Missouri Law Review

Volume 54
Article 8
Issue 1 Winter 1989

Winter 1989

Obtaining Operating Capital in a Chapter 12 Farm

Reorganization
Jerry L. Jensen

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Jerry L. Jensen, Obtaining Operating Capital in a Chapter 12 Farm Reorganization, 54 Mo. L. Rev. (1989)
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 Jensen: Jensen: Obtaining Operating Capital

OBTAINING OPERATING CAPITAL

IN A CHAPTER 12 FARM
REORGANIZATION
Jerry L. Jensen*

I. INTRODUCTION

The current financial crisis in American agriculture has forced many

farmers to seek relief under the federal bankruptcy laws.' Due to the unique
nature of agriculture, existing provisions of the Bankruptcy Code were
deemed unworkable for most farmers who desired to continue farming and
reorganize their debts. 2 In response, Congress enacted Chapter 12, a new,
separate chapter for family farmers. 3

* Law Clerk to the Honorable William L. Edmonds, United States Bank-

ruptcy Judge for the Northern District of Iowa. J.D., Creighton University School
of Law, 1987; LL.M., University of Arkansas School of Law, 1988. This Article
was prepared in partial fulfillment of the author's degree requirements for a Master
of Laws in Agricultural Law from the University of Arkansas School of Law,
Fayetteville.
1. For a discussion of the financial crisis in agriculture, see HarI, The
Architecture of Public Policy: The Crisis in Agriculture, 34 U. KAN. L. REv. 425
(1986).
2. H.R. Rep. No. 958, 99th Cong., 2d Sess. 45, reprinted in 1986 U.S.
CODE CONG. & ADMNI. NEws 5246, 5249:
Under current law, family farmers in need of financial rehabilitation may
proceed under either Chapter 11 or Chapter 13 of the Bankruptcy Code.
Most family farmers have too much debt to qualify as debtors under
Chapter 13 and are thus limited to relief under Chapter 11. Unfortunately,
many family farmers have found Chapter 11 needlessly complicated, unduly
time-consuming, inordinately expensive and, in too many cases, unworkable.
3. 11 U.S.C.A. §§ 1201-31 (West Supp. 1987) (codifying Bankruptcy Judges,
United States Trustees, and Family Farmer Bankruptcy Act of 1986, Pub. L. No.
99-554, §§ 251-57, 100 Stat. 3088, 3104-16 (1986)). For a general discussion of
Chapter 12, see Aiken, Chapter 12 Family Farmer Bankruptcy, 66 NEB. L. REv.
632 (1987); Armstrong, The Family Farmer Bankruptcy Act of 1986: An Analysis
for Farm Lenders, 104 BANKING L.J. 189 (1987); Hahn, Chapter 12 - The Long
Road Back, 66 NEB. L. REv. 726 (1987); Matson, Understandingthe New Family
Farmer Bankruptcy Act, 21 U. RicH. L. REv. 521 (1987); Wilson, Chapter 12:
Family Farm Reorganization, 8 J. AGRIc. TAX'N & L. 299 (1987); Note, Bankruptcy
Chapter 12: How Many Family Farms Can It Salvage?, 55 UMKC L. REv. 639
(1987).

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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
MISSOURI LAW REVIEW [Vol. 54

The legislative history of Chapter 12 indicates that the new chapter

was designed to give family farmers facing bankruptcy a fighting chance
to reorganize their debts and keep their land. 4 To effectuate the legislative
purpose of Chapter 12, a family farmer will need to continue farming,
generating revenue to make plan payments and rehabilitate his debt.
Once the Chapter 12 petition is filed, most farmer-debtors will need
to obtain operational financing to continue farming. A farmer needs large
amounts of capital for feed, fuel, fertilizer, seed, labor, and other expenses.
If the debtor is unable to obtain operational financing, he will likely be
forced to quit farming and liquidate his operation.
If a Chapter 12 debtor is unable to use cash collateral pursuant to
section 3635 of the Code or if no unencumbered assets are available, he
will need to find a new or existing lender willing to advance operational
credit. The debtor and creditor will need to follow the provisions of section
364 of the Code in order to effectuate a valid post-petition financing
6
arrangement.
Since there is no provision in the Bankruptcy Code which requires a
creditor to extend credit to the Chapter 12 debtor, the debtor will need
to convince a lender that it is protected under the provisions of the Code
and that lending will prove beneficial. The drafters of Chapter 12 did not
add any new incentives that would encourage lenders to grant post-petition
credit. Rather, many opponents of Chapter 12 argue that it will dry up
the availability of agricultural credit and make such credit more expensive
7
for farmers.
A recent American Banker's Association survey indicates that the en-
actment of Chapter 12 has decreased the availability of agricultural credit.8
The survey, which ran from June 1986 to June 1987, indicated that 77%
of the banks surveyed believed Chapter 12 had decreased farm credit.9
Sixty-four percent of the surveyed banks said they increased their collateral
requirements and 41.8% said Chapter 12 had increased costs for borrowers. 10
Fifty-one percent stated they specifically had denied credit on 10% or more

4. H.R. Rep. No. 958, 99th Cong., 2d Sess. 45, reprinted in 1986 U.S.
CODE CONG. & ADmit. NEws 5246, 5249.
5. See 11 U.S.C. § 363 (1982 & Supp. IV 1986).
6. See 11 U.S.C. § 364 (1982 & Supp. IV 1986).
7. See Armstrong, supra note 3, at 212-14; Matson, supra note 3, at 539;
White, Taking From Farm Lenders and FarmDebtors: Chapter12 of the Bankruptcy
Code, 13 J. CORP. L. 1, 27-29 (1987); Note, supra note 3, at 662-64.
8. Chapter 12 Bankruptcy Statutes Decrease Farm Credit Availability, Ag
Survey Reveals, ABA BANKERs WEEKLY, May 10, 1988, at 4. This article reports
the results of the American Bankers Association's Mid-Year Farm Credit Survey,
which covered the period of June 1986 to June 1987.
9. Id.
10. Id.
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 Jensen: Jensen: Obtaining Operating Capital
19891 FARM REORGANIZATION

of their loan applications due to the threat of a Chapter 12 filing."

This lender reluctance to deal with Chapter 12 farmers stems from the
powers Chapter 12 gives to farmers. One of the most significant features
12
of Chapter 12 is the writedown of secured debt to the fair market value.
3
Pursuant to section 1225(a)(5)(B)(ii)' of the Code, a farmer can scale down
undersecured claims to the value of the collateral. The remaining indebt-
edness is treated as an unsecured claim.' 4 There is no absolute priority
rule in Chapter 12, as the creditor has no right to vote on acceptance or
rejection of the plan of reorganization. 5 The debtor can retain farm assets
and pay the secured creditor the present value of the collateral. The secured
creditor will probably receive very little or none of the undersecured portion
6
of the debt.'
Since a large amount of debts of Chapter 12 debtors are undersecured,
secured lenders will be required to write off large amounts of debt, par-
ticularly loans secured by real estate.' 7 This is certain to have at least a
short term effect on a lender's willingness to look for additional exposure
in agricultural lending.'" Current farm lenders who have been hit hard by
large debt write-offs may decide to withdraw from the farm market. The
banks may choose to loan funds to other businesses or to simply invest
their excess capital in investments such as treasury bonds. 9
If the debtor is unable to obtain operating capital from traditional
lending sources such as the Farm Credit System, Farmers Home Admin-

11. Id.
12. See 11 U.S.C. § 1225(a)(5)(B)(ii) (Supp. IV 1986).
13. Id. § 1225(a)(5)(B)(ii) states that
Except as provided in subsection (b), the court shall confirm a plan if-
(5) with respect to each allowed secured claim provided for by the plan-

(B)(ii) the value, as of the effective date of the plan, of property to be distributed
by the trustee or the debtor under the plan on account of such claim is not less
than the allowed amount of such claim....
14. White, supra note 7, at 13.
15. Id. at 11; see also Comment, Cramdown Under the New Chapter 12
of the Bankruptcy Code: A Boon to the Farmer, A Bust to the Lender, 23 LAND
& WATER L. REv. 227, 232-34 (1988).
16. 11 U.S.C. § 1225(b)(1) (Supp. IV 1986) provides that a Chapter 12 plan
may be confirmed if the holder of an allowed unsecured claim is paid at least
what he would receive in a Chapter 7 liquidation and the Chapter 12 plan provides
that all disposable income is applied to make payments under the plan.
17. For example, in Iowa, the average unsecured debt for each Chapter 12
debtor was $136,567. Faiferlick & Harl, The Chapter 12 Bankruptcy Experience
in Iowa, 9 J. Acmic. TAx'N & L. 302, 308 (1988).
18. See Harl, Analyzing Chapter 12, AGRic. FiNANCE, Mar. 1987, at 14, 15
[hereinafter HarI, Analyzing Chapter 12].
19. White, supra note 7, at 28-29. But see Bauer, Where You Stand Depends
on Where You Sit: A Response to Professor White's Sortie Against Chapter 12,
13 J.Cornu. L. 33 (1987).
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
MISSOURI LAW REVIEW [Vol. 54

istration, life insurance companies, and commercial banks, he may have

to look for non-traditional alternative sources. Often family members or
landlords may be willing to extend credit to meet operating expenses. They
may be particularly interested if they can obtain a first priority security
interest under section 364(d) of the Code. 20
Several agribusiness firms recently have entered the agricultural lending
market. One of the new credit suppliers is Farmland Industries, Inc., a
large supply cooperative. Farmland recently has begun extending operating
capital to farmers in a nineteen state service area through Farmland Services
Company.21 The input supply industry may become an increasingly important
supplier of agricultural credit for the "high risk" farm borrower such as
a Chapter 12 debtor. To increase sales of fertilizer, seed, and other inputs,
such suppliers would probably be more willing to take on additional credit
risks.22
In some states, state financial assistance may be available. Because of
the severe farm financial problems, a number of agricultural states have
developed government programs directed towards making credit available
for their farmers.23 The programs, which include loan participations, interest
rate buydowns, loans to lenders, guarantees and linked deposits vary between
states.
North Dakota has enacted legislation which provides for loan parti-
cipations and interest buydowns to make farm operating loans more at-
tractive to private lenders.? The Bank of North Dakota is to make available
an appropriate amount of funds to purchase participation interests in
operating loans to farmers and agribusinesses.2? The Bank may not charge
greater than 8% per annum interest on a participation interest it purchases. 26
In addition, the Bank is to establish an interest rate buydown fund with
which the industrial commission may buydown or reduce the interest which
a farmer pays on the Bank's portion of the participation operating loans
by up to an additional five percentage points a year below the 8% figure. 27
The North Dakota statute defines "operating loan" as a loan or
extension of credit with a term of one year or less made by a non-
governmental financial institution to a farmer for the operation of an
existing farm.2 There do not appear to be any restrictions regarding loans

20. See 11 U.S.C. § 364(d) (1982).

21. Thompson, New Capital Sources for Ag Credit, Aomc. FINANcE, Dec.
1987, at 33.
22. Id.
23. Gardner, The State Role in Addressing Farm Financial Problems, pre-
pared for 1986 AM. AGRIC. ECON. MEETInG SYMWOSrU'i.
24. N.D. CENT. CODE §§ 6-09.9-03, 6-09.9-05 (1987).
25. Id. 6-09.9-0.3(1).
26. Id.
27. Id. § 6.09.9-05.
28. Id. § 6.09.9-02(3).
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REORGANIZATION

to farmers who are operating under a bankruptcy reorganization. Therefore,

the Chapter 12 debtor may be able to convince a new lender to grant
operational credit if the Bank of North Dakota is willing to participate in
the loan.
Wyoming29 and Ohio30 have both enacted statutes providing for linked
deposits. The State Treasurer of Wyoming may enter into agreements with
financial institutions in Wyoming under which the financial institution makes
agricultural loans to create and maintain jobs in Wyoming and the State
Treasurer agrees to deposit state funds with the financial institution in the
amount of the loan principal 1 The funds deposited in the financial in-
stitution earn interest at a rate that is reduced by the number of interest
percentage points the preferred rate of interest is below the existing market
lending rate. 2 The purpose of this program is to encourage agricultural
lenders to loan money to farmers at lower interest rates. This type of
program may be of particular interest to a Chapter 12 debtor who is having
difficulty making his reorganization plan cash flow because of high cost
operating funds.
To reduce the costs of agricultural production credit the Kansas leg-
islature has provided for a tax credit if a state or national banking as-
sociation agrees to extend or renew an agricultural production loan at a
rate of at least 1% below the bank's prime interest rate.3 3 Although this
statute does provide for lower credit costs, it does not encourage lenders
to grant any new credit. The state does not provide any guarantees.
Recent legislation enacted in Wisconsin actually guarantees some loans
made to farmers. An agricultural production loan, which is a loan to
finance the purchase of fertilizer, seed, fuel, pesticides, tillage services, or4
crop insurance, can be eligible for a governmental authority guarantee.
The loan is eligible for a 90% guarantee if it does not exceed $20,000 and
the interest rate is 9% or less.35 Additionally, the participating lender must
obtain a security interest in3the
6
agricultural commodity and the borrower
must obtain crop insurance.
A farmer is only eligible for a guaranteed loan if it is reasonably likely
that the farmer's cash flow and managerial ability are sufficient to preclude
voluntary or involuntary liquidation.3 7 The statute does not state that
reorganizing farm debtors are forbidden from participating in this guar-

29. Wyo. STAT. § 9-4-832 (1977).

30. Omo REv. CODE ANN. §§ 135.71-135.76 (Supp. 1987).
31. Wyo. STAT. § 9-4-832(a) (1977).
32. Id.
33. KAN. STAT. ANN. § 79-1126 (1984).
34. Wisc. STAT. ANN. § 234.90 (West 1987).
35. Id. § 234.90(2).
36. Id.
37. Id. § 234.90(4).
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
MISSOURI LAW REVIEW [Vol. 54

anteed loan program. 8 Thus, the program may be very valuable to the
Chapter 12 debtor who is having difficulty convincing a new lender to
grant operational credit, insofar as most of the risks are eliminated.
State programs such as interest rate buydowns, linked deposits, and
tax credits for interest rate reduction will probably be of little value in
convincing a lender to grant additional credit for farm operational needs.
These programs do not provide any guarantee for non-payment. However,
state programs which provide for loan participation or guarantees by the
state or an agency will likely induce lenders to grant new credit to struggling
farmers.
The programs discussed above are examples of some states' lending
programs. Several other states have enacted similar programs.3 9 The Chapter
12 debtor or his attorney should determine whether his state has a program
that may provide assistance in obtaining operational financing or lower
cost credit.
Farmers in states that do not encourage lenders to make loans to
Chapter 12 debtors will have to fall back on the Bankruptcy Code. Such
situations are the focus of this Article. It will discuss some of the procedures
and problems the Chapter 12 debtor will encounter in obtaining operational
financing under current provisions of the Bankruptcy Code. The beginning
sections of this Article discuss some of the aspects of operational financing
that need to be considered before a Chapter 12 petition is filed, including
the impact of Chapter 12 on the availability of agricultural credit. The
remaining sections focus upon potential sources of operational financing.
These sources include new credit obtained under section 364 of the Bank-
ruptcy Code and use of cash collateral and unencumbered assets.40

II. PRE-FLING CONSIDERATIONS

Before a Chapter 12 petition is filed, the debtor should determine how

much operational financing he needs and where it can be obtained. 4' If
the debtor is unable to obtain adequate amounts of operating capital, the

38. See id.

39. See ILL. ANN. STAT. ch. 5, paras. 1201-58 (Smith-Hurd Supp. 1988);
IOWA CODE ANN. §§ 175.1-175.36 (West Supp. 1988); MINN. STAT. ANN. §§ 41.51-
41.61 (West Supp. 1989); MINN. STAT. ANN. §§ 41A.01-41A.09 (West Supp. 1989).
40. For a general discussion of operational financing in Chapter 11 cases,
see Dodd, Obtaining Operating Capital in a Chapter 11 Reorganization Proceeding
Under §§ 363(c) and 364(d) of the Bankruptcy Code, 1983 ANN. SUrv. BANCR.
L. 217; Hershner & Boyer, The Financing of Crops in Chapter 11 Cases, NORTON
BNcKR. L. ADVISER, Dec. 1984, at 13: Lodoen, Chapter 11 Farm Reorganizations:
Farmers Beware!, 9 J. AcRic. TAX'N & L. 99 (1987); Note, Section 364(d) Su-
perpriority Financing: Has a Secured Creditor Met His Match?, 5 BANKR. Dv.
J. 109 (1988).
41. See Lodoen, supra note 40, at 105.
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REORGANIZATION

filing of the Chapter 12 petition would be futile and a waste of money.

