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Most people assume bankruptcy means liquidating all a debtor's nonexempt assets and distributing the proceeds among creditors. But the bankruptcy laws also provide for rehabilitating the debtor. Chapter 11 allows a debtor to enter into an agreement with creditors under which all or a part of the business continues. The debts of the business are restructured so as to allow the debtor to continue business operation. Chapter 11 is more complex than Chapter 12 (which is the subject of another fact sheet in this series, Bankruptcy: Chapter 12 Reorganizations) however it may provide an option for those farm operators whose businesses are too large for Chapter 12.

If a farm debtor cannot qualify for Chapter 12, Chapter 11 provides similar reorganization possibilities. In general, any partnership, corporation, or limited liability entity except a governmental unit may be a debtor in a Chapter 11 case. To initiate a Chapter 11 case, a voluntary petition is filed with the court. A schedule of assets and liabilities and a statement of financial affairs also must be filed. The objective in a Chapter 11 case is to adjust and reorganize a debtor's obligations so as to allow the business to continue. In most cases, the debtor, known as the debtor in possession once the case has begun, remains in possession of his or her property, develops a plan, and generates funds to pay debts. If there is evidence of mismanagement or fraud, a trustee may be appointed upon the request of creditors.

The ability of the debtor to remain in possession and to continue to operate the business is a substantial reason to file a Chapter 11. The debtor can continue to raise and sell crops and livestock, use equipment, and acquire the necessary inputs to continue the farming operation. A committee of creditors will generally be appointed to oversee the farming operation under the supervision of the debtor in possession once the case has been initiated.

Although the ultimate goal in any Chapter 11 is the formulation and acceptance of a reorganization plan, rarely does the debtor have a plan developed when the case is filed. There is thus often a period between the filing of the petition and confirmation of a plan during which business will be carried on by the debtor as the debtor in possession. As a debtor in possession, the debtor has all the rights of a bankruptcy trustee. He or she may continue to use assets in the ordinary course of business without court approval. There are, however, certain restrictions applicable to the use of cash collateral. The debtor in possession cannot use, sell, or lease "cash collateral" unless each creditor with an interest in the collateral consents or unless the court authorizes such use. To obtain court permission to use cash collateral such as proceeds of stored grain, milk proceeds, or the proceeds of livestock sales, the debtor in possession must provide any creditor who holds a lien on such property with adequate protection. In other words, the creditor's secured position must be protected and not harmed by the use of the creditor's collateral.

Besides being able to continue to use the business assets, the debtor in possession is authorized to borrow funds. He or she may obtain unsecured credit in the ordinary course of business without court approval, and may obtain secured credit by granting a lien on unencumbered property of the estate or a subordinate lien on encumbered property with court approval. Finally, if the debtor cannot obtain credit on either an unsecured basis or by using previously unencumbered assets, a super-priority lien may be obtained if he or she can establish that any lender who also has a lien on the property will be adequately protected.

In the case of a farming operation, it is possible to obtain secured credit by using crops planted after the filing of the petition as collateral. If the petition has been filed prior to the planting of crops, such crops are free of the lien of any prepetition creditors. In other words, the filing of a bankruptcy petition (including Chapter 7 or Chapter 12) cuts off the after-acquired property clause contained in any prepetition security agreement. This rule does not apply, however, to proceeds, products, offspring, rents, or profits of prepetition property. Thus, if a lender has a security interest in livestock and offspring, the security interest will extend to offspring conceived and born after the filing of the case.

Besides continuing the business, like a trustee, the debtor in possession can avoid certain transactions that occurred prior to the filing of the bankruptcy case. These avoidance powers are complex, but a brief summary may be helpful. The debtor in possession can avoid any transfers of property made within 90 days before the filing of the bankruptcy petition to a creditor on account of a pre-existing debt if such a transfer allows the creditor to receive more than otherwise entitled to. Such transfers are called preferences under the Bankruptcy Code. Thus, the debtor in possession may avoid the granting of any security interest, conveyances of property, or payments that were made within 90 days of the filing date. This 90-day period may be extended to one year for transfers made to insiders. Exceptions to these preference rules are provided in cases of transfers made for new values, payments for debts incurred in the ordinary course of business, and the perfection of purchase money security interests within a time period required by the Uniform Commercial Code.

