the services of a competent professional should be sought.

Produced by Communication and Educational Technology Services, University of Minnesota Extension.

In accordance with the Americans with Disabilities Act, this material is available in alternative formats upon request. Please contact your University of Minnesota Extension office or the Distribution Center at (800) 876-8636.

University of Minnesota Extension is committed to the policy that all persons shall have equal access to its programs, facilities, and employment without regard to race, color, creed, religion, national origin, sex, age, marital status, disability, public assistance status, veteran status, or sexual orientation.