The debtor will save attorney fees, court costs, and time if he and his
attorney adequately investigate the operational financing issue prior to filing
a petition in a bankruptcy court. 42
Proper timing of the commencement of the Chapter 12 proceeding may
also be crucial to a successful reorganization. If possible, the debtor should
plan the filing of the petition at a time when operating capital is available.
Unless the debtor is able to obtain new financing or has unencumbered
assets on hand, he will probably need to use the cash proceeds of encumbered
grain or livestock to finance the continued operation of the farm. Therefore,
if he plans to use the proceeds of grain or livestock, he should start the
case when he has large levels of inventory on hand. With court approval,
the debtor can use the cash collateral which the grain or livestock 43sale
creates to pay expenses of planting a new crop or feeding livestock. If
there is no inventory of grain or livestock on hand, the debtor may have
no source of financing he can rely on to continue operating the farm.
If there are no unencumbered assets or cash collateral available, the
debtor should seek a commitment from a new lender to finance the farming
operation." The debtor should not begin bankruptcy with the hope of

42. The average cost of confirming Chapter 12 plans in Iowa included

attorney's fees and expenses of $9,937 and trustee's fees of $3,441. Faiferlick &
HarI, supra note 17, at 331.
43. 11 U.S.C. § 363(c)(2) (1982) provides that the trustee may not use cash
collateral unless each interested entity consents or the court authorizes such use
after notice and a hearing.
44. 11 U.S.C. § 364 (1982 & Supp. IV 1986) provides as follows:
(a) If the trustee is authorized to operate the business of the debtor under
section 721, 1108, 1304, 1203, or 1204, of this title, unless the court orders
otherwise, the trustee may obtain unsecured credit and incur unsecured
debt in the ordinary course of business allowable under section 503(b)(1)
of this title as an administrative expense.
(b) The court, after notice and a hearing, may authorize the trustee to
obtain unsecured credit or to incur unsecured debt other than under
subsection (a) of this section, allowable under section 503(b)(1) of this
title as an administrative expense.
(c) If the trustee is unable to obtain unsecured credit allowable under
section 503(b)(1) of this title as an administrative expense, the court, after
notice and a hearing, may authorize the obtaining of credit or the incurring
of debt-
(1) with priority over any or all administrative expenses of the kind specified
in section 503(b) or 507(b) of this title;
(2) secured by a lien or property of the estate that is not otherwise subject
to a lien; or
(3) secured by a junior lien on property of the estate that is subject to
a lien.
(d) (1) The court, after notice and a hearing, may authorize the obtaining
of credit or the incurring of debt secured by a senior or equal lien on

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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
MISSOURI LAW REVIEW [Vol. 54
finding a new lender post-filing. As indicated in the previous section, most
4
agricultural lenders are reluctant to finance a bankrupt debtor. 1

III. OBTAINING CREDIT UNDER SECTION 364

If the Chapter 12 debtor cannot use cash collateral and has no unen-
cumbered funds, he will probably need to obtain new credit to continue
farming. Because of the need for post-petition financing, the Code contains
provisions in section 364 specifically dealing with the rights and procedures
46
for obtaining such credit.
The farmer-debtor may be able to obtain credit from a relative, friend,
supplier, private lender, the Farm Credit System or a government lender.
Every lender should become familiar with section 364 before extending
credit to a Chapter 12 debtor. 47 The court must approve the extension of
any credit, other than unsecured credit or unsecured debt "in the ordinary
48
course of business."

A. Obtaining Unsecured Credit

A trustee or debtor-in-possession may obtain unsecured credit in the

ordinary course of business, 49 unless the court orders otherwise.50 This

property of the estate that is subject

to a lien only if -
(A) the trustee is unable to obtain such credit otherwise; and
(B) there is adequate protection of the interest of the holder of the lien
on the property of the estate on which such senior or equal lien is proposed
to be granted.
(2) In any hearing under this subsection, the trustee has the burden of
proof on the issue of adequate protection.
45. Banks appear to be requiring more collateral, stronger financial conditions
and cash flow projections in reaction to Chapter 12. Welsh, Chapter 12 is Our
Only Hope, FARm J., April, 1987, at 18, 19.
46. See 11 U.S.C. § 364 (1982 & Supp. IV 1986).
47. For a discussion of obtaining credit under section 364, see Dodd, supra
note 40; Grossman, Troubled Times: The Farm Debtor Under the Amended Bank-
ruptcy Code, 38 OIKA. L. REv. 579 (1985); Note, Section 364(d) Superpriority
Financing: Has a Secured Creditor Met His Match?, 5 BANKR. DEv. J. 109 (1988).
48. 11 U.S.C. § 364 (1982 & Supp. IV 1986).
49. It is extremely important for both the debtor and the new creditor to
determine if the credit is being obtained in the ordinary course of business. However,
the Bankruptcy Code fails to provide any definition or guidelines for an "ordinary
course" transaction. In Creditors v. Johns-Manville Corp. (In re Johns-Manville
Corp.), 60 Bankr. 612 (Bankr. S.D.N.Y.), rev'd on other grounds, 801 F.2d 60
(2d Cir. 1986), the court set out an analysis to use when determining if a post-
petition transaction is in the ordinary course of business. The court considered
whether a certain post-petition transaction was entered into in the ordinary course
of business through the use of two different tests: the "creditor's expectation test"
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REOR GANIZA TION

unsecured credit will be allowed under section 503(b)(1) as an administrative

expense payable before other prioritized and unprioritized unsecured debts.,
The Chapter 12 debtor can incur ordinary debts, such as seed, fertilizer,
and feed bills and assure the supply creditors that their debts will receive
priority.
In addition, the court can authorize the debtor in possession to obtain
unsecured credit other than in the ordinary course of business. 32 This new
creditor will also be given an administrative expense priority:
The creditor should be aware of the risks involved in extending credit
under section 364(a) or (b). The priority afforded by the grant of an
administrative expense priority may not be enough protection for the new
creditor. Many of the Chapter 12 reorganizations will probably fail and
be converted into Chapter 7 liquidations. The administrative expenses of
a superseding Chapter 7 case will have a priority over administrative expenses
of a superseded Chapter 12 case.5 4 Therefore, all administrative expenses
in the Chapter 7 proceeding will be paid first, which may result in payments
of little or nothing to the section 364(a) or (b) creditor.
Additionally, a secured creditor who is afforded adequate protection
that later proves to be inadequate will be entitled to a priority claim under
section 507(b). This claim will have priority over general administrative
expenses, including the unsecured debt incurred under section 364(a) or
(b).5 5 The court in In re Calister held that a creditor was entitled to a

and the "horizontal dimension test". The creditor's expectation test examines the
debtor's transaction from the view of a hypothetical creditor and inquires whether
the transaction subjects a creditor to economic risks of a nature different from
those he accepted when he decided to extend credit. Id. at 616. The second analysis
used in Johns-Manville was the horizontal dimension or industry-wide test. This
test compares the business of this debtor to other similiar businesses. The court
must decide whether a type of transaction is in the course of that debtor's business
or in the course of some other business. Id. at 618.
50. 11 U.S.C. § 364(a) (Supp. IV 1986).
51. Id.
52. Id § 364(b).
53. Id.
54. 11 U.S.C. § 726(b) (Supp. IV 1986) provides as follows:
Payment on claims of a kind specified in paragraph (1), (2), (3), (4), (5),
(6) or (7) of section 507(la) of this title, or in paragraph (2), (3), (4) or
(5) of subsection (a) of this section, shall be made pro rata among claims
of the kind specified in each such particular paragraph, except that in a
case that has been converted to this chapter under section 1112, 1208, or
1307 of this title, a claim allowed under section 503(b) of this title incurred
under this chapter after such conversion has priority over a claim allowed
under section 503(b) of this title incurred under any other chapter of this
title or under this chapter before such conversion and over any expenses
of a custodian superseded under section 543 of this title.
55. 11 U.S.C. § 507(b) (1982) provides as follows:
If the trustee, under section 362, 363, or 364 of this title, provides adequate
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
84 MISSOURI LAW REVIEW [Vol. 54

superpriority status because the adequate protection which the debtor pro-
vided was inadequate.- 6 The collateral the debtor used was diminishing in
value due to unforeseeable market forces, destruction, and depreciation.
Because of the superpriority status, the creditor was entitled to be paid
before the payment of general administrative expenses." The creditor who
extends credit under section 364(a) or (b) must be aware that the secured
creditor who is inadequately protected will receive payment before the new
creditor. The new creditor under section 364(a) or (b) extends unsecured
credit which is entitled only to payment as a general administrative expense. 8
The issuance of a financing order under section 364(c)(1) also creates
a superpriority lien that has priority over any or all administrative expenses
including credit extended under sections 364(a) and (b).19 In In re Flagstaff
Food Service Corp., the court held that the administrative expenses of
attorney and accountant fees could not be paid from the estate until the
section 364(c) lien was fully satisfied' 3 In this case the fees of the attorneys
and accountants were not paid. 61 The court stated that "knowledgeable
bankruptcy attorneys must be aware that the priority ordinarily given to
administrative expenses may prove illusive in light of the various provisions
62
in the Code for competing or super-priorities.

B. Obtaining Credit with Superpriority Administrative Expense

Because a new creditor will not have any special priority under either
section 364(a) or (b), it is doubtful the Chapter 12 debtor will be able to
induce a new lender to extend operational financing under either of the
provisions. If the trustee is unable to obtain unsecured credit allowable
under section 503(b)(1) as an administrative expense, the court, after notice
and a hearing, may authorize obtaining of credit or incurring of debt with:
(1) priority over all administrative expenses; (2) security in the form of a
lien on unencumbered assets; or (3) security in the nature of a junior lien

protection of the interest of a holder of a claim secured by a lien on

property of the debtor and if, notwithstanding such protection, such creditor
has a claim allowable under subsection (a)(1) of this section arising from
the stay of action against such property under section 362 of this title,
from the use, sale, or lease of such property under section 363 of this
title, or from the granting of a lien under section 364(d) of this title, then
such creditor's claim under such subsection shall have priority over every
other claim allowable under such subsection.
56. In re Callister, 15 Bankr. 521 (Bankr. D. Utah 1981).
57. Id.
58. 11 U.S.C. § 364(a), (b) (1982 & Supp. IV 1986).
59. Id.§ 364(c)(1).
60. General Electric Credit Corp. v. Levin & Weintraub (In re Flagstaff
Food Serv. Corp.), 739 F.2d 73 (2d Cir. 1984).
61. Id.
62. Id. at 75.
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REOR GANIZA TION

on property that is subject to a lien pursuant to section 364(c). 63

The farm debtor will probably not have any unencumbered assets that
can be offered as security, unless a security interest in after-acquired property
is nullified under section 552.64 Additionally, it is doubtful that he will be
able to find a new creditor willing to accept a junior lien. Therefore, the
debtor's best chance of obtaining credit under section 364(c) will be through
the use of a superpriority administrative expense. 65 Since section 364(c)
only applies to situations where the status of existing liens and property
rights remain unchanged by the new borrowing, there is no requirement
of adequate protection to existing secured creditors.' However, once a new
creditor is given a lien status he should be entitled to adequate protection
if subsequent credit extensions are made under section 364(c) or section
364(d). 67
This superpriority afforded the farm supplier or lender gives them a
superior administrative claim that must be satisfied prior to any other
administrative expenses.68 While this is a valuable method of protection to
the new creditor, the creditor must be aware that often times administrative
expenses remain totally unpaid, especially if the farm reorganization fails
and results in liquidation. If the case is converted to a Chapter 7 proceeding,
there may be no assets available for payment of administrative expenses
after secured claims are satisfied. 69

C. Obtaining Credit Through Senior Lien

Since creditors may be unwilling to extend credit on the basis of a

junior lien or superpriority administrative expense, the Code authorizes
obtaining credit secured by a senior or equal lien on property of the estate
that is already subject to a lien.70 Credit extended under sections 364(a),
(b), or (c) is not secured by any particular assets of the estate. Therefore,
there is a risk of nonpayment. Any credit extended under section 364(d)
will be secured by particular assets of the estate. Therefore, the new creditor
7
would be assured of recovering at least the value of the secured property. '

63. 11 U.S.C. § 364(c) (1982).

64. See id. § 552.
65. Many farm lenders accepted junior liens as security for loans in the
past. However, due to declining land values, many of these junior liens were
unsecured and of no value to the creditor. Therefore, most farm lenders will
probably be reluctant to grant new credit secured by a junior lien.
66. J. ANDERSON & J. MoRus, CHAPTER 12 FARm REORGANIZATIONS § 5.10,
at 5-48 (1987-88).
67. 2 COLLIER ON BANKuPTcY para. 364.04, at 364-10 (15th ed. 1979).
68. 11 U.S.C. § 364(c)(1) (1982).
69. Administrative expenses are payable from unsecured estate property only.
70. 11 U.S.C. § 364(d) (1982).
71. See id. § 506(a).
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
MISSOURI LAW REVIEW [Vol. 54

The senior lien granted under section 364(d) is a very valuable protection
for the new creditor. All creditors would be well advised to seek a senior
lien when extending credit to a Chapter 12 debtor. However, the court
can only authorize credit under section 364(d) if the debtor in possession
establishes that he was unable to obtain credit otherwise and that there is
adequate protection of the lienholder's
72
interest in the property upon which
the senior lien will be granted.

