In re Packer

Citation: 586 B.R. 274Docket: Bankruptcy No. 17–81746

Court: United States Bankruptcy Court, N.D. Illinois; June 19, 2018; Us Bankruptcy; United States Bankruptcy Court

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The court, presided over by Bankruptcy Judge Thomas M. Lynch, has denied the motion from First Trust and Savings Bank of Albany, Illinois, to convert the bankruptcy case of Rusty and Kristi Jo Packer from Chapter 12 to Chapter 7. The Packers filed for Chapter 12 bankruptcy on July 27, 2017, and operate a family farm primarily through a limited liability company, Packer Farms, LLC, established to manage liability and insurance concerns as they began hiring outside workers. Other entities involved include Midwest Agri-Services, LLC, and Genesys Specialty Group, LLC, the latter being co-owned with Chad VanHolten. 

The Bank's motion for conversion was based on allegations that the Packers committed fraud by making material misstatements in their bankruptcy schedules and misusing cash collateral. The Bank claimed the Packers held crops hostage to negotiate for cash collateral use beyond what is permitted by law. During a trial held on March 6, 2018, only Rusty Packer and the Bank's president testified, while the Chapter 12 trustee, who had previously filed a separate motion regarding case dismissal or conversion, withdrew that motion during the trial. The trustee's objection to the Packers' proposed reorganization plan, citing feasibility issues and lack of required documentation, differed in grounds from the Bank's motion. The Packers disclosed various business interests and real estate assets in their bankruptcy schedules, listing these assets as having "unknown" values.

The Packers reported ownership of a 2015 GMC 2500 truck attributed solely to Kristi Packer, with a notation of "Packer Farms." They detailed financial assets including several checking and savings accounts across different banks, totaling $49,057.34. Additionally, they classified contingent claims related to "Packer Farms-2014 crop insurance" as having an "unknown value" and noted uncashed checks totaling $40,936.76. The Packers listed various farm equipment and office supplies valued at $2,000, with a reference to an attached list of miscellaneous equipment that was not provided. They claimed a value of $176,925.75 for growing crops, supported by a worksheet detailing crop plans and estimated revenues for multiple farms. Mr. Packer testified regarding ownership of farmland, stating that the "Home" farm was owned by him and his wife, while the "Erie" farmland was owned by the Village of Erie and leased to Genesys Specialty. He clarified that crops on the "Home" farm were owned by him and his wife or Packer Farms, while those on the Erie farm were owned by Genesys Specialty. For the "Peat" and "Fenton" farms, he indicated they were rented and leased, respectively, and he had no ownership interest in the crops planted there. The Bank has agreed not to contest the Packers' claim of owning 50% of Genesys, with the remaining share owned by Chad VanHolten. Mr. Packer affirmed that he entered into custom farming agreements for planting on the Peat and Fenton farms.

Mr. Hanson from the Bank testified that a custom farm agreement involves a farmer working on land they do not own, with the crop ownership resting with the landowner. Although both parties prepared a joint exhibit binder of written custom farm agreements, these documents were not submitted as evidence. The Bank emphasized the Debtors' bankruptcy schedules, which listed various creditors, including Ag Direct, AmTrust, and multiple instances of 'Farm debt' linked to Midwest Agri Service and Packer Farms. Mr. Packer confirmed that either Midwest Agri Service or Packer Farms, LLC was primarily obligated on these debts, and he believed he or his wife were also co-obligors, even though he could not provide written proof of personal liability for some debts. The bankruptcy schedules did not indicate that any debts were incurred jointly with another debtor, except for Ag Direct and Roy Lindstrom, with most debts related to Packer Farms or Midwest Agri Service. Mr. Packer stated that Lindstrom, a lawyer for Midwest Agri Services, also acted as their attorney. The specific nature of the debts was not disclosed by either party. Regarding Ag Direct, Mr. Packer expressed confidence in his personal liability, despite not recalling the specific claim. The Debtors listed equipment and vehicle leases with several financial institutions under executory contracts but did not specify which claims involved co-debtors. They filed a motion on August 3, 2017, to use unspecified "Cash Collateral" for the 2017 crop season, offering periodic payments and a post-petition replacement lien to the Bank and secured lenders. The motion detailed the Debtors' assets, including farm products valued at $176,925.75 and $40,936.76 in uncashed checks from the previous harvest, with expectations of receiving approximately $176,925.75 from sales and government subsidies, alongside $83,000.00 worth of harvested crops in storage.

The Cash Collateral Motion outlines the Debtors' connections to Packer Farms, LLC, Midwest Agri Service, LLC, and Genesys Specialty Group, LLC, noting that both Packer Farms and Midwest Agri are wholly owned by the Debtors. Packer Farms functions as the primary farming operation, while Midwest Agri has ceased operations related to soil amendments and fertilizers. Debtor Rusty Packer holds a 50% stake in Genesys, which markets and sells fertilizer products.

Initially, the Bank objected to the Cash Collateral Motion but subsequently consented to an interim order on September 15, 2017, allowing the Debtors to allocate $9,000 for family living expenses and $6,000 for farm expenses. This order provided secured creditors, including the Bank, with replacement liens and mandated the creation of a "Cash Collateral Account" for the prompt deposit of checks and crop sale proceeds; this account was established at the Bank.

