“Engaged In” Eligibility Struggles: Chapter 12 And Subchapter V (In re Mongeau)

A farming operation? (Photo by Marilyn Swanson)

By: Donald L Swanson

“Engaged in” eligibility for Chapter 12 (farming operations) and Subchapter V (commercial or business activities) are similar-but-separate things.

An opinion by the Kansas Bankruptcy Court shows the difficulty in addressing the “engaged in” eligibility standards in Chapter 12—even when Subchapter V opinions are consulted as analogous. 

The opinion is In re Mongeau, Case No. 21-40055 in the Kansas Bankruptcy Court (issued October 22, 2021, Doc. 107).

The Mongeau Case

On February 1, 2021, Debtors file their Chapter 12 bankruptcy. Creditor moves to dismiss the case, claiming Debtors are not “engaged in a farming operation” on the petition date.

Debtors in response:

  • acknowledge they stopped growing crops and liquidated most of their farm assets in late 2020, before filing Chapter 12 in early 2021; but
  • contend they are “engaged in a farming operation” because, on the petition date, they still have minimal cattle operations, still have some equipment, and intend to return to farming.

The Bankruptcy Court takes evidence and rules that Debtors satisfy their burden of proving they are “engaged in a farming operation.”

Facts

Husband Debtor has been employed as a banker.  Wife Debtor has been operating her own CPA firm. Both have also been running a large crop and cattle farming operation, through an LLC they jointly and equally own.

Throughout 2020, Debtors engage in an orderly liquidation of their farming assets—with sale proceeds paid to creditors.

Much of their real property and equipment are purchased by family members for use in the extended family’s farms, and many of Debtors’ leases are taken over by family members.

On their petition date, neither Debtors nor their LLC own any growing crops, chemicals, or tractors.  They do own, on that date:

  • one plow (to be picked up by the purchase money secured creditor);
  • one pickup that Debtors use in working their family’s farms (they drive separate/different vehicles to commute to work); and
  • are considered by their extended family to own an interest in equipment purchased by a family member, due to post-petition sweat equity they put into the extended family’s farms.

On their petition date, Debtors are actively wrapping up their LLC’s farm operations. That includes a handful of 2021 income items, stemming from 2020 activities, requiring post-petition efforts:

  • a USDA payment of $128,829.93 (distributed post-petition to creditors);
  • a patronage dividend of $6,942.70 (set off by the creditor after obtaining relief from stay);
  • an FSA payment of $5,623 relating to livestock;
  • a USDA payment of $831 under the 2013 Livestock Forage Disaster program; and
  • a cooperative patronage refund of $249.29 for year 2020.

Further, Debtors and their LLC are defendants in a state court lawsuit brought by a creditor, which involves post-petition hearings on the distribution of funds held in trust from sale of farm equipment and crops.

Both Debtors are involved in post-petition clean-up work for their farming operation, such as keeping track of income, getting assets and government payments collected, and communicating with creditors.

Debtors plan to return to conducting a livestock operation, on a smaller scale with assistance from extended family members, and claim to be part of their extended family’s farms by providing labor.

Conclusions of Law

Applicable legal standards include:

  • Under § 1208(c), the Court may dismiss a Chapter 12 case for “cause”;
  • Debtors bear the burden of proving Chapter 12 eligibility;
  • Chapter 12 eligibility focuses on the statute’s structure and the plain meaning of its words; and
  • Chapter 12 eligibility is determined as of the date the case is filed.

Two elements for determining if a debtor is “engaged in a farming operation” (such determination is made on a case-by case basis by considering the totality of the circumstances) are:

  1. a temporal element—debtor must be engaged in a farming operation on the date of filing; and
  2. a substantive element—whether debtor’s activities on that date qualify as a “farming operation.”

–Factors Under Each Element

When determining the temporal element, one court has identified the relevant factors as: (1) “the debtor’s daily involvement on the farm, (2) the debtor’s legal ownership interest in the farming operation and/or its assets, and (3) the debtor’s physical presence on the farm.”