1. Inability to Obtain other Credit

A recent Chapter 12 case discussed the requirement that the debtor

establish his inability to obtain other credit. 73 In In re Stacy Farms,7 4 the
debtor requested authorization to incur debt under section 364(d) and grant
a superpriority senior lien to Dime Bank, a post-petition lender. The court
concluded that the debtor failed to establish its inability to obtain other,
more favorable credit. The debtor's only evidence of inability to obtain
credit was the Farmers Home Administration's (FmHA) refusal to provide
working capital for 1987 and the debtor's counsel's statement that lenders
required a superpriority lien in this type of situation. There was no evidence
that debtor had sought loans from institutions other than Dime Bank or
FmHA, or that Dime Bank's commitment was the most favorable credit
available. Therefore, the court concluded that the debtor failed to carry
its burden under section 364(d)(1)(A). 75 Other cases have refined this
conclusion. In re Crouse Group, a Chapter 11 proceeding, held that the
debtor failed to establish his inability to obtain credit in accordance with
section 364(d) since he had only approached one lender and never even
asked any of his existing creditors if they would extend credit.7 6 In re
Snowshoe Co. held that the Code imposes no duty to seek credit from
every possible lender before concluding that credit is unavailable without
senior lien status. 77 The court concluded that the debtor had met the
requirement by contacting several financial institutions in the immediate
78
geographic area.
It does not appear the debtor has to make an exhaustive search for
credit. However, he should approach more than one lender in seeking
credit in accordance with section 364(a) or (b). For example, a Chapter
12 debtor living in a small, rural county should probably try to seek
operating capital from several local banks in the county, the Farm Credit

72. Id. § 364(d)(1)(A), (B).

73. In re Stacy Farms, 78 Bankr. 494 (Bankr. S.D. Ohio 1987).
74. Id. at 498.
75. Id. at 498-99.
76. In re Crouse Group, Inc., 71 Bankr. 544, 550 (Bankr. E.D. Pa. 1987).
77. Bray v. Shenandoah Fed. Say. & Loan Ass'n (In re Snowshoe Co.,
Inc.), 789 F.2d 1085, 1088 (4th Cir. 1986).
78. Id.
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 Jensen: Jensen: Obtaining Operating Capital

19891 FARM REORGANIZATION

System, and government entities such as FmHA before seeking an order

to obtain secured credit.

2. Adequate Protection

Since the debtor under section 364(a) grants a new lien on property
already subject to a security interest, the pre-petition lienholder must be
provided with adequate protection. 79 The provision of adequate protection
had been a major stumbling block for many farmers attempting to reorganize
under the Bankruptcy Code. 0 The drafters of the new Chapter 12 provisions
noted that lost opportunity costs payments present serious barriers to farm
reorganization because farmland values had dropped dramatically. Family
farmers are normally unable to pay lost opportunity costs. Because of this
stringent requirement, many family farm reorganizations were "throttled
in their infancy" when a secured creditor filed a motion for relief from
automatic stay.8' Section 361 of the Code provides that adequate protection
may be provided by granting such relief that will result in the realization
by the secured party of the indubitable equivalent of such entity's interest
in such property. 82 Because of the harshness of section 361 to the successful
family farm reorganization, the drafters of the Chapter 12 provisions
developed a new adequate protection standard to be used exclusively in
Chapter 12 cases.83

79. 11 U.S.C. § 364(d)(1)(B) (1982).

80. Wilson, supra note 3, at 303. The elimination of the need to pay losi,
opportunity costs is no longer exclusive to Chapter 12 cases, as the Supreme Court
has recently decided an undersecured creditor is not entitled to interest on its
collateral while the automatic stay is in effect. The Supreme Court's decision in
United States Savings Ass'n v. Timbers of Inwood Forest Assoc., 108 S. Ct. 626
(1988), resolves a conflict between circuits. The Fourth Circuit in Grundy Nat'l
Bank v. Tandem Mining Corp., 754 F.2d 1436 (4th Cir. 1985) and the Ninth
Circuit in Crocker Nat'l Bank v. American Mariner Indus., Inc. (In re American
Mariner Indus., Inc.), 734 F.2d 426 (9th Cir. 1984) had held that an undersecured
creditor is entitled as a matter of law to periodic interest payments during the
proceeding. The Eighth Circuit determined in In re Briggs Transp. Co., 780 F.2d
1339 (8th Cir. 1986) that an undersecured creditor is not entitled to such payment
as a matter of law, but may be so entitled under certain circumstances. The Fifth
Circuit held in 1985 that a creditor is not entitled to such payments as a matter
of law. This is the case the Supreme Court affirmed.
81. H.R. Rep. No. 958, 99th Cong., 2d Sess. 49, reprinted in 1986 U.S.
CODE CONG. & ADinm. NEws 5246, 5250.
82. 11 U.S.C. § 361(3) (1982).
83. Id. § 1205 provides as follows:
(a) Section 361 does not apply in a case under this chapter.
(b) In a case under this chapter, when adequate protection
is required under section 362, 363, or 364 of this title of an interest of
an entity in property, such adequate protection may be provided by -
(1) requiring the trustee to make a cash payment or periodic cash payments
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

MISSOURI LA W REVIEW [Vol. 54

Section 1205 eliminates the need to pay lost opportunity costs.8 4 There
is no indubitable equivalent language contained in section 1205. It is clear
that what needs to be protected is the value of property, not the creditor's
interest in property.15 In addition, section 1205 includes a new means for
providing adequate protection.6 A Chapter 12 debtor can provide adequate
protection for farmland by paying the "reasonable rent customary in the
community where the property is located. 8' 7 In addition to reasonable rent,
the debtor can provide adequate protection by cash payments or replacement
liens.8" Section 1205 also contains a "catch all" provision, which allows
adequate protection through such other relief as will adequately protect
the secured creditor's value, other than entitling such creditors to com-
pensation allowable under section 503 (b) (1) as an administrative expense.8 9
The focus of at least three of these types of adequate protection is protecting
the creditor's value in the collateral.90

a. Rental Payments

The concept of paying reasonable rent may be a valuable method of

providing adequate protection for the Chapter 12 debtor. 9' The payment
of customary rental value would probably be the cheapest method of
providing adequate protection to farm lenders with liens on agricultural
land.9 2 An Ohio bankruptcy court recently discussed this new method.93 In

to such entity, to the extent that the stay under section 362 of this title,
use, sale, or lease under section 363 of this title, or any grant of a lien
under section 364 of this title results in a decrease in the value of property
securing a claim or of an entity's ownership interest in property;
(2) providing to such entity an additional or replacement lien to the extent
that such stay, use, sale, lease, or grant results in a decrease in the value
of the property securing a claim or of an entity's ownership interest in
property;
(3) paying to such entity for the use of farmland the reasonable rent
customary in the community where the property is located, based upon
the rental value, net income, and earning capacity of the property; or
(4) granting such other relief, other than entitling such entity to compen-
sation allowable under section 503(b)(1) of this title as an administrative
expense, as will adequately protect the value of property securing a claim
or of such entity's ownership interest in property.
84. Id.
85. H.R. Rep. No. 958, 99th Cong., 2d Sess. 49-50, reprinted in 1986 U.S.
CODE CONG. & ArmNw. NEWS 5246, 5250-51.
86. H.R. Rep. No. 958, 99th Cong., 2d Sess. 49, reprinted in 1986 U.S.
CODE CONG. & Armw. NEws, 5246, 5250.
87. 11 U.S.C. § 1205(b)(3) (Supp. IV 1986).
88. Id. § 1205(b)(1),(2).
89. Id. § 1205(b)(4).
90. See id.§ 1205(b)(1),(2),(4).
91. Armstrong, supra note 3,at 192-93.
92. Id.
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93. In re Kocher, 78 Bankr. 844 (Bankr. S.D. Ohio 1987).
 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REORGANIZATION

In re Kocher, the Federal Land Bank, a secured farmland creditor, sought

relief from the automatic stay because the debtor failed to provide adequate
protection. 94 The debtor's offer of adequate protection was to pay reasonable
market rent to the Federal Land Bank, which the debtor argued was no
more than $40 per tillable acre. Federal Land Bank objected on the grounds
that $40 per tillable acre was not a reasonable rent. Further, the Bank
argued that $40 per acre would be far less than the projected decline in
the value of the land over the next year. 95 The court, noting that the
Federal Land Bank had introduced no persuasive evidence as to the land's
value, held the Federal Land Bank was entitled only to $40 per tillable
acre. 96 Moreover, in dicta, the court suggested that section 1205(b)(3)
provides that the debtor's payment of a fair rental value constitutes adequate
protection "per se." 97 The debtor does not need to provide the creditor
with any more than the fair rental value of the land.
In its analysis, the court considered the legislative intent of Chapter
12, which was to give family farmers a fighting chance to reorganize their
debts and keep their land. 9 It stated that to require the reasonable rental
payments to completely offset the decrease in the secured creditor's collateral
would "subvert the purpose of Chapter 12 and would stand the legislative
history of section 1205 on its head." 99
Senator Charles Grassley, the author of section 1205(b)(3), explained
the rationale for allowing the Chapter 12 debtor to use this alternative
form of adequate protection:
Allowing the farmer-debtor to provide adequate protection by paying rent
recognizes the economic realities of foreclosure. During a time of depressed
farm values, the lender will usually be the high bidder at a foreclosure
sale. If the lender cannot resell the property, it typically will rent the
property at the market rate. If the debtor pays market rent while he
reorganizes, the lender will be getting only what it would realistically get
as a result of foreclosure. Paying a reasonable rent as a method of protecting
secured creditors was permitted during the Depression by the second Frazier-
Lemke Act, which survived constitutional challenge in the Supreme Court. °0
This legislative history suggests that courts may follow the dicta in Kocher T1'
and limit secured parties to reasonable rent even when doing so will not
compensate the secured creditor for the decline in the farmland's value.'02

94. Id.
95. Id. at 848.
96. Id. at 850.
97. Id.
98. Id.
99. Id.
100. 132 CONG. RiEc. 3529 (daily ed. Mar. 26, 1986) (statement of Sen.
Grassley).
101. See In re Kocher, 78 Bankr. 844, 850 (Bankr. S.D. Ohio 1987).
102. 132 CONG. REc. S3529 (daily ed. Mar. 26, 1986) (statement of Sen.
Grassley).by University of Missouri School of Law Scholarship Repository, 1989
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

MISSOURI LAW REVIEW [Vol. 54

The rental value form of adequate protection has given rise to other
issues as well. Courts have addressed whether a farmland lender is entitled
to rental payments even if the farmland's value is stable. The Code does
not indicate whether debtors must pay reasonable rent to all farmland
creditors or just those where there is a decrease in the value of property. 03
The legislative history indicates that reasonable rent is all that a creditor
could expect if the automatic stay were not in effect and the creditor were
allowed to foreclose.'0 4 This language appears to indicate that the farmland
secured creditor should be entitled to reasonable rental payments regardless
of whether there is a decline in value during the stay period. 05 Additionally,
unlike the three other subsections in section 1205, the statutory language
is not limited to the situation where farmland is declining in value. 1' 6 But
allowing the secured creditor to receive rental payments when there is no
decline in value of the land would in effect give them lost opportunity
cost payments.'07 As previously indicated, lost opportunity cost payments
were intended to be eliminated from Chapter 12.108
In re Turner held that the provision in Chapter 12 for adequate
protection through the payment of reasonable customary rent did not
mandate that secured claims in land with stable value were entitled to
rental payments.' °9 In Turner, Travelers Insurance Company held a first
lien on real estate. The creditor offered no proof as to whether the land
was declining in value. The court held that the secured creditor is required
to show a necessity for adequate protection, which includes at least a
showing that the farm property securing the debt was likely to decrease
in value between the time of the filing of the petition and confirmation
of the plan." 0 The court noted that if Travelers, the secured creditor, was
attempting to obtain rental payments as compensation for use of its col-
lateral, the request would in reality be a request for lost opportunity costs,
which are not recoverable in Chapter 12."' It held that section 1205(b)(3)
did not authorize the granting of rental payments to a farmland lender
when the land value was stable." 2

103. See 11 U.S.C. § 1205(b)(3) (Supp. IV 1986); see also 6 COLLIER BANK-
RUPTCY PRACTICE GUmE para. 100.11, at 100-53, 54 (1988).
104. 132 CONG. REc. S3529 (daily ed. Mar. 26, 1986) (statement of Sen.
Grassley).
105. 6 COLLIER BANKRUPTCY PRACTICE GUIDE para. 100.11, at 100-53, 54
(1988).
106. See I1 U.S.C. § 1205(b) (Supp. IV 1986); see also 6 COLLIER BANKRUPTCY
PRAcTICE GUIDE para. 100.11, at 100-53, 54 (1988).
107. In re Turner, 82 Bankr. 465, 468-69 (Bankr. W.D. Tenn. 1988).
108. H.R. Rep. No. 958, 99th Cong., 2d Sess. 48, reprinted in 1986 U.S.
CODE CONG. & ADmIN. NEws 5246, 5250.
109. In re Turner, 82 Bankr. 465 (Bankr. W.D. Tenn. 1988).
110. Id. at 468-69.
111. Id.
112. Id.
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REOR GANIZA TION

The Turner court also noted in dicta its agreement with the Kocher
court.' The Turner court stated that if Travelers showed a decrease in
value, the rental payments would be all that it was entitled to receive even
though this failed to compensate Travelers for the decrease in value of
4
the land."
It appears clear that a secured creditor can obtain rental payments
during the automatic stay if the value of the land is declining." 5 The issue
of whether rental payments can be a basis for adequate protection in a
section 364 situation, however, is not as clear. Section 1205(b) states that
when sections 362, 363, or 364 require adequate protection of an entity's
interest in such property, the debtor may provide that protection by paying
reasonable customary rent for the farmland's use." 6 However, if section
364(d) allowed this sort of adequate protection, serious consequences would
result for the secured farmland lender.
An example of a section 364 transaction may help clarify the problem.
Suppose a Chapter 12 debtor obtains an operating loan for $500,000 from
Hometown Bank and the court approves a financing order which grants
Hometown Bank a senior lien on 1,000 acres of farmland, which is worth
$500,000. This farmland is already subject to a security interest in the
amount of $800,000, held by Federal Land Bank. The court can only grant
a new post-petition lender senior lien status if the pre-petition secured
creditor is adequately protected. " 7 If the adequate protection payments are
based on the reasonable, customary rent, it is possible that a lienholder
could suffer a loss for which it is not compensated and still be adequately
protected under the definition set forth in section 1205.
The payment of reasonable customary rent will not always provide
protection in the amount of new credit extended. If the Chapter 12 plan
falls and is converted to a Chapter 7 proceeding, the land will be sold
and Hometown Bank will receive the amount of new credit extended before
Federal Land Bank receives anything from the liquidation proceeds."' Since
the market value of the property is less than Hometown's and Federal
Land Bank's liens, Federal Land Bank will suffer a loss to the extent that
the new credit extended exceeds the reasonable rental payments. For ex-
ample, suppose the customary rent is $40.00 per tillable acre, which was
the fair rental value proposed in Kocher." 9 The Federal Land Bank would
receive adequate protection payments of $40,000 during the first year. If
the Chapter 12 case is converted to Chapter 7 within the first year of the

113. Id. at 468.

114. Id.
115. See In re Turner, 82 Bankr. 465 (Bankr. W.D. Tenn. 1988).
116. 11 U.S.C. § 1205(b)(3) (Supp. IV 1986).
117. Id. § 364(d)(1)(B).
118. See id. § 364(d).
119. See In re Kocher, 78 Bankr. 844, 850 (Bankr. S.D. Ohio 1987).
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

MISSOURI LAW REVIEW [Vol. 54

plan it is possible that Federal Land Bank may receive nothing from the
Chapter 7 liquidation proceeds, even though it had a first lien prior to
the filing of the Chapter 12 petition. The Federal Land Bank will be
entitled to compensation for inadequate protection payments under section
507(b). 20 However, if there are no unsecured assets in the estate, the
creditor will not receive any payment.
If the court determined that reasonable rental payments would not
constitute adequate protection in a section 364(d) situation, the Federal
Land Bank would not suffer this large loss. The court would not allow
the debtor to obtain credit from Hometown Bank with senior lien status
unless Federal Land Bank was adequately protected from a decrease in
the value of its lien.' 2' If the case was converted to Chapter 7, the Federal
Land Bank would receive at least the value of the land, even if there was
no payout on unsecured debt.
The issue of adequate protection is different in a section 362 motion
to lift the automatic stay than when a debtor wishes to obtain credit under
section 364(d).12 In the automatic stay situation, the debtor still has a
security interest in the bargained for collateral. However, if a senior lien
is granted to a new creditor under section 364(d), the secured creditor's
security interest is diluted by the amount of new credit.'2 The payment
of reasonable rent should provide adequate protection in a section 362
relief from stay motion. 124 However, if the rental payments are less than
the amount of new credit extended under section 364(d), the court should
hold that the subordinated creditor is not adequately protected.

b. Constitutionality of Rental Payments as Adequate Protection

If section 1205(b)(3) is construed to allow Chapter 12 debtors to provide

adequate protection by only paying reasonable rent, when the grant of a
senior lien under section 364 reduces the creditor's ownership position,' 25
constitutional problems may arise. In situations where the reasonable rental
payments are less than the amount of the new senior lien, there would
likely be an unconstitutional taking under the fifth amendment of the
Constitution.126 As indicated in the previous section, rental payments will
probably be much less than the amount of the new senior lien.

