Summary of a Recent
Judicial Development in
Bankruptcy

Cash Rent Not Income from Farming Operation

Sean Brister
National AgLaw Center Graduate Assistant

The United States Bankruptcy Court for the Central District of Illinois has ruled that a farmer who received cash rent "up front and in full" from a lease of farm ground was ineligible for Chapter 12 bankruptcy relief. In re Swanson, 289 B.R. 372, 372-75 (C.D. Ill. 2003). The bankruptcy court determined that the cash rent was not income derived from a farming operation and therefore the farmer did not earn more than fifty percent of his gross income from a farming operation, as required to be a "family farmer" eligible for Chapter 12 bankruptcy relief. See id. at 372-75.

To be eligible for Chapter 12 a debtor must be a "family farmer with regular income." Id. at 373. (citing 11 U.S.C. § 109(f)). A "family farmer" is defined as an

(A) individual or individual and spouse engaged in a farming operation whose aggregate debts do not exceed $1,500,000 and not less than 80 percent of whose aggregate noncontingent, liquidated debts (excluding a debt for the principal residence of such individual or such individual and spouse unlesss such debt arises out of a farming operation), on the date the case is filed, arise out of a farming operation owned or operated by such individual or such individual and spouse, and such individual or such individual and spouse receive from such farming operation more than 50 percent of such individual's or such individual and spouse's gross income for the taxable year preceding the taxable year in which the case concerning such individual or such individual and spouse was filed.

Id. (quoting 11 U.S.C. § 101(18)).

A "farming operation" is defined as including "'farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, or livestock, and production of poultry or livestock products in an unmanufactured state.'" Id. (quoting 11 U.S.C. § 101(21)).

Paul R. Swanson, Sr., was an Illinois farmer who filed a Chapter 12 bankruptcy petition in 2002. See id. His gross income for 2001 was itemized as (1) $39,750.00 from cash that he received for a lease on his farm property; (2) $36,454.00 from a one-half interest in proceeds derived from the sale of hogs, cattle, and grain; (3) $219.00 from income earned derived from interest on other funds; (4) $7,992.00 from social security payments; and (5) approximately $2,000.00 from wages earned from an off-farm job. See id. The debtor sought to have his bankruptcy plan confirmed and one of his creditors, the Union/Central Bank ("Bank"), filed motions seeking relief from the bankruptcy stay, dismissal of the debtor's Chapter 12 case, and that the debtor show cause for denying the Bank's appraiser access to the farm property. See id. at 372-73. The bankruptcy court ruled that the debtor was not eligible for Chapter 12 relief because he was not a "family farmer" with regular annual income and granted the Bank's motion to dismiss. See id.

The bankruptcy court noted that there was no dispute that the $36,454.00 derived from the sale of livestock and grain was income derived from a farming operation, and that the income from social security payments, wages from the debtor's off-farm job, and interest payments were not derived from a farming operation. See id. Therefore, the court explained, the debtor's "eligibility for Chapter 12 turns on whether the cash rent is or is not income received from a farming operation." Id. Thus, the only issue before the bankruptcy court was whether the $39,750.00 of cash rent received from the annual lease of the debtor's farm real estate was income received from a farming operation. See id.

In In re Armstrong, 812 F.2d 1024 (7th Cir. 1987), the Seventh Circuit was faced with the issue of "whether the debtor was a 'farmer' who, by virtue of that status, could not be forced into bankruptcy via an involuntary petition . . . ." Id. at 374. In Armstrong, the debtor received money derived from a land lease in which the tenant tendered payment "'in cash and up front." Id. The Seventh Circuit ruled that because the payment was "'in cash and up front'" the debtor did not have the normal risks associated with crop production, and therefore "he did not meet the definition of farmer and could be subject to an involuntary filing." Id.

In In re Seabloom, 78 B.R. 543 (Bankr.C.D.Ill. 1987), a debtor tried to distinguish his cash rental payment from the Armstrong decision because part of the rent was due up front, and part of the rent was due after the crops were sold. See id. In that case, the bankruptcy court rejected this distinction because the tenant's "obligation to pay the rent was absolute and not contingent upon the crop yields or prices, the risks were solely on the shoulders of the tenant." Id.

In the present case, the debtor argued that Armstrong was not binding because it involved eligibility for an involuntary petition. See id. The debtor also asserted that the "totality of the circumstances test," rather than the "mechanistic risk analysis approach" used in Armstrong, should be applied to his case. See id.

The court noted that in In re Coulston, 98 B.R. 280 (Bankr.E.D.Mo. 1989), the bankruptcy court rejected the holding in Armstrong and "held that cash rent could be farm income where the debtor 'behaved historically as a farmer' and ''had both an honest intention and a reasonable probability of returning to 'true' farming.'" See id. (quoting Coulston, 98 B.R. at 283). In Coulston, the bankruptcy court determined that the debtor met this two-part test "and ruled that the cash rent he received in the year prior to bankruptcy was farm income thereby making him eligible for Chapter 12 relief." Id.

In the present case, the court stated that it was required to follow the holding in Armstrong because of the "binding precedent rule." See id. The binding precedent rule requires lower courts to "follow the holdings of their court of appeals and the Supreme Court, [and] affords a lower court no discretion where a higher court has decided the issue before it." Id. (citations omitted). The court explained, however, that "[l]ower courts are not bound to follow a higher court's dictum.'" Id. (citation omitted). It also explained that a court's statement is considered dictum if it was not necessary for the court's decision, and that statements that explain a court's rationale are considered to be part of the holding. See id. (citation omitted).

The court stated that "[t]here is simply no doubt that the Seventh Circuit's determination in Armstrong, that cash rent, paid in full and up front, is not income received from a farming operation, is part of its holding. That determination was necessary to the result, and was in no way gratuitous." Id. at 375. The court added that even though the ultimate issue in Armstrong was different from the issue in the present case, the determination of whether cash rent was income from a "'farming operation'" was central and identical in both cases. See id. The court also ruled that Armstrong could not be distinguished on the facts because in both cases the rent "was paid in full and up front." Id. Thus, the court ruled that Armstrong was binding in the present case. See id.

The bankruptcy court concluded that since the Armstrong decision was binding, the debtor's cash rent income was not income from a farming operation. See id. Therefore, the debtor did not meet the definition of a family farmer because less than fifty percent of his 2001 income arose from a farming operation. See id.

The case was decided on January 29, 2003; this summary was posted April, 2003