As to the substantive element, there is no widely accepted list of factors.  Both Debtors and Creditors propose competing lists on this element, which lists include the following common factors:

  • Have Debtors abandoned all farming operations at the time of filing?;
  • Do Debtors intend to continue farming operations in some form, including a different type of farming?; and
  • Do Debtors own farm assets, such as equipment?

Debtors identify this additional factor: Are Debtors’ activities subject to the cyclical risks involved in farming?

The Court finds these factors are appropriate under the circumstances of this case.

–Applying The Factors

Applying these factors, the Court concludes that Debtors are engaged in a farming operation (on their petition date) because:

  • Debtors had not completely abandoned all farming operations;
  • Debtors are “engaged” in their extended family’s farms;
  • Debtors’ daughter has cattle that she runs with other cattle owned by extended family members, and Debtors help work those cattle;
  • Debtors own a partial interest in cattle equipment, based on their post-petition labor in extended family farming operations—a debtor need not “only use assets belonging to them”; and
  • Ownership in farm equipment based on a joint venture understanding with a non-debtor can be sufficient.

Additionally, there is a business management side to farming that cannot be overlooked.  Examples include:

  • analyzing government programs, crop insurance, and the various markets;
  • determining land values;
  • identifying and adapting appropriate technologies and proper nutrition for livestock;
  • determining soil conditions, balancing environmental issues, and determining proper veterinarian procedures for livestock; and
  • accomplishing complicated reporting to various government agencies, maintaining books and creditor-relations, and addressing tax implications of farming. 

Then there are wind-up activities—the results of risks previously taken.  Husband Debtor spends a lot of time winding up the remains of Debtors’ farming operations.  Modern farming has intricate relationships with large creditors and federal and state governments—and handling such business is part of being a farmer, under the totality of circumstances test.

Moreover, Debtors have an intent to continue a small cattle operation in the future. 

Further, Debtors own some farm assets (a pickup they use in their family’s farm operations, and a plow that’s to be surrendered to a creditor), and they are defending a lawsuit involving ownership and distribution of proceeds from sale of farm assets.

–Liberal Construction of Eligibility

The definition of “farming operation” is “to be construed liberally.”

Under the Bankruptcy Code, a Chapter 12 debtor is entitled to completely liquidate a farming operation under § 1222(b)(8):

  • This Code provision “reflects a recognition by Congress that many family farm reorganizations, to be successful would involve the scaling down of the farm operation”; and
  • “It would make little sense to block a debtor from the relief provided by Congress under Chapter 12 simply because Debtors made a reasonable financial decision to end a nonprofitable farming operation which would cause the Debtors to fall deeper into debt.”

The Court rejects the idea that an orderly, pre-petition liquidation compels the conclusion that Debtors are no longer “engaged in a farming operation,” because “farming” is much more than planting a seed.

The Court concludes that Debtors are eligible for Chapter 12 relief because they are “engaged in a farming operation” on the petition date.

Subchapter V Analogy

The Court analogizes this Chapter 12 eligibility issue to cases under Subchapter V of Chapter 11.

A debtor is eligible for relief under Subchapter V if the debtor satisfies the eligibility requirements of § 1182(1)(A). Such eligibility requirements include: the debtor must be “engaged in a commercial or business activity.”

Similar to Chapter 12 eligibility issues, courts have struggled in Subchapter V cases with what it means to be “engaged in” a business activity.

Some courts have concluded that winding down a business that stopped operating prepetition is sufficient to be “engaged” in business activities.  This Court finds those Subchapter V cases persuasive in this Chapter 12 eligibility context.  That’s because, no matter what farming used to be, farming today is a business.  The wind down work for farming is no different than the wind down work for other businesses.

A Precedential Caution

The Court adds this precedential caution:

  • The Court’s ruling in this case is only that Debtors have carried their burden based on the unique and individual facts of this case; and
  • Counsel for Chapter 12 debtors should proceed with caution in this area in the future.

Conclusion

Courts continue struggling with eligibility issues in both Chapter 12 and Subchapter V cases, based on the statutory “engaged in” standard under each scheme.

The In re Mongeau opinion discussed above is another example of such struggles.  And the difficulty of the struggle is emphasized by the Court’s caution, in the Mongeau opinion, that little is certain, and much is in flux, in such contexts.

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