The debtor in possession also can avoid fraudulent transfers made within one year before the filing of the bankruptcy petition. Under the Bankruptcy Code, a fraudulent transfer is a transfer 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. Finally, the debtor in possession can avoid or set aside transfers that are not properly recorded or perfected under state law. These avoidance powers are potent tools that the debtor in possession can use to formulate his or her plan.

Under Chapter 11, only the debtor may submit a plan of reorganization within 120 days of the initiation of the bankruptcy case. Any interested party may file a plan thereafter. A plan, including a plan proposed by a creditor, may provide for the liquidation of some or all of the debtor's nonexempt assets. Such a liquidating plan may be proposed and approved by the court even in the case of a farmer.

Under a typical reorganization plan, the debtor attempts to restructure debts. Such a plan will generally provide for repayment of loans secured by real estate to be paid over an extended period of time. Intermediate term loans will be proposed to be paid over the remaining useful life of the collateral, typically five to ten years. The interest rate on any such loans may be adjusted under a plan, although it will generally be necessary for the debtor to pay interest at a "market rate" following confirmation of the plan. Most plans will propose that unsecured creditors be paid less than the full amount of their claims in full satisfaction of their claims.

A Chapter 11 plan typically classifies claims against the debtor, specifies the treatment to be given each class of claim, and provides the means for carrying out the plan. The plan must be confirmed by the bankruptcy court. There are three steps involved in obtaining confirmation of a plan under Chapter 11:

1. The plan is developed by the debtor.
2. Acceptance of the plan by creditors is sought by the debtor.
3. The confirmation hearing is held and the plan is either confirmed or not confirmed.

For a Chapter 11 plan to be confirmed, it must be accepted by at least one class of impaired claims. These are claims of creditors that will not, under the plan, be paid in full or whose legal rights are adjusted by the plan. In addition, the bankruptcy court must determine that the plan is feasible.

The bankruptcy court may, under certain circumstances, "cram-down" a plan over the objection of creditors. In order to confirm a Chapter 11 plan over the objection of a secured creditor, a holder of a secured claim must receive the entire value of the property securing the claim or the entire value of the claim, whichever is smaller. Unsecured creditors must either accept the Chapter 11 plan or the owners of the business must not receive any property under the plan on account of their prebankruptcy interest in the farming operation. Finally, a plan cannot be confirmed if the plan does not pay each claim holder as much as he or she would have received under a Chapter 7 liquidation unless those who receive less accept the plan.

Creditors may object to the confirmation of the debtor's plan in a Chapter 11 case. Such objections will usually challenge whether the debtor has met the technical requirements of Chapter 11. However, creditors may also challenge the debtor's valuation of their collateral and the feasibility of the debtor's plan. As a result, it is usually necessary for the debtor to obtain expert testimony concerning the current value of machinery, equipment, livestock, and crops. In addition, the debtor needs to provide creditors with detailed financial projections which will assist the bankruptcy court in determining that the business may be successfully restructured. The rules of the Bankruptcy Code relating to the confirmation of a Chapter 11 plan are extremely complex. The legal issues presented by a contested confirmation are extremely technical. As a result, no business person should consider a Chapter 11 reorganization without competent and experienced legal and financial advice.

Confirmation of a plan under Chapter 11 acts as a discharge of all debts, filed or not, excluding those specified as not dischargeable elsewhere in the Bankruptcy Code. Upon confirmation of a plan, the debtor receives back all property free and clear of all liens and encumbrances unless such liens are preserved by the plan. Both the debtor and the creditors are bound by the terms of the confirmed plan.

Conclusion
Chapter 11 offers a second opportunity to reorganize and restructure the debtor's farming operation. When carefully considered and adopted, a Chapter 11 proceeding can provide meaningful relief for the financially distressed farmer.

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: order@extension.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.

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