120. 11 U.S.C. § 507(b) (1982).

121. See id. § 364(d)(1)(B).
122. In re Berens, 41 Bankr. 524, 527 (Bankr. D. Minn. 1984).
123. 11 U.S.C. § 364(d) (1982).
124. Id. § 362(d)(1) provides that the court shall grant a creditor relief from
the automatic stay for cause, including the lack of adequate protection.
125. See 11 U.S.C. § 364(d)(3) (1982).
126. See generally Dodd, supra note 40.
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REOR GANIZA TION

The concept of adequate protection is derived from the fifth amend-

ment, 2 1 which provides that no person shall be deprived of life, liberty
or property, without due process of law, nor shall private property be
taken for public use without just compensation. 128 A recent Chapter 12
case discussed this fifth amendment issue. 129 In In re Bullington, the debtors
proposed a plan of reorganization in which the secured claim of Travelers
Insurance Company would be reduced from the loan balance of $645,929.77
to $475,000, the fair market value of the farm. Travelers objected to the
plan proposal on the grounds that it made the loan a year before Chapter
12 was enacted. The insurance company argued it relied on the fact that
the only relief that would be available to debtors was a Chapter 11
reorganization. 3 0
The bankruptcy court held that allowing the debtor to propose a plan
which only pays the secured creditor the fair market value of the property
is not a violation of the fifth amendment.' The court stated that "[a]
mortgage may be voided to the extent it is unsecured without being an
unconstitutional deprivation of property, since the result is the same as in
foreclosure . "...1132

Since a security interest has been held to be a property interest within

the meaning of the fifth amendment, its diminution in value is considered
a taking if no compensation is provided.1 33 Through the enactment of
Chapter 12, Congress has certainly indicated that it favors successful re-
organization of family farms. 34 However, the failure to provide adequate
protection cannot be rendered constitutional simply because Congress has
decided to favor reorganization.
The court in In re Saypol held that the legislative history of the adequate
protection provisions of section 361131 centers on protecting a secured

127. H.R. Rep. No. 595, 95th Cong., 1st Sess. 339 (1977).
128. Amendment V of the United States Constitution provides as follows:
No person shall be held to answer for a capital, or otherwise infamous
crime, unless on a presentment or indictment of a Grand Jury, except in
cases arising in the land or naval forces, or in the Militia, when in actual
service in time of War or public danger; nor shall any person be subject
to jeopardy of life or limb; nor shall be compelled in any criminal case
to be a witness against himself, nor be deprived of life, liberty, or property,
without due process of law; nor shall private property be taken for public
use, without just compensation.
129. In re Bullington, 80 Bankr. 590 (Bankr. M.D. Ga. 1987).
130. Id. at 591.
131. Id.at 593-94.
132. Id.
133. See Wright v. United Cent. Life Ins. Co., 311 U.S. 273 (1940); Louisville
Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935).
134. See H.R. Rep. No. 958, 99th Cong., 2d Sess. 48, reprinted in 1986 U.S.
CODE CONG. & ADmUN. NEWS 5249.
135. See S. Rep. No. 989, 95th Cong., 2d Sess. 53, reprinted in 1978 U.S.
CODE CONG. & ADmIN. NEws 5787, 5839; H.R. Rep. No. 575, 95th Cong., Ist
Sess. 338-39,
Published reprintedof
by University 1978 U.S.School
in Missouri CONG.
CODE of & ADmIN. NEws
Law Scholarship 5963, 6295-96.
Repository, 1989 19
 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
MISSOURI LAW REVIEW [Vol. 54

creditor from suffering a decline in the value of the collateral during the
bankruptcy proceeding. 36 Although section 361 is inapplicable to Chapter
12 cases,'1 37 it appears that the secured creditor must be protected from a
decline in value of his security interest to meet constitutional requirements.'
In considering whether an offer of adequate protection is appropriate
in a particular case, a bankruptcy court should: 1) determine the value of
the secured creditor's interest; 2) determine the risks to that value that will
result from the debtor's use of the property; and 3) determine whether
the adequate protection proposal protects that value of the secured claim
from the risks to which it is exposed. l 9 It is important to note that the
issue as to adequate protection is different in a section 362 motion to lift
the automatic stay than when a debtor wishes to use cash collateral or
obtain credit under section 363 or 364.140 If the automatic stay is not lifted,
the creditor still has a security interest in the bargained for existing col-
lateral.' 14 If a debtor is allowed to use cash collateral under section 363,
the creditor's security is gone. The secured party no longer has the asset
it originally bargained for as collateral. 42 Likewise, if a debtor is allowed
to obtain credit by granting a senior lien on already encumbered property,
the subordinated creditors's security interest is diluted by the amount of
43
new credit.
Since a creditor actually loses his collateral under sections 363 and
364, the standard of adequate protection must be very high. 4 The court
must, in spite of a provision that favors reorganization, be aware that
bankruptcy power is subject to the fifth amendment, which prohibits the
taking of private property without compensation and due process of law. 45
The offering of reasonable, customary rental payments as adequate
protection1 46 to a secured creditor whose lien is being subordinated pursuant
to section 364(d) would probably not meet constitutional requirements. If
the rental payments were less than the amount of the new senior lien,
there would likely be an unconstitutional taking under the fifth amendment.

136. Barclays Bank of N.Y. v. Saypol (In re Saypol), 31 Bankr. 796, 800
(Bankr. S.D.N.Y. 1983).
137. See 11 U.S.C. § 1205(a) (Supp. IV 1986).
138. See Dodd, supra note 38, at 217-20.
139. See In re Feather River Orchards, 56 Bankr. 972, 974 (Bankr. E.D. Cal.
1986).
140. See In re Berens, 41 Bankr. 524, 527 (Bankr. D. Minn. 1984).
141. Id.at 527-28.
142. Id.; see also 11 U.S.C. § 363(e) (Supp. IV 1986).
143. See 11 U.S.C. § 364(d) (1982).
144. See In re Polzin, 49 Bankr. 370, 371-72 (Bankr. D. Minn. 1985); In re
Berens, 41 Bankr. 524, 527-28 (Bankr. D. Minn. 1984).
145. Dodd, supra note 38, at 219.
146. 11 U.S.C. § 1205(b)(3) (Supp. IV 1986).
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c. Replacement Lien

The issuance of a replacement or rollover lien to a secured creditor

has been a popular form of adequate protection in Chapter 11 farm
reorganizations.' 47 Since section 1205 also provides that replacement liens
are a permissible form of adequate protection, 48 Chapter 12 debtors will
certainly attempt to use cash collateral or obtain credit by granting the
secured creditor a replacement lien in -the next season's crop.
In a recent Chapter 12 case, however, the court held that a replacement
149
lien did not constitute adequate protection because it was too speculative.
The Chapter 12 debtor attempted to obtain credit under section 364(d) by
granting the secured creditor a replacement lien in the next season's harvest
proceeds.15 0 The court agreed with the reasoning of other courts in Chapter
11 proceedings, stating that "[s]atisfaction of a lien from future crop
proceeds is insufficient to constitute adequate protection against the loss
of a lien on existing collateral due to the uncertainty and speculation
necessarily attendant to the farming business."''
The court noted that a replacement lien was not adequate protection
despite the elimination of the "indubitable equivalent" language and the
requirement in some circuits to pay lost opportunity costs. 5 2 While the
court realized that without new credit the farm would go out of business,
it felt that the offer of adequate protection must be weighed against the
express provision of law. The court was unwilling to eradicate the collateral
positions of the secured creditors without determining that they had received
adequate protection for their loss, as doing so would not comport with
153
the Congressional intent behind the enactment of section 364(d).
The issue of whether a replacement lien constitutes adequate protection
has been extensively litigated in Chapter 11 cases involving the use of cash
collateral. '14 As the replacement lien will certainly be an issue in determining
whether a Chapter 12 debtor can use cash collateral, it is fully discussed
later in the cash collateral section of this Article.
Although section 1205 specifically allows that the provision of a re-
placement lien or paying cash or reasonable rental payments may constitute
adequate protection, these are only examples of adequate protection in
Chapter 12 cases. 55 The only means which section 1205 prohibits is the

147. ANDERSON & MoRIus, supra note 66, § 1.17, at 1-74.

148. 11 U.S.C. § 1205(b)(2) (Supp. IV 1986).
149. In re Stacy Farms, 78 Bankr. 494 (Bankr. S.D. Ohio 1987).
150. Id.at 497.
151. Id.at 498.
152. Id.
153. Id.
154. ANDERSON & MoRIus, supra note 66, § 1.17, at 1-74.
155. 2 COLLIER ON BANKRUPTCY para. 361.01, at 361-14 (15th ed. 1988).
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
96 MISSOURI LAW REVIEW [Vol. 54
56
offering of an administrative expense priority under section 503(b)(1).1
Other forms of adequate protection include a third party guarantee; 57
limiting or conditioning the conduct of business operations; providing
insurance coverage; allowing inspection of collateral; providing accounting
information; and segregation and accounting for cash collateral." 8
As previously indicated, the Code specifically provides that the debtor
must demonstrate the inability to obtain credit under sections 364(a) or
(b) and provide adequate protection before the court will approve a section
364(d) financing agreement.' 59 In addition to these requirements, the court
may require that some restrictions be placed in a financing order before
granting a superpriority or senior lien status.'16 In re Stratbucker held that
credit could only be granted under section 364(c) or (d) if certain restrictions
were met. 16' The court stated that the priority would be limited to those
contracts in which the interest rate did not exceed 18% per year. 62 Ad-
ditionally, the court stated the priority shall not be granted to any debt
unless it is evidenced by a written contract specifying the nature and amount
of goods purchased, the price, the rate of interest, and the term of
63
repayment.
The court may also require the debtor to establish that the proposed
lending agreement is fair, reasonable, and adequate under the circumstances.
In re Reading Tubing Industries held that the debtor has the burden to
64
demonstrate that less onerous post-petition financing was unavailable.
The Chapter 12 debtor will probably need to show that the terms of a
section 364 financing agreement are reasonable before the court will approve
such an agreement. The fact that the agreement calls for a higher than
average interest rate or stringent reporting requirements will probably not
render such an agreement unreasonable.

D. Cross-collateralizationClauses

The provisions of section 364 were designed to encourage lenders to

lend money to reorganizing debtors and thereby effectuate the rehabilitative

156. 11 U.S.C. § 1205(b)(4) (Supp. IV 1986).

157. See In re Reading Tubing Indus., 72 Bankr. 329, 333 (Bankr. E.D. Pa.
1987); LaSalle Nat'l Bank v. Harrow Leasing Corp. (In re Harrow Leasing Corp.),
35 Bankr. 916, 921-22 (Bankr. E.D. Pa. 1983).
158. 3 COLLIER BANKRUPTCY PRACTCE GumE para. 41.06, at 41-22, 23 (1988).
159. 11 U.S.C. § 364(d)(1)(A), (B) (1982).
160. 5 COLLIER BANKRUPTCY PRACTIcE GUmE para. 89.08, at 89-14, 15 (1988).
161. In re Stratbucker, 4 Bankr. 251, 252 (Bankr. D. Neb. 1980).
162. Id.at 253.
163. Id.
164. In re Reading Tubing Indus., 72 Bankr. 329, 332 (Bankr. E.D. Pa.
1987).
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1989] FARM REORGANIZATION

theme of bankruptcy. 16 However, the providing of administrative expense

priority, superpriority status, or senior lien status' 66 alone may not be
enough to entice new lenders. Many agricultural lenders have absorbed
huge losses because of bankrupt debtors. 167 Accordingly, they have been
reluctant to provide new financing to Chapter 12 debtors; choosing instead
to lend to non-farm businesses or invest in treasury bills.1 68
To encourage new creditors to make operational loans to Chapter 12
debtors, the court may need to allow the inclusion of a cross-collateralization
clause in a loan secured under a section 364(c) or (d) financing order. 69
Such a provision would be in addition to the superpriority or senior lien
status. Cross-collateralization is an arrangement in which the creditor post-
petition lends money secured by a section 364(c) or (d) court order. The
new lien however, secures not only the post-petition loan but also the
70
prepetition unsecured indebtedness.
Cross-collateralization may be particularly adaptable to the Chapter 12
situation because of the enormous amount of unsecured credit which farm
creditors hold."' Cross-collateralization is only helpful to a potential lender
who has an unsecured pre-petition claim. If the lender were fully secured
he would not need to rely on a cross-collateralization clause to provide
security. 172
A cross-collateralization clause enables a creditor to improve its pre-
petition status through post-filing actions. Blocking improvements in po-
sition by action pre or post bankruptcy is in the heart of the Bankruptcy
Code. 73 Since cross-collateralization clauses are not mentioned in section
364, it is not surprising that the courts are hostile toward them.
The issue of whether cross-collateralization clauses are valid first arose
in Otte v. Mfr. Hanover Commercial Corp. (In re Texlon).174 Texlon did

