By Jim Lodoen and Andrea ChaseMost know of the Farm Crisis of the 1980s, and some of us even experienced it. Times are tough on the farm right now as commodity prices have significantly dropped—some by 50 percent since 2014. But it is not the ’80s, when interest rates were at 18-20 percent, land values dropped 1-2 percent per month and lending was balance-sheet-driven. Unlike 1987, when 5,788 Chapter 12 family farm bankruptcies were filed, 2019 saw just 595.
But 2020 presents a new set of coronavirus-related and other challenges that will affect the ag sector in different ways. Changing consumer demand, supply chain disruption, constricted trade, labor availability and broader economic weakness—coming in the wake of years of depressed commodity prices are likely to drive an increase in distressed farm and agribusiness loans over the next decade.
Step one: get the facts
Before addressing the distressed loan, lenders and their legal counsel must understand the borrower-specific picture:
- Review loan documents, mortgage filings, UCC filings, Effective Financing Statement filings/direct notices (depending upon whether your state has a farm product central filing system) and lien notices to confirm that the lender has enforceable error-free documents, that it is timely and properly perfected in the collateral and that it has its expected priority over other creditors.
- Confirm the existence of collateral by actual inspections with up-to-date values tied to current prices and appraisals in order to assess whether outstanding credits are over-secured, just barely secured, or partially under-secured.
- Determine what may be necessary by way of human resources, financial resources or legal rights to access property to feed livestock, milk cows, harvest crops and preserve collateral.
- Review financial statements, bank statements or other information to identify other creditors and improper transfer of funds.
- Consider whether the borrower is honest and cooperative.
- Understand the timing of future income from farm products, government payments or other sources.
- Determine whether the lender has handled the credit properly and subject to loan policies and whether there is lender liability exposure.
- Inform counsel of any regulatory requirements affecting the credit.
Four options for action
Counsel and the lender are now in an informed position to consider the various alternatives to preserve and ultimately monetize the credit.
1. Out-of-court workout and forbearance agreement
A forbearance agreement is often the first step to manage a distressed credit. Among its benefits is that the credit relationship can be reset with clear benchmarks in place. This may include some pay-down of the credit, liquidation of specific collateral, refinancing by a new lender, regular and shorter reporting, delivery of deeds-in-lieu of foreclosure, voluntary surrender of collateral, authority to file a confession of judgement, a forbearance fee or default interest or anything else the lender might require. Plus, it informs the borrower that the credit has reached a level of seriousness and assists the borrower in mentally adjusting expectations.
Among other benefits, the lender may obtain additional security, fix loan documents, file perfection documents if needed and gain time for the 90-day preference period to run so that such filings or grants of collateral are not avoided in a bankruptcy filing. The lender can also obtain the borrower’s acknowledgement of the default, the amount of current obligations and agreement that there has been no waiver by the lender of its rights. The forbearance agreement can also include the borrower’s release of any claims.
A forbearance agreement may be extended/amended on one or more occasions if the borrower is making progress and complying with the agreement.
In conjunction with the forbearance agreement, and at times without one, an out-of-court restructuring of a credit can occur, especially in situations where the credit problems are due to unexpected and non-recurring circumstances and where the lender has ultimate confidence in the borrower’s honesty and ability to service the restructured credit.
Receiverships are becoming more common due to modernization of many state receivership statutes. They are generally available as an option when an agreement provides for a receivership as a lender remedy or when certain statutory factors exist such as waste, insolvency, or danger of loss of assets.
Historically, a limited receivership pertained to particular property, such as a piece of real estate.
General receiverships covering much or all property are now common. They are especially suited for livestock operations and agribusinesses, or during growing seasons where a high level of daily management is needed pending ultimate liquidation. A good receiver can provide a great deal of value to a distressed farm credit, and the lender should to consider a candidate’s agricultural experience when selecting a proposed receiver.
The pursuit of a receivership may push the borrower into filing a bankruptcy proceeding because the borrower does not want to give up control to a receiver. This may be fine if a lender wants a borrower in bankruptcy because a farmer cannot be put into bankruptcy involuntarily.
A receivership may work best either when there is mutual agreement between the borrower and the lender to put the borrower’s assets into a receivership or when the borrower has been engaging in fraudulent activity and the borrower wishes to stay clear of a federal bankruptcy proceeding. If a borrower files bankruptcy in the midst of litigation seeking a receiver or shortly after a receiver is appointed, the receivership may be superseded by the bankruptcy filing, unless the bankruptcy court abstains and allows the receivership to proceed. (The likelihood varies by district.)
3. Replevin and foreclosure
Replevin/claim and delivery (personal property) or foreclosure (real estate) are proceedings to attach and sell collateral, actions that often bring the borrower to the bargaining table. The lender typically pursues these options when cooperation has broken down, forbearance agreements have been breached or there is a level of misconduct which requires the courts to control the borrower. These remedies are state specific with the process, including bonding requirements, and borrower’s rights such as the existence and duration of a redemption period subject to state law.
Bankruptcy provides a borrower some breathing room, control and additional legal tools to restructure or pay on its loan. A lender may prefer a borrower being in bankruptcy because it provides judicial oversight and control.
In addition, schedules and pleadings are filed under penalty of perjury by the borrower with federal criminal laws at the ready to control dishonest conduct.
Most farmers who have debt up to $10 million and seek bankruptcy reorganization will file Chapter 12. Chapter 11 is available for farmers with more debt or for agribusinesses. Chapter 12 is quicker and cheaper and provides the farmer-borrower with increased restructuring leverage over the lender. A Chapter 12 plan is likely to be confirmed if the proposed plan is feasible, and if the secured lender is provided with payments equal to the value of its collateral, plus interest, over time. Chapter 11, on the other hand, provides lenders with additional leverage. Unfortunately, a Chapter 11 is expensive for all parties.
The best approach to managing a distressed farm or agribusiness borrower credit will vary. No size fits all. Only after the lender and its counsel have a firm understanding of the facts, law and documents can an approach be developed with the best chance of success.
Jim Lodoen is a Minneapolis-based partner, and Andrea Chase is a Kansas City, Missouri-based associate, at the law firm Spencer Fane.