165. Grossman, Troubled Times: The Farm Debtor Under the Amended
Bankruptcy Code, 38 OKLA. L. REv. 579, 639 (1985).
166. See 11 U.S.C. § 364 (1982 & Supp. IV 1986).
167. See Harl, Analyzing Chapter 12, supra note 18, at 14, 15.
168. White, supra note 7, at 28-29. But see Bauer, Response to Professor
White's Sortie Against Chapter 12, 13 J. CoRP. L. 33 (1987).
169. For a discussion of cross-collateralization arrangements, see Bohm, The
Legal Justificationfor the Proper Use of Cross-CollateralizationClauses in Chapter
11 Bankruptcy Cases, 59 AM. BxAN. L.J. 289 (1985); Tabb, A CriticalReappraisal
of Cross Collateralization in Bankruptcy, 60 S. CAL. L. REv. 109 (1986); Weintraub
& Resnick, Cross-Collateralizationof Prepetition Indebtedness As An Inducement
for Postpetition Financing: An Euphemism Comes of Age, 14 U.C.C. L.J. 86
(1981).
170. In re Monach Circuit Indus., 41 Bankr. 859, 861 (Bankr. E.D. Pa.
1984).
171. For example, in Iowa, the average unsecured debt for each Chapter 12
debtor was $136,567. Faiferlick & Harl, supra note 17, at 308.
172. Tabb, supra note 169, at 111.
173. See 11 U.S.C. §§ 547, 549 (1982 & Supp. IV 1986).
174. Otte v. Mfr. Hanover Commercial Corp. (In re Texlon Corp.), 596 F.2d
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1092 (2d Cir. 1979).
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MISSOURI LAW REVIEW [Vol. 54

not invalidate the concept of cross-collateralization outright. Rather, the

court stated that a financing scheme so contrary to the spirit of the
Bankruptcy Act should not have been granted by an ex parte order. In
the case, the bankruptcy court relied solely on representations by a debtor-
in-possession that credit essential to operation of the business was otherwise
unobtainable. The court stated that a hearing may have determined that
other sources of credit are available; that other creditors would share in
financing under similar favorable terms; or that creditors did not want the
175
business continued if another lender was preferred.
Most of the cases following Texion have held that cross-collateralization
clauses are disfavored, but can be recognized if certain procedural and
substantive factors are met. 176 In re VanGuard Diversified, Inc. developed
a four part test to determine whether a cross-collateralization clause should
be allowed.'" The court determined that the debtor-in-possession must
demonstrate the following:
1) Its business operations will not survive, absent the proposed financing;
2) It is unable to obtain alternative financing on acceptable terms;
3) The proposed lender will not acceed to less preferential terms; and
4) The proposed financing is in the best interests of the general creditor
body.'7

It applied the four part test and concluded that the cross-collateralization
clause would be proper, as VanGuard would in all likelihood cease operating
and be forced to liquidate absent continued financing. 7 9
It seems quite likely that a Chapter 12 debtor could meet this four
part test without much difficulty. Most farming operations would not be
able to continue absent the infusion of additional operating capital. It
probably would not be difficult to show that the debtor is unable to obtain
alternative financing or that the proposed lender will not agree to less
preferential terms. Agricultural creditors have absorbed huge losses in the
current farm crisis and want as much protection as possible for future
advances. 80
The most difficult part of the test is to show that the proposed finding
is in the best interests of the general creditor body. In the Chapter 12
context, this may indicate that the debtor needs to show that the creditors

175. Id. at 1098.

176. Tabb, supra note 169; see In re Antico Mfg., Inc., 31 Bankr. 103 (Bankr.
E.D.N.Y. 1983); In re General Oil Distrib., Inc., 20 Bankr. 873 (Bankr. E.D.N.Y.
1982); Borne Chemical Co. v. Lincoln First Commercial Corp. (In re Borne Chemical
Co.), 9 Bankr. 263 (Bankr. D.N.J. 1981); In re Flagstaff Foodservice Corp., 16
Bankr. 132 (S.D.N.Y. 1981).
177. In re Vanguard Diversified, Inc., 31 Bankr. 364 (Bankr. E.D.N.Y. 1983).
178. Id. at 366.
179. Id. at 367.
180. HarI, Analyzing Chapter 12, supra note 18, at 15.
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REORGANIZATION

would be better off if the farm continued to operate rather than liquidate.
In many instances creditors would prefer liquidation over reorganization.
It is important to note that creditors in Chapter 12 proceedings do not
vote on the acceptance or rejection of the reorganization plan, but rather
the court makes the determination. 8 '
The court in In re Monarch Circuit Industries, Inc. differed from most
bankruptcy courts by holding that cross-collateralization clauses were not
authorized by the Bankruptcy Code because of their preferential nature 182
and therefore could not be approved even after notice and a hearing.
While the Monarch Court noted that several bankruptcy courts construed
the holding in Texion as providing that cross-collateralization provisions
may not be approved ex parte, but only after notice and a hearing,'83 it
concluded that the language of section 364(c) limits the extent of the priority
or lien to the amount of the debt incurred after court approval. Therefore,
the pre-petition indebtedness referred to in the cross-collateralization clause
was not obtained under section 364(c) and no relief could be granted for
that amount.' 4
Despite the decision in Monarch, the Ninth Circuit has stated that
cross-collateralization clauses are covered by section 364.'1 In Burchinal
v. Central Washington Bank (In re Adams Apple Inc.), the debtor, who
was engaged in apple growing and marketing, entered into a cross-colla-
teralization arrangement to obtain funds needed to care for his crops. The
debtor testified that without the loan, his 1983 crops would fail and he
would lose his orchards. He also stated that the bank would only provide
financing if a cross-collateralization clause were included, and that he could
86
not obtain other financing.1
Although the plain language of section 364 does not indicate whether
Congress approved the inclusion of a cross-collateralization clause in a
post-petition loan agreement, the court in Adams Apple looked to the
Congress' overall policy in passing section 364.187 It noted that section 364
was designed to provide the debtor a means to obtain credit after filing
88
bankruptcy, which could include a cross-collateralization type provision.
Although some courts have disfavored the use of cross-collateralization
clauses, post-petition lenders can enter into financing agreements which
include cross-collateralization provisions with the relative assurance that the

181. See 11 U.S.C. § 1225 (Supp. IV 1986).

182. In re Monach Circuit Indus., Inc., 41 Bankr. 859 (Bankr. E.D. Pa.
1984).
183. Id. at 861-62.
184. Id. at 862.
185. Burchinal v. Central Washington Bank (In re Adams Apple, Inc.), 829
F.2d 1484, 1488-89 (9th Cir. 1987).
186. Id. at 1486.
187. Id. at 1488.
188. Id.
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

MISSOURI LAW REVIEW [Vol. 54

court's authorization will not be reversed or modified on appeal.' 8 9 Section
364(e) of the Code provides that the reversal or modification on appeal
of a section 364 authorization does not effect the validity of any debt or
any priority or lien granted to an entity that extended such credit in good
faith. 190
There is no statutory definition of good faith in the Bankruptcy Code.
The court in In re EDC Holding Co. assumed that Congress intended the
statute to protect not the lender who seeks to take advantage of a lapse
in oversight by the bankruptcy judge but rather the lender who believes
his priority is valid, but cannot be certain because of possible objections
that may arise on appeal.' 9' The court further stated that the policy behind
section 364(e) was to overcome people's natural reluctance to deal with a
bankrupt firm by assuring them that if they are acting in good faith, they
can extend additional credit without worry of losing their priority on
appeal. 192
Bankruptcy courts have extensively discussed the application of section
364(e) to cross-collateralization situations.' 93 In In re Adams Apple, the
appellant contended that section 364(e) does not apply to a lien to secure
a pre-petition loan. 94 The court held that section 364(e) applies since a
cross-collateral lien is within the purview of section 364. The court noted
that section 364 was designed to provide a debtor a means to obtain credit
after filing bankruptcy and if section 364(e) was not applied to cross-
collateralization situations, Congress' intent of fostering private investment
in falling companies would be defeated. 95 The protections of section 364(e)
could be very valuable to a new extender of credit in a Chapter 12
proceeding. This new creditor can be assured of his priority if he is acting
in good faith.
The use of a cross-collateralization clause may induce a new lender to
extend post-petition operational financing. Without the use of a cross-
collateralization provision, the Chapter 12 debtor will probably have a
difficult time finding new operational credit, in spite of the priorities and
protections of section 364.

189. 11 U.S.C. § 364(e) (1982).

190. Id.
191. In re EDC Holding Co., 676 F.2d 945, 947 (7th Cir. 1982).
192. Id.
193. See Burchinol v. Central Washington Bank (In re Adams Apple, Inc.),
829 F.2d 1484 (9th Cir. 1987); In re First South Say. Ass'n, 820 F.2d 700 (5th
Cir. 1987); Unsecured Creditors' Comm. Mobil Oil Corp. v. First Nat'l Bank &
Trust of Escanaba (In re Ellingsen MacLean Oil Co., Inc.), 65 Bankr. 358 (Bankr.
W.D. Mich. 1986), aff'd, 834 F.2d 599 (6th Cir. 1987); In re FCX, Inc., 54 Bankr.
833 (Bankr. N.C. 1985); In re Monach Circuit Indus., Inc., 41 Bankr. 859 (Bankr.
Pa. 1984).
194. Burchinal v. Central Washington Bank (In re Adams Apple, Inc.), 829
F.2d 1484, 1488 (9th Cir. 1987).
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195. Id. 26
 Jensen: Jensen: Obtaining Operating Capital
19891 FARM REORGANIZATION

IV. POST-PETITION PROPERTY AND PROCEEDS

Since the Chapter 12 debtor will probably have difficulty obtaining

new credit under section 364,'9 the debtor should determine whether there
are any unencumbered assets that he can use to meet post-filing operating
expenses. In most farm cases, a creditor's security agreement applies to
97
all proceeds, products, offspring, rents and profits of the secured property.
Therefore, the debtor is normally prohibited from using these proceeds and
products to finance the operation of the farm. However, there are provisions
in the Bankruptcy Code that can terminate pre-petition security interests
in after-acquired property and proceeds. 98
Section 552(a) of the Bankruptcy Code nullifies certain pre-petition
liens on post-petition property to the extent that such liens include after-
acquired property.'1 Article 9 of the Uniform Commercial Code provides
that a debtor may execute a security agreement creating a lien on after-
acquired property. 200 However, this type of security interest is subject to
being cut off through the bankruptcy proceeding. 20' The effect of the filing
of the bankruptcy petition is to prevent the lien from floating to new post-
filing collateral, which is consistent with the "fresh start" concept of the
20 2
Bankruptcy Code.
Section 552(a) is not as harsh on creditors as it appears, because of
the extremely important exception in section 552(b). That section allows

196. See supra text accompanying notes 7-19.

197. Hershner & Boyer, The Farmer in Distress - Can Bankruptcy Help?,
1985 ANN. StnRv. BANKR. L. 177, 199.
198. 11 U.S.C. § 552 (1982 & Supp. IV 1985) provides as follows:
(a) Except as provided in subsection (b) of this section, property acquired
by the estate or by the debtor after the commencement of the case is not
subject to any lien resulting from any security agreement entered into by
the debtor before the commencement of the case.
(b) Except as provided in subsections 363, 506(c), 522, 544, 545, 547, and
548 of this title, if the debtor and an entity entered into a security agreement
before the commencement of the case and if the security interest created
by such security agreement extends to property of the debtor acquired
before the commencement of the case and to proceeds, product, offspring,
rents, or profits of such property, then such security interest extends to
such proceeds, product, offspring, rents, or profits acquired by such security
agreement and by applicable non-bankruptcy law, except to any extent
that the court, after notice and a hearing and based on the equities of
the case, orders otherwise.
See also Kunkel, Walter & Lander, The Reach of Prefiling Security Interests in
Postfiling Proceeds of Agricultural Collateral - An Analysis of Bankruptcy Code
Section 552, 8 J. AGrIc. TAX'N & L. 311 (1987).
199. 11 U.S.C. § 552(a) (1982).
200. U.C.C. § 9-204.
201. 11 U.S.C. § 552(a) (1982).
202. Kunkel, Walter & Lander, supra note 198, at 312.
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MISSOURI LA W REVIEW [Vol. 54

a creditor to retain its security interest in all pre-petition collateral and in

the post-petition proceeds, products, offspring, rents, or profits of pre-
petition collateral. 2 3 However, section 552(b) further provides that the court
may after notice and hearing restrict the reach of the creditor's lien, based
on the equities of the case. 2 4
Although it is extremely important for the debtor to determine if any
pre-petition liens in property acquired post-petition are nullified by operation
of section 552, it is sometimes difficult to distinguish between after-acquired
property, which is clearly taken from the secured party under section 552(a),
and proceeds which may be preserved to the secured party under section
552(b). 201 If the security interest is nullified, the debtor can freely use any
post-petition collateral to provide financing for the continued operation of
the farm. Moreover, the proceeds exception contained in section 552(b)
applies only to the proceeds of pre-petition collateral. 206 For example, a
secured parties' lien in cattle acquired after the petition is nullified by
section 552(a). Any offspring of these cattle are also free of the lien. 2 7
Once the assets are free of liens, the debtor may also be able to obtain
new financing by granting a new creditor a security interest in the post-
208
petition property under section 364(c).
There has been extensive litigation in Chapter 11 farm cases regarding
the application of section 552(b). 209 Since no section of Chapter 12 addresses
this question, Chapter 12 courts may well look to these Chapter 11 cases
for a resolution of the issue.
It appears to be quite clear that section 552(b) will not allow a prepetition
secured creditor to obtain a post-petition lien on crops that are planted
after filing the petition. 210 Therefore, farmers normally try to file their
bankruptcy petition prior to planting season. This will allow them the
opportunity to grant a new security interest in the new crops so as to
obtain funds for seed, fertilizer, fuel, and other planting expenses. 21, How-
ever, if the crops have been planted prior to commencement of the case,

203. 11 U.S.C. § 552 (b) (Supp. IV 1986).

204. Id.
205. 4 COLLIER ON BANKRJPTcY para. 552.01, at 552-4, 5 (15th ed. 1988).
206. See In re Bohne, 57 Bankr. 461, 464 (Bankr. D. N.D. 1985).
207. See In re Big Hook Land & Cattle Co., 81 Bankr. 1001, 1003 (Bankr.
D. Mont. 1988).
208. See 11 U.S.C. § 364(c)(2) (1982).
209. ANDERSON & MORRIS, supra note 66, § 2.02, at 2-14.
210. Kunkel, Walter & Lander, supra note 198, at 319. See In re Sheehan,
38 Bankr. 859, 863 (Bankr. D. S.D. 1984); In re Kruse, 35 Bankr. 958, 965-66
(Bankr. D. Kan. 1983); First Nat'l Bank of Colorado Springs v. Hamilton (In re
Hamilton), 18 Bankr. 868, 871 (Bankr. D. Colo. 1982).
211. Heshner & Boyer, The Financing of Crops in Chapter 11 Farm Cases,
NORTON BANKR. L. ADVISER, Dec. 1984, at 13.
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REORGANIZATION

the pre-petition security interest will continue, since the security interest
21 2
attached to the crops when planted.
With regard to livestock, a valid pre-petition security interest in livestock
should continue to the offspring of such livestock pursuant to section
552(b).21 1 However, if the debtor acquired livestock post-petition, which
were not offspring of the pre-petition livestock, section 552(a) would avoid
214
the security interest in the after-acquired livestock.
In In re Bohne, a Chapter 11 proceeding, the creditor had a valid
security interest in all livestock now or hereafter acquired together with
the young and produce thereof. 2 5 The debtor, who filed his petition in
November, 1985, took the position that the calves born in 1986 were after-
acquired property and therefore not subject to the bank's pre-petition lien,
pursuant to section 552(a). 21 6 The court held that section 552(b) "provides
that a valid pre-petition security interest in pre-petition property and the
offspring of such property operates to continue that security interest in
offspring acquired subsequent to the bankruptcy petition. '"217 Therefore,
since the calves were offspring of the pre-petition property, the pre-petition
security interest in livestock extends to any 1986 calves which were offspring
21 8
of pre-petition livestock.
Although a valid security interest in livestock will likely continue to
the offspring of pre-petition livestock, 219 the farmer-debtor may be able to
recover the costs and expenses incurred in preserving the calves. Section
506(c) provides that the debtor may recover from the secured collateral
the reasonable, necessary costs of preserving or disposing of the collateral
to the extent of any benefit to the secured creditor. 221
Unlike cases with crops or livestock, courts have split on the question
of whether milk produced post-petition by cows owned pre-petition are
"proceeds, products, rents or profits" covered under section 552(b). 22
Courts holding that the secured party's interest in the milk is cut off by
section 552(a) because milk is not a proceed, construe section 552(b) as a

212. Kunkel, Walter & Lander, supra note 198, at 319.

213. See In re Bohne, 57 Bankr. 461, 464 (Bankr. D. N.D. 1985).
214. See In re Big Hook Land & Cattle Co., 81 Bankr. 1001, 1003 (Bankr.
D. Mont. 1988).
215. In re Bohne, 57 Bankr. 461, 462 (Bankr. D. N.D. 1985).
216. Id.
217. Id.at 464.
218. Id.
219. See Inre Bohne, 57 Bankr. 461 (Bankr. D. N.D. 1985).
220. See Inre Hamilton, 18 Bankr. 868, 872-73 (Bankr. D. Colo. 1982). But
see In re Bohne, 57 Bankr. 461 (Bankr. D. N.D. 1985); Brookfield Prod. Credit
Ass'n v. Borron, 738 F.2d 951 (8th Cir. 1984).
221. 11 U.S.C. § 506(c) (1982).
222. Ray, After-Acquired Property in Farm Bankruptcies - Some Practical
Considerations, 7 NORTON BANKR. L. ADviso., July 1986, at 1, 2.
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MISSOURI LA W REVIEW [Vol. 54

narrow exception to section 552(a).2 3 One court reasoned 4

that milk is
created totally post-petition like crops planted post-petition. Another court
reasoned that milk is produced using post-petition assets such as feed and
labor.22 Since the secured creditor did not contribute to these inputs226
the
court concluded that the creditor's lien should not reach the milk.
Cases holding that milk is a proceed under section 552(b) have more
liberally construed the statutory language. 227 The central reasoning of these
cases is that milk is a proceed under Article 9 of the U.C.C.228 In In re
Johnson, the debtor's milk cows were subject to security interests held by
Highland State Bank and FmHA. Highland's financing statement also gave
it a security interest in proceeds and products of livestock, while FmHA's
financing statement covered farm products and proceeds thereof. Using an
Article 9 analysis, the court determined that milk was a farm product.2 9
U.C.C. section 9-109(3) provides that goods are farm products if they are
products of livestock in their unmanufactured states, such as milk.2 0 Ad-
ditionally, the secured creditors also had a perfected security interest in
proceeds from the sale of the debtor's milk since their financing statement
explicitly covered proceeds of farm products. Since milk is the "proceeds,
products, offspring, rents or profits" of pre-petition livestock within the
meaning of section 552(b), the court held that the security interests extended
to the debtor's post-petition milk.231
Two cases have also discussed whether the equities of the case justify
termination of the secured party's lien in the milk even if the milk is a

223. See In re Lawrence, 41 Bankr. 36 (Bankr. D. Minn. 1984).

224. Id. at 38.
225. In re Vanas, 50 Bankr. 988, 997 (Bankr. E.D. Mich. 1985).
226. Id. at 998.
227. See In re Potter, 46 Bankr. 536 (Bankr. E.D. Tenn. 1985); In re Nielson,
48 Bankr. 274 (D.N.D. 1984); United States v. Hollie (In re Hollie), 42 Bankr.
111 (Bankr. M.D. Ga. 1984).
228. Kunkel, Walter & Lander, supra note 198, at 315.
229. In re Johnson, 47 Bankr. 204, 206 (Bankr. W.D. Wisc. 1985).
230. U.C.C. § 9-109(3) provides that goods are "farm products" if
they are crops or livestock or supplies used or produced in farming
operations or if they are products of crops or livestock in their unman-
ufactured states (such as ginned cotton, wool-clip, maple syrup, milk and
eggs), and if they are in the possession of a debtor engaged in raising,
fattening, grazing or other farming operations. If goods are farm products
they are neither equipment nor inventory.
231. In re Johnson, 47 Bankr. 204, 207 (Bankr. W.D. Wisc. 1985). U.C.C.
§9-306(2) provides as follows:
Except where this Article otherwise provides, a security interest continues
in collateral notwithstanding sale, exchange or other disposition thereof
unless the disposition was authorized by the secured party in the security
agreement or otherwise, and also continues in any identifiable proceeds
including collections received by the debtor.
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proceed under section 552(b). 212 In re Lawrence held that the special cir-
cumstances of milk production justified termination of the lien even if
milk were considered a proceed. 231
In contrast, the Johnson court concluded that the equity exception to
section 552(b) could not be used to cut off the secured party's lien in
milk. 2 34 The court reasoned the equity is to act only if legal remedies are
inadequate. The court stated that the equity exception was unnecessary
since the debtor could obtain the use of milk proceeds by following the
procedures for the use of cash collateral. 23s
The question of whether government payments are proceeds coming
under section 552(b) protection is especially important to the Chapter 12
debtor. Most farmers rely heavily on government farm program benefits
to help meet the expenses of operating their farms. 236 For many large
farming operations, government farm benefits, such as deficiency payments,
may be the largest source of operational financing. In calender year 1986,
direct government subsidy payments to producers totaled $11.8 billion, with
another $8.3 billion made available to eligible producers through net CCC
loans. 237 Several bankruptcy courts have addressed the issue of whether a
pre-petition security agreement covers federal price support payments. 2 8
The major source of government payments are deficiency payments.
Target prices provide for direct payments to producers of the difference
between the target price and the average market price for a set period or
the loan rate. The difference between the target price and average market
price is referred to as a "deficiency payment".239 In re Nivens addressed
the issue of whether deficiency payments are proceeds of crops. 32 The
court held:
[D]eficiency payments are made, because it is determined that farmers
should receive a target price for the crop. The crop lien includes a lien
on the proceeds and the deficiency payments are monies from the gov-
ernment which make up the difference between the amount of money

232. In re Johnson, 47 Bankr. 204, 207 (Bankr. W.D. Wisc. 1985); In re

Lawrence, 41 Bankr. 36, 38 (Bankr. D. Minn. 1984).
233. In re Lawrence, 41 Bankr. 36, 38 (Bankr. D. Minn. 1984).
234. In re Johnson, 47 Bankr. 204, 207 (Bankr. W.D. Wisc. 1985).
235. Id.
236. For a discussion of government farm payments, see Flaccus & Dixon,
The New Bankruptcy Chapter 12: A Computer Analysis of If and When a Farmer
Can Successfully Reorganize, 41 ARK. L. REv. 263, 272-84 (1988).
237. ECON. RESEAR H SERv., U.S. DEPT. OF AGRIC., FARM FINANcE, AGRi-
cuLTuRAL OurLooK, June 1987, at 21.
238. See generally Hamilton, Securing Creditor Interests in Federal Farm
Program Payments, 33 S.D. L. REv. 1 (1988).
239. 1 J. JUERGENSMEYER & J. WADLEY, AGRIcuLTURAL LAw § 9.9, at 279
(1982 & Supp. 1985).
240. First State Bank of Abernathy v. Holder (In re Nivens), 22 Bankr. 287
(Bankr. N.D. Tex. 1982).
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MISSOURI LAW REVIEW [Vol. 54

actually received for the crop and that amount which the Department of
Agriculture had determined, on a nationwide basis, that a producer should
receive for a particular crop. It is logical to conclude that the deficiency
payments are substitute for proceeds of crops. 24'

Although this decision did not discuss the implications of section 552(b),
the case does provide guidance in determining whether deficiency payments
can be used by the debtor, free of any security interests. Based on the
court's decision, any deficiency payments received on account of crops
planted prior to bankruptcy would likely be held subject to a prepetition
security interest, unless the equities of the case exception is invoked.
In addition to cash payments, some government subsidies are paid to
the farmer in the form of payment-in-kind (PIK) certificates. In simple
terms, PIK certificates are entitlement payments made to a farmer to not
plant certain acreage or to abandon a planted crop.242 In re Kruse held
that government entitlement payments including PIK payments are proceeds
if received in exchange for an abandoned planted crop.24 3 Relying on section
552(b) the court reasoned that the Production Credit Association (PCA)
had a lien on any PIK entitlements which the debtor received on account
of the crop that was planted before the bankruptcy petition was filed and 2
thereafter abandoned or turned under pursuant to the PIK program. "
However, the court stated that any proceeds of a PIK agreement entered
into after filing the bankruptcy petition would be free of any pre-petition
security interests pursuant to section 552(a). In contrast, post-petition pay-
ments received under the PIK program stemming from an agreement not
to grow crops are not proceeds, but rather after-acquired property and
therefore exempt from any pre-petition security interest. 245
The Chapter 12 debtor should not encounter any problem using gov-
ernment payments to finance his farming operation if the benefits are
received for crops planted after filing of the petition.2 6 However, if the
government payments are received for crops planted before filing the pe-
tition, the payments will probably be considered proceeds, resulting in any
pre-petition liens surviving the bankruptcy filing. u 7 Additionally, the debtor
may be able to use government payments, which appear to be subject to

241. Id. at 291-92.

242. See 1 J. JUERGENSMEYER & J. WADLEY, AGoicutruR.AL LAw § 9.9, at
279 (1982 & Supp. 1985).
243. In re Kruse, 35 Bankr. 958 (Bankr. D. Kan. 1983).
244. Id. at 964-65.
245. Id.
246. The lien should be cut off pursuant to 11 U.S.C. § 552(a) (1982).
247. The lien will continue in the proceeds unless the court invokes the
"equities of the case" exception. See 11 U.S.C. § 552(b) (1982 & Supp. IV 1986).
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19891 FARM REORGANIZATION

a security interest, based on current federal regulations. 248 Federal regulations

prohibit Agricultural Stabilization & Conservation Service (ASCS) payments
from being assigned to serve any pre-existing indebtedness. 2A9 The regulations
also prohibit the encumbrance of any ASCS program payments made in
PIK certificates. 2 0 These federal regulations may have a significant impact
on the financing of farm operations. Farmers may have access to another
source of unencumbered funds that can be used to finance the operation
of their farms. However, farm lenders may become reluctant to extend
additional credit if farmers are unable to use most federal farm program
benefits as collateral to secure farm debt.
If a pre-petition lien in farm products is cut off under section 552(a)
or (b), the Chapter 12 debtor will be allowed to use this freed-up property

248. In In re Halls, 79 Bankr. 417 (Bankr. S.D. Iowa 1987), the court held
that program payments made in the form of PIK certificates and cash were not
cash collateral because of federal statutory and regulatory provisions. In that case
the debtor had borrowed operating capital in 1986 from the creditor, FDIC's
predecessor in interest, granting a security interest in, among other things, "en-
titlements and payments from all state and federal farm programs." Id. at 418.
The debtor was enrolled in the 1986 and 1987 Federal Feed Grain Program. The
debtor received both cash deficiency payments and PIK certificates. The debtor
contended that the regulatory provisions governing the program precluded the FDIC
from encumbering any program payments made in PIK certificates or any 1987
program payments made in cash. Based on the regulations contained in 7 C.F.R.
Part 709, the court in Halls concluded that the FDIC could not encumber 1987
program payments made in cash since the FDIC did not finance the 1987 crop.
Therefore, the farmer was allowed to use the cash payments for 1987 without
meeting the requirements for use of cash collateral under § 363.
249. 7 C.F.R. § 709.3 (1988) provides that a payment which may be made
to a producer under an ASCS program may be assigned only as security for cash
or advances to finance making a crop for the current crop year. No assignment
may be made to secure or pay any preexisting indebtedness of any nature whatsoever.
The purpose behind this provision is to ensure that the intended beneficiary of
government payments receive the payments. The purpose of the ASCS payments
is to benefit the producing farmer and allow him to plant a new crop. ASCS
payments are not intended to be used to pay a farmer's pre-existing indebtedness.
See also 16 U.S.C. § 590h(g) (1982).
250. 7 C.F.R. § 770.6 (1988) provides that "in kind" payments may not be
the subject of an assignment, except as determined and announced by CCC. Further,
7 C.F.R. § 770.4 (1988) provides that commodity certificates shall not be subject
to any lien, encumbrance, or other claim or security interest, except that of an
agency of the United States government arising specifically under federal statute.
The court in In re Halls, 79 Bankr. 417 (Bankr. S.D. Iowa 1987) also addressed
the issue of whether PIK certificates could be assigned. Based on 7 C.F.R. § 770.6
(1988), the court concluded that payment in kind certificates can never be subject
to any encumbrances. Id. at 419-20. Based on the court's interpretation of the
regulations, the PIK certificates were not encumbered by FDIC's security interest.
The debtor was free to negotiate the PIK certificate and use the proceeds for
operation of the farm. The court believed the regulations were enacted to prevent
interruption of the marketability of PIK certificates. But see In re Arnold, 88
Bankr. 917 (Bankr. N.D. Iowa 1988).
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
MISSOURI LAW REVIEW [Vol. 54
and any proceeds of this collateral to finance the farming operation. The
debtor can freely use the proceeds without obtaining court approval or
providing adequate protection.2n These proceeds may be very valuable to
the reorganizing farm debtor.

V. SALE OF ExISTING ASSETS TO GENERATE OPERATING FUNDs

If the Chapter 12 debtor does not have any unencumbered assets, the
farmer-debtor may need to seek court or trustee approval to sell encumbered
assets to finance the continued operation of the farm. 2 2 As previously
indicated, most agricultural lenders are reluctant to extend additional credit
to Chapter 12 debtors.2Y3 Therefore, the cash proceeds of farmland, farm
equipment or stored farm products may be the only source of operational
financing for the Chapter 12 debtor.
Since most of the debtor's assets probably will be subject to liens, the
debtor must follow the procedures set forth in section 363 of the Code
before he can use any sale proceeds to meet operational expenses. 214 Al-
though section 363(c)(1) allows the Chapter 12 debtor in possession to use
or sell estate property in the ordinary course of business, the sale will not
be free and clear of liens unless one of the provisions in section 363(0 is
met.25 Section 363(0 provides that the trustee may sell free and clear of
any liens only if: (1) applicable non-bankruptcy law would permit a sale
of such property free of the interest, (2) the other entity consents, (3) the
interest is a lien and the sales price is greater than the aggregate value of
all liens on such property, (4) the interest is in bona fide dispute, or (5)
the entity could be compelled in a legal or equitable proceeding to accept
a money satisfaction of such interest.2 56
Since the secured creditor often objects to the sale of encumbered
property, the court must rely on a provision of section 363(0 other than
(2) above to allow property to be sold free and clear of liens. 2 7 Although
the language of section 363(f) is not clear, several courts have concluded
that farm products can be sold free and clear of liens as long as the
secured creditor is granted a lien in the proceeds. 28

251. The proceeds could be used without meeting the requirements for use
of cash collateral set forth in 11 U.S.C. § 363 (1982 & Supp. IV 1986).
252. 11 U.S.C. § 363(c) (1982 & Supp. IV 1986).
253. See supra text accompanying notes 7-19.
254. See 11 U.S.C. § 363 (1982 & Supp. IV 1986).
255. Id. § 363(c)(1), (0.
256. Id. § 363(f).
257. 2 COLLIER ON BMNKuprcy para. 363.07, at 364-31, 32 (15th ed. 1979).
258. See In re Nikolaisen, 38 Bankr. 267 (Bankr. D.N.D. 1984); In re Frank,
27 Bankr. 748 (Bankr. S.D. Ohio 1983).
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 Jensen: Jensen: Obtaining Operating Capital
19891 FARM REORGANIZATION

Section 12062 9 has modified the restrictive terms of section 363(f) to

allow Chapter 12 debtors to sell farmland and farm equipment free and
clear of liens without the consent of secured creditors. 260 However, since
section 1206 only applies to the sale of farmland and farm equipment, the
debtor will still need to follow section 363(f) to sell farm products, such
26
as crops and livestock. '
Once the farm products, farmland, or farm equipment are sold, the
proceeds will become cash collateral. Cash collateral is defined as cash,
negotiable instruments, documents of title, securities, deposit accounts, or
other cash equivalents in which the estate and another entity each have
an interest. Cash collateral may include the proceeds, products, offspring,
262
rents, or other profits of any property subject to security interests.
The debtor will not be allowed to use the cash collateral unless the
court authorizes the use under section 363(c)(2). 263 If most of the debtor's
assets are cash collateral, conflicts will often arise immediately after filing.
The debtor has operating expenses that must be paid immediately to continue
the farming operation. Since creditors are often unwilling to consent to
the use of cash collateral, the farmer may need to seek an emergency order
authorizing its use. The Rules of Bankruptcy Procedure provide that the
debtor may move for such an order, 26 realizing that the prohibition of
its use can result in emergency situations. The debtor may need to use the
cash to buy feed for livestock or seed to plant crops. In these situations,
the debtor can hardly afford to wait until a final hearing.
The Code does not provide clearcut standards for determining when
a debtor should be allowed to use cash collateral. 265 One court concluded
that it must balance two irreconcilable and conflicting interests in reviewing

259. 11 U.S.C. § 1206 (Supp. IV 1986) provides as follows:

After notice and a hearing, in addition to the authorization contained in
section 363 (f), the trustee in a case under this chapter may sell property
under section 363(b) and (c) free and clear of any interest in such property
of an entity other than the estate if the property is farmland or farm
equipment, except that the proceeds of such sale shall be subject to such
interest.
260. ANDERSON & Monus, supra note 66, § 5.04, at 5-21.
261. See 11 U.S.C. § 1206 (Supp. IV 1986).
262. Id. § 363(a).
263. Id. § 363(c) (2).
264. FED. R. BAmNK. P. 9014 provides that in a contested matter in a case
under the Code not otherwise governed by these rules, relief shall be requested by
motion, and reasonable notice and opportunity for hearing shall be afforded the
party against whom relief is sought. In In re Sheehan, 38 Bankr. 859 (Bankr. D.
S.D. 1984), the court noted that "Local Rule of Bankruptcy Procedure 15(c) provides
for expedited hearings on 48 hours' notice to parties in interest for the proposed
use, sale, or lease of property". Id. at 861.
265. Note, Standards and Sanctions for the Use of Cash Collateral Under
the Bankruptcy Code, 63 TEx. L. REv. 341, 343 (1984).
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MISSOURI LAW REVIEW [Vol. 54

an application for the use of cash collateral. 266 It noted that the holder
of a lien must not be left unprotected by unrestricted use. On the other
hand, the purpose of the reorganization chapters of the Code is to re-
habilitate debtors, which normally
267
means access to cash collateral is nec-
essary to operate a business.
The drafters of Chapter 12 did not include any special standards to
guide courts' consideration of whether it should allow the use of cash
collateral. 268 The legislative history to the Family Farmer Bankruptcy Act
indicates that no Chapter 12 debtor may use cash collateral unless the
secured creditor consents, or unless the court, after notice and hearing,
authorizes such use.269 The drafters of the new Chapter 12 provision intended
to have courts apply existing legal precedents consistent with this legislation
when considering whether to allow the use of cash collateral. 270 Based on
the conferees' statement it appears that Congress intended courts to follow
the same procedures as they did in Chapter 11 farm reorganizations in
determining the use of cash collateral.
The general test for authorization to use cash collateral is whether the
secured party who has an interest in the collateral will receive adequate
protection in exchange for the use of the cash collateral.27 ' Secured creditors
will nearly always object to the use of cash collateral since
272
cash is always
more attractive than any form of adequate protection.
As noted above, because of section 361 obstacles to the successful
family farm reorganization, Congress developed a new adequate protection
standard exclusively for Chapter 12 cases. 273 Section 1205 eliminates the
need to pay lost opportunity costs. There is no indubitable equivalent
language contained in section 1205. It is clear that what needs to be
274
protected is the value of property, not the creditor's interest in property.
Adequate protection may be provided by periodic cash payments, a re-
placement lien for the decrease in value of the collateral, reasonable rental
payments or such other relief that will adequately protect the secured
creditor's value. 275 Numerous cases in Chapter 11 have discussed adequate
276
protection for the farm crop lender.

266. Stein v. United States (In re Stein), 19 Bankr. 458, 459 (Bankr. E.D.
Pa. 1982).
267. Id.
268. H.R. Rep. No. 958, 99th Cong., 2d Sess. 49, reprinted in 1986 U.S.
CODE CONG. & ADmIN. NEws 5246, 5250.
269. Id.
270. Id.
271. Dodd, supra note 40, at 221.
272. See In re Berens, 41 Bankr. 524, 527-28 (Bankr. D. Minn. 1984).
273. See U.S.C. § 1205 (Supp. IV 1986).
274. H.R. Rep. No. 958, 99th Cong., 2d Sess. 45, reprinted in 1986 U.S.
CODE CONG. & ADMIN. NEws 5246, 5250-51.
275. 11 U.S.C. §, 1205(b)(1), (2), (3), (4) (Supp. IV 1986).
276. See In re Weiser, Inc., 74 Bankr. II (Bankr. S.D. Iowa 1986); In re
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 Jensen: Jensen: Obtaining Operating Capital

1989] FARM REORGANIZATION

A. Sale of Farmland or Farm Equipment

If the Chapter 12 debtor has a larger farming operation than he actually

needs, he may want to consider selling an unneeded tractor or section of
land. The Act allows the Chapter 12 trustee, after court authorization, to
sell farmland or farm equipment free and clear of any interest in such
property. The proceeds of the sale will be subject to any security interest
in the property. 217 As noted above, the debtor does not need to seek the
consent of the secured creditor prior to selling the assets.278
Once the assets are sold and converted to cash collateral, the Chapter
12 debtor could seek permission to use the proceeds, pursuant to section
363(c)(2). 279 The debtor would be required to provide adequate protection
2 80
to the secured farmland or equipment lender.
The Joint Explanatory Statement of the Committee of Conference for
the Family Farm Bankruptcy Act gives the following explanation for the
enactment of section 1206: "Most family farm reorganizations, to be
successful, will involve the sale of unnecessary property. This section of
the Conference Report allows Chapter 12 debtors to scale down the size
of the farming operations by selling unnecessary property."
This section modifies 11 U.S.C. 363(f) to allow family farmers to sell
assets not needed for the reorganization prior to confirmation without the
consent of the secured creditors, subject to approval of the court.
This section also explicitly makes clear that the creditor's interest
(which includes a lien) would attach to the proceeds of the sale. Of course,
the holders of secured claims would have the right to bid at the sale to
the extent permitted under 11 U.S.C. 363(k).7 1

The Nebraska Bankruptcy Court held that a plan can be confirmed

which provides for the sale of a severable portion of farmland which is
subject to a mortgage. 2 2 Relying on section 1206, the court concluded that
the sale of severable portions of land is proper if fair market value is
283
offered and the secured creditor retains a lien in the proceeds of the sale.
Although the proceeds would be subject to any liens, they could become

276. See In re Weiser, Inc., 74 Bankr. 11l (Bankr. S.D. Iowa 1986); In re
Berens, 41 Bankr. 524 (Bankr. D. Minn. 1984); In re Sheehan, 38 Bankr. 859
(Bankr. D. N.D. 1984); In re Nickolaisen, 38 Bankr. 267 (Bankr. D. N.D. 1984).
277. 11 U.S.C. § 1206 (Supp. IV 1986).
278. Id.
279. 11 U.S.C. § 363(c)(2) (1982) provides that a trustee may use cash collateral
only with creditor consent or court approval.
280. See 11 U.S.C. § 363(e) (Supp. IV 1986); 11 U.S.C. § 1205 (Supp. IV
1986).
281. H.R. Rep. No. 958, 99th Cong., 2d Sess. 50, reprinted in 1986 U.S.
CODE CONG. & ADum.N. NEws 5246, 5251.
282. In re Lauck, 76 Bankr. 717 (Bankr. D. Neb. 1987).
283. Id. at 718-19.
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

MISSOURI LA W REVIEW [Vol. 54

a valuable source of funds to meet current operational financing needs if

the debtor is able to provide adequate protection.

B. Sale of Farm Products Through Granting of Replacement Liens

If the Chapter 12 debtor does not have any unnecessary farmland or

farm equipment to sell, he will probably need to use the cash proceeds 28 4
of crops or livestock to finance the continued operation of the farm.
Farmers who have granted crop liens will find most of their current
working capital subject to the restrictions against use of cash collateral. B5
Therefore, unless they can either obtain the creditor's consent or court
approval, the chances of beginning the reorganization process may be
hopeless. As stated above, the debtor must provide adequate protection
before the court will approve the use of cash collateral. 2 6 In most Chapter
11 farm reorganizations, the debtor attempts to provide the adequate
protection to the secured creditor by granting a replacement or rollover
lien on future farm products.3 The debtor will argue that allowing him
to use the cash proceeds from the sale of cows will benefit the creditor
holding the security interest in the cows in that the cash will be used to
feed and maintain the remaining cows, which are subject to the security
interest. 2s8 The debtor will give the creditor an additional lien in any livestock
which he purchases or are born after filing. 2 9
The issue of granting a replacement or rollover lien as adequate pro-
tection has been extensively litigated in Chapter 11 farm reorganizations. 29°
Because section 1205 also provides that a debtor can use a replacement
lien to satisfy the adequate protection standard, this issue is certain to give
rise to frequent litigation. 29' At least one bankruptcy court has determined
that a replacement lien will constitute adequate protection in a Chapter 12
case. 292 In In re Westcamp, the debtor provided a replacement lien on yet-
to-be-grown crops to adequately protect the creditor's cash collateral which
the debtor was to use. The court concluded that the debtor had eliminated

284. See Flaccus & Dixon, The New Bankruptcy Chapter 12: A Computer
Analysis of If and When a Farmer Can Successfully Reorganize, 41 ARK. L. REv.
263, 319 (1988).
285. U.C.C § 9-306(2) provides that a security interest continues in any
identifiable proceeds.
286. 11 U.S.C. § 363(e) (Supp. IV 1986).
287. ANDERSON & MoRus, supra note 66, § 1.17, at 1-73.
288. Id. § 2.02, at 2-10, 11.
289. Id. at 2-11.
290. Id.
291. 11 U.S.C. § 1205(b)(2) (Supp. IV 1986).
292. In re Westcamp, 78 Bankr. 834 (Bankr. S.D. Ohio 1987). But see In
re Stacy Farms, 78 Bankr. 494 (Bankr. S.D. Ohio 1987).
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 Jensen: Jensen: Obtaining Operating Capital
19891 FARM REORGANIZATION

normal risks associated with farming operations and therefore a replacement

lien would adequately protect the creditor's interest.2 93
The court noted that normally the value to a creditor of a lien on an
existing crop or its proceeds is greater than the promise of a lien on a
crop to be grown. However, in this case the court determined that the
debtor had introduced evidence that the granting of a replacement lien
together with the assignment of federal crop insurance and ASCS deficiency
payments would result in the elimination of the risks of farming. 294
The Westcamp decision is in line with the reasoning of several Chapter
11 cases in which the farmer was allowed to use cash collateral as long 29
as crop insurance is provided and a rollover lien is given to the creditor. 1
In In re Sheehan the Chapter 11 debtors sought court approval to use
$4.7 million of cash collateral to finance the continued operation of his
farm. 296 The debtors offered an 11 point adequate protection plan which
included detailed budgets, a replacement lien in the future crop, a re-
placement lien in new equipment, all risk crop insurance, the services of 297
an experienced accountant and a new professional management team.
The court concluded that the 1984 crop would be more than an expectancy
in light of this adequate protection offer and therefore would provide the
creditors with the values of their bargains. Since the creditors would be
adequately protected, the court held that the debtor could use the cash
collateral to provide financing for the new crop. 298
In another case, In re Nikolaisen, the debtors sought court approval
to use cash collateral to finance the planting of their 1984 crops. 299 The
debtors proposed to use stored grain from the previous year's crop, which
was subject to a security interest held by the Commodity Credit Corporation
(CCC). The debtor proposed to grant the CCC a first lien in all 1984
crops and assign any federal crop insurance proceeds200 The creditor ob-
jected to the use of the stored crop on the basis that it was not adequately
protected, in that the offer of a future interest is too speculative and is
30
not the equivalent of their present interest in the certified, stored grain. '
The court held that the granting of a first lien in 1984 crops and assignment
of crop insurance proceeds virtually insures the creditor of its interest and
therefore the creditor was adequately protected. 0 2

293. In re Westcamp, 78 Bankr. at 839.

294. Id. at 838.
295. See In re Weiser, Inc., 74 Bankr. 111 (Bankr. S.D. Iowa 1986); In re
Sheehan, 38 Bankr. 859 (Bankr. D. S.D. 1986); In re Berens, 41 Bankr. 524 (Bankr.
D. Minn. 1984).
296. In re Sheehan, 38 Bankr. 859, 863 (Bankr. D. S.D. 1984).
297. Id. at 865.
298. Id.at 869.
299. In re Nikolaisen, 38 Bankr. 267 (Bankr. D. N.D. 1984).
300. Id. at 268.
301. Id. at 269.
302. Id. at 270.
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8
114 MISSOURI LAW REVIEW [Vol. 54

Some courts have been more reluctant to hold that a replacement lien
is adequate protection in Chapter 11 farm reorganizations.-, 3 In re Berens
held that a replacement lien will not provide adequate protection when it
is shown the debtor will lose money on the crops during a year of average
yield.304 The court reasoned that the possibility of poor weather, disease,
lower crop prices and other risks were too high to allow the debtors to
use cash collateral on rented land. 0 5 It is important to note that the debtors
were unable to provide all risk insurance as a form of adequate protection.
The court stated that a replacement lien in crops to be grown is not
sufficient adequate protection unless there is an expectation of a significant
06
profit margin or a minimal guarantee of payment through crop insurance.
The farmer-debtor may run into a problem if he wishes to use proceeds
in order to allow him to enter a new type of farming. 3 7 The farmer in
In re Frank proposed to sell soybeans, which were subject to the creditor's
security interest, to purchase cattle.3 03 The court refused to authorize the
use of the proceeds since the proposal encompassed the removal of sig-
nificant assets from the ready reach of creditors and into a less "liquid"
form, which involved more than typical business risk.30 9
In In re Martin, the Eighth Circuit Court of Appeals held that when
determining whether to allow the use of cash collateral, the court must
establish the value of the secured creditor's interest, identify the risks to
the secured creditor's value resulting from the debtor's request for use of
cash collateral, and determine whether the debtor's adequate protection
proposal protects value as nearly as possible against risks to that value
consistent with the concept of indubitable equivalence.310 The debtors sought
to use cash collateral in March of 1984 to plant and harvest their 1984
crop by offering the secured creditor a substitute lien in the 1984 crop
31
along with an assignment of federal crop insurance proceeds. '
The Eighth Circuit Court of Appeals held that the bankruptcy court
failed to establish that the value of the lien offered on the 1984 crop was
equal to the amount of cash collateral being requested.312 The court noted
that the debtor did not present any evidence regarding proven yields or
expected market prices of the 1984 crops. Additionally, the bankruptcy
court failed to adequately identify the risks to the secured creditors value

303. See In re Berens, 41 Bankr. 524 (Bankr. D. Minn. 1984); In re Berg,

42 Bankr. 335 (D. N.D. 1984); In re Serbus, 48 Bankr. 5 (Bankr. D. Minn. 1984).
304. In re Berens, 41 Bankr. 524, 527 (Bankr. D. Minn. 1984).
305. Id. at 528.
306. Id.
307. See In re Frank, 27 Bankr. 748 (Bankr. S.D. Ohio 1983).
308. Id. at 749.
309. Id. at 750.
310. In re Martin, 761 F.2d 472, 476-77 (8th Cir. 1985).
311. Id. at 475.
312. Id. at 477.
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 Jensen: Jensen: Obtaining Operating Capital
1989] FARM REORGANIZATION
3 13
associated with the planting and harvesting of a crop not yet in existence.
The court suggested that the bankruptcy court consider the following factors
in determining whether the value of the secured party's lien in the stored
crops was sufficiently protected:
the anticipated yield in light of the productivity of the land; the husbandry
practices of the farmer, including his proven crop yields from previous
years; the health and reliability of the farmer; the condition of the farmer's
machinery; whether there are encumbrances on the machinery which may
subject it to being repossessed before the crop is harvested; the potential
encumbrances on the present or future crop by other secured creditors;
the availability of crop insurance and the risk of crop failure not covered
by the crop insurance;
314
and the anticipated fluctuation in market price of
the farmer's crop.

It is important to note that Martin was a Chapter 11 proceeding and

the court relied on an adequate protection scheme that differs from the
adequate protection provision of Chapter 12. 11- The Martin court analyzed
the case based on the indubitable equivalent language of section 361(3).
The drafters of Chapter 12 specifically noted that316the indubitable equivalent
requirement does not apply to family farmers.
Since the indubitable equivalent requirement does not apply in Chapter
12, it is possible that some courts may conclude Martin is inconsistent
with Chapter 12.3 17 If the Martin test is held inapplicable, the court may
determine that a replacement lien is adequate protection without requiring
the Chapter 12 debtor to show that the future crop will be profitable or
that the replacement lien will protect against the risks involved in planting
and harvesting a new crop.
In spite of the removal of the indubitable equivalence language, the
Martin decision should provide guidance to bankruptcy courts in determining
the value of the creditor's security interest and the risks resulting from
the use of cash collateral in a Chapter 12 case. The replacement lien must
adequately protect the creditor's secured value before cash collateral can
be used.
If the Chapter 12 debtor is unable to use the cash proceeds of farm
products, farmland, or farm equipment, he will have a difficult time
reorganizing the farming operation. In many cases, cash collateral will be

313. Id.
314. Id.
315. 11 U.S.C. § 361 (1982 & Supp. IV 1986) is the adequate protection
provision which must be followed in Chapter 11 proceedings. Section 361 does not
apply in Chapter 12 since the drafters included a new adequate protection provision
for reorganizing family farmers. See 11 U.S.C. § 1205 (Supp. IV 1986).
316. H.R. Rep. No. 958, 99th Cong., 2d Sess. 45, reprinted in 1986 U.S.
CODE CONG. & ADnImN. NEws 526, 5250-51.
317. Armstrong, supra note 3, at 195-96.
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

MISSOURI LAW REVIEW [Vol. 54

the only available source of operational financing in that most agricultural

lenders are reluctant to extend new credit to Chapter 12 debtors." 8

V. POST-CONFIRMATION FINANCING

This Article has focused primarily on the problems a Chapter 12 debtor

may encounter in obtaining operational financing during the pre-confir-
mation stage of the bankruptcy proceeding. However, a Chapter 12 debtor
may have an equally difficult problem obtaining the post-confirmation
financing needed to fund the plan. The legislative history to Chapter 12
indicates that the drafters recognized the problem of obtaining post-con-
firmation credit. The explanatory statement provides:
The Conferees are concerned that farmers be able to obtain post-confir-
mation credit. The Conferees are in agreement that current law allows
Chapter 13 debtors to do so. Because section 1227 is modeled after section
1327, family farmers may provide in their plans for post confirmation
financing secured by assets that have revested in the debtor. The debtor
may also use revested property to the extent it is not encumbered by the
plan or order of confirmation to secure post-confirmation credit.319

Section 1227 sets forth the effect of the court's confirmation of a

Chapter 12 plan.320 The confirmed plan binds the debtor, each creditor,
each equity and security holder, and each general partner in the debtor
whether such person has been provided for in the plan and regardless of
whether such person has objected to, accepted, or rejected the plan. 2' In
addition, the plan vests all of the property of the estate in the debtor,
unless it is otherwise provided in the plan or order confirming the plan.
The property vested in the debtor will be free and clear of any claim or

318. See supra text accompanying notes 7-19.

319. H.R. Rep. No. 958, 99th Cong., 2d Sess. 45, reprinted in 1986 U.S.
CODE CONG. & ADuN. NEws 5246, 5251-52.
320. 11 U.S.C. § 1227 (Supp. IV 1986) provides as follows:
(a) Except as provided in section 1228(a) of this title, the provisions of
a confirmed plan bind the debtor, each creditor, each equity security
holder, and each general partner in the debtor, whether or not the claim
of such creditor, such equity security holder, or such general partner in
the debtor is provided for by the plan, and whether or not such creditor,
such equity security holder, or such general partner in the debtor has
objected to, has accepted, or has rejected the plan.
(b) Except as otherwise provided in the plan or the order confirming the
plan, the confirmation of a plan vests all of the property of the estate
of the debtor.
(c) Except as provided in section 1228(a) of this title and except as otherwise
provided in the plan or in the order confirming the plan, the property
vesting in the debtor under subsection (b) of this section is free and clear
of any claim or interest of any creditor provided for by the plan.
321. 11 U.S.C. § 1227(a) (Supp. IV 1986).
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 Jensen: Jensen: Obtaining Operating Capital
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interest of any creditor provided for by the plan, unless otherwise pro-
3
vided. 22
Although section 1227(c) provides that property will vest in the debtor
free and clear of any creditor's claims, in many cases the plan will not
meet confirmation criteria unless the creditor retains its lien. 323 To meet
the confirmation requirements the plan must provide for each allowed
secured claim in one of the three following alternatives:
1. the holder of such claim has accepted the plan;
2. the plan provides that the holder of the claim retains the lien
securing the claim and the value of the property distributed under
the plan is not less than the allowed secured claim; or
3. the debtor surrenders the property securing such claim to the
holder.3-
If the secured creditor is satisfied with his treatment under the plan
and thereby accepts it, the confirmation standard is met. 325 However, if
the holder of the allowed secured claim does not accept the plan, the
debtor will be required to either surrender the property to the secured
creditor or allow the secured creditor to retain his lien.3 26 Since many
secured creditors in Chapter 12 cases will be reluctant to accept it, the
plan will have to provide for retention of the secured creditor's lien. If
the plan provides for retention of the lien, the property of the estate will
not revest in the debtor free of liens and the debtor will not be able to
use this property as security for post-confirmation loans, unless the debtor
complies with the provisions of section 364.327
Since the provisions of section 1227 are virtually identical to section
1327,328 which discusses the effedt of Chapter 13 confirmation, it is important
to look at the issues that have evolved in Chapter 13 proceedings. There
have been some problems with the interpretation of section 1327(c), which

322. Id. § 1227 (b), (c).

323. See id. § 1225(a)(5) which provides:
(a) Except as provided in subsection (b), the court shall confirm a plan
if...
(5) with respect to each allowed secured claim provided for by the plan
(A) the holder of such claim has accepted the plan;
(B)(i) the plan provides that the holder of such claim retain the lien
securing such claim; and
(ii) the value, as of the effective date of the plan, of property to be
distributed by the trustee or the debtor under the plan on account of such
claim is not less than the allowed amount of such claim; or
(C) the debtor surrenders the property securing such claim to such holder.
324. Id.
325. 11 U.S.C. § 1225(a)(5)(A) (Supp. IV 1986).
326. Id. § 1225(a)(5)(B), (C).
327. Small, Family FarmerBankruptcy Act of 1986, 1987 ANN. Sunv. BANYR.
L. at 75.
328. See 11 U.S.C. § 1327 (1982).
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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

MISSOURI LAW REVIEW [Vol. 54

provides that all property vesting in the debtor at confirmation is free and
clear of any claim or interest, unless the plan provides otherwise.2 9 The
litigated cases involve the effect of section 1327(c) on claims when the
secured creditor fails to object to the plan. The major controversy has
been whether section 1327(c) includes liens.330 The legislative history to
section 1327(c) provides no guidance. 3 ' Collier on Bankruptcy notes "there
appears to be no sound reason for lifting liens by operation of law at
'
confirmation under Chapter 13. '332
The weight of authority indicates that the terms "claim" or "interest"
includes liens and therefore section 1327(c) directly affects the status of a
holder of a secured claim in a confirmed Chapter 13 plan if that creditor
accepts the plan. 333 The court in In re Brock stated:
Congress was wise to provide in Section 1327 that after confirmation the
property vests in the debtor free and clear of any claim or interest of
any creditor provided for in the Plan. A debtor may carry out his duties
under a Confirmed Plan without fear of having a creditor pull out from
under him the very equipment needed to accomplish the Plan. Section
1327, therefore, virtually renders a secured creditor provided for in a
Confirmed Plan impotent. It would appear that such a creditor's remedies
are limited to a motion to convert or dismiss in the event 4the debtor
defaults in the payments required to be made to the trustee.?
However, there is some indication that the terms claim or interest may
not include liens.3 35 If so, even failing to object to the plan will not lead
to invalidation of the secured party's lien. The court in In re Honaker
reasoned that a "claim" is distinct from a lien and therefore held that
section 1327(c) does not vest property in the debtor free and clear of liens.
It determined that by operation of section 541(a)(1) the estate was vested
with the same interest in the collateral that the debtor had, which is an
36
interest subject to a valid security interest or mortgage.
If the court determines that a lien is covered under section 1227(c)
and the creditor accepts the plan,3 37 property which was subject to a lien
will vest in the debtor free and clear of all liens. 38 The debtor can use

329. 5 COLLIER ON BANKRUPTCY para. 1327.01, at 1327-5 (15th ed. 1988).

330. Id.
331. See H.R. Rep. No. 595, 95th Cong., 1st Sess. 430 (1977).
332. 5 COLLIER ON BAMNuPrcY para. 1327.01, at 1327-5 (15th ed. 1988).
333. See In re Pettit, 18 Bankr. 832 (Bankr. S.D. Ohio 1982); Ford Motor
Credit Co. v. Lewis (In re Lewis), 8 Bankr. 132 (Bankr. D. Idaho 1981); Associates
Commercial Corp. v. Brock (In re Brock), 6 Bankr. 105 (Bankr. N.D. Il1. 1980).
334. Associates Commercial Corp. v. Brock (In re Brock), 6 Bankr. 105, 108
(Bankr. N.D. Ill. 1980).
335. Second Nat'l Bank of Saginaw v. Honaker (In re Honaker), 4 Bankr.
415 (Bankr. E.D. Mich. 1980).
336. Id.
337. 11 U.S.C. § 1225(a)(5)(A) (Supp. IV 1986).
338. Id. § 1227(c).
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 Jensen: Jensen: Obtaining Operating Capital
19891 FARM REORGANIZATION

this property to provide collateral to post-confirmation creditorsY 39 The

offer of property which is free and clear of liens should induce a new
lender to extend the operational financing needed to fund the plan. This
is clearly what the drafters of Chapter 12 intended. 34°

VII. CONCLUSION

If the Chapter 12 debtor wishes to continue farming and successfully

reorganize his debts, he must have access to operational financing funds.
There are basically three sources of operational financing for the Chapter
12 debtor: obtaining post-petition financing under section 364 of the Code;
use of unencumbered assets; or use of cash collateral.
If the farmer cannot convince the bankruptcy court to authorize the
use of cash collateral or if no unencumbered assets or cash collateral are
available, the farmer's chances of remaining in farming are remote. Current
agricultural lenders appear reluctant to extend operating credit to the Chap-
ter 12 debtor even though they may be able to obtain a superpriority status
or senior liens on estate property under section 364 of the Code.
If the farmer has a high debt/asset ratio, obtaining financing will be
extremely difficult. Additionally, the farmer-debtor who is unable to make
his reorganization plan cash flow will have an equally difficult problem
in obtaining new credit after confirmation. The drafters of Chapter 12 did
not add any new incentives that would encourage lenders to grant post-
petition credit.
The federal government or state governments in farming states may
need to pursue the possibility of injecting capital into the agricultural
market, either through direct or guaranteed lending, to allow family farmers
to stay on the land and thereby effectuate the legislative intent of Chapter
12. Without this injection of new operating capital, many Chapter 12
reorganizations will fail at a very early stage.

339. H.R. Rep. No. 958, 99th Cong., 2d Sess. 45, reprinted in 1986 U.S.
CODE CONG. & ADMiN. NEws 5246, 5251-52.
340. Id.

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 Missouri Law Review, Vol. 54, Iss. 1 [1989], Art. 8

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