Checks related to the Debtors' operations were deposited into the Cash Collateral Account at First Trust with the Bank's approval. These checks were made out to Packer Farms and First Trust, reportedly at Rusty Packer's request. Mr. Hanson, a witness, admitted he was unaware until October 2017 that the Erie farm properties had been leased to Genesys, leading him to suggest that the Bank might not have approved the collateral usage if it had known the Debtors lacked direct interest in a portion of the expected $176,925.75 in crop proceeds from these properties.

Despite this, the "Packer Farms L.L.C. 2017 Crop Plan," included in the Debtors' bankruptcy schedules filed on July 27, 2017, explicitly indicated that the Erie farms were rented to Genesys. Mr. Hanson acknowledged familiarity with the schedules and recognized that the expected crop proceeds cited in the Cash Collateral Motion matched those in the Crop Plan. Additionally, the Motion specified that the Debtors farm approximately 67.5 acres directly owned and custom farm another 171.7 acres under agreements with Genesys and others. It clarified that the Debtors did not claim a direct right to the estimated crop proceeds, instead referring to the bankruptcy schedules that indicated the rented status of the properties generating those revenues.

Descriptions of the Debtors' farming operations indicate that their income derives partially from three limited liability companies, with their asset interests being indirect through these companies. The Bank contends that the Debtors should only report half of the expected proceeds from crops produced by Genesys, given their 50% ownership stake. However, the Bank failed to provide sufficient evidence, such as Genesys' operating agreement or financial statements, to support its claim. Testimony from Mr. Packer revealed that he farmed Genesys crops under a custom farming arrangement, suggesting he held a legal or equitable interest in the crops. The court concludes that the Bank has not proven any misrepresentation by the Debtors regarding their rights to the proceeds in the Cash Collateral Motion.

The Motion seeks to convert the bankruptcy case from Chapter 12 to Chapter 7 under Section 1208(d) of the Bankruptcy Code, establishing jurisdiction under 28 U.S.C. 1334 and confirming it as a core proceeding. Conversion is contingent upon a demonstration of fraud by the Debtors; however, the decision to convert rests within the court's discretion, as established in Seventh Circuit precedents. The same discretionary standard applies to Chapter 12 cases as it does to Chapter 11 cases regarding conversion requests.

Courts differ on the standard of proof for fraud in motions to convert under the Bankruptcy Code. The Supreme Court established in Grogan v. Garner that the preponderance-of-the-evidence standard applies to fraud-related debts under Section 523(a)(2), as there is no constitutional right to discharge in bankruptcy. This standard is consistent with Congressional intent, as it has historically used the preponderance standard in substantive fraud actions, such as the False Claims Act. The Seventh Circuit also applies this standard for denying discharge under Section 727(a). 

Some courts extend this preponderance standard to conversion under Section 1208(d), while others argue that the unique interests in a family farmer's case justify a higher clear and convincing standard. Notably, Congress has provided special protections for farmers in bankruptcy, including restrictions on involuntary petitions and case conversions without consent. 

Despite the debate on the applicable standard, the current court concludes that it need not decide on the standard's applicability, as the Bank has not met its burden to prove fraud under the preponderance standard.

The Bank failed to prove fraud related to the case under Section 1208(d), which requires more than mere bad faith; it necessitates intentional misleading or failure to disclose material information by the debtor. Case law suggests that fraud can include intentional concealment of assets or misrepresentations, but does not require creditor reliance on fraudulent statements. The Seventh Circuit has endorsed a broad definition of "actual fraud," which encompasses deceitful actions intended to cheat another, though it does not mandate misrepresentation. Intent to defraud can be established through circumstantial evidence. Under Section 727(a)(4), proving fraudulent intent involves showing that the debtor made a false statement under oath knowingly and with intent to deceive, with a material relation to the bankruptcy case. The Bank contends that the Debtors' filings exhibit falsehoods indicative of reckless disregard for the truth. However, the identified inaccuracies pertain to overinclusions of assets and debts, rather than omissions or concealments, and the Debtors are acknowledged to have at least partial interests in the reported assets and liabilities.

Debtors disclosed certain assets and liabilities related to corporate entities in which they held either a 100% or 50% interest. In contrast to previous cases cited by the Bank, where fraud was identified due to omissions concerning assets or liabilities, the current situation involves properly designated corporate interests. The Bank's cited cases primarily focused on undisclosed assets, with counsel acknowledging that these cases dealt with asset omissions. For instance, in *In re Nichols*, the court ruled that the debtor's errors in listing assets did not constitute fraud, noting the debtor acted in good faith based on advice from counsel and had a legitimate succession plan for the family farm. The debtor's full disclosure was deemed sufficient to negate fraud implications. Similarly, the current Debtors accurately listed assets under corporate names, indicating no intent to misrepresent ownership. While the Bank contended that the Debtors should have reported expected crop proceeds as reflecting only their half interest, it failed to prove the Debtors' understanding of their rights was limited. Nonetheless, the Debtors provided adequate information for the trustee and creditors to seek clarification.

The Debtors' schedules were criticized for lacking detailed explanations, particularly regarding the listing of liabilities that may mislead stakeholders about the extent of their interests. The Bank contended that the Debtors should have indicated joint liabilities correctly, particularly for debts shared with corporate entities. However, many entities identified as joint debtors, such as "Packer Farms," "Midwest Agri Services," and "Farm debt," are ones in which the Debtors have clear interests. The Bank did not prove that any debt attributed to Roy Lindstrom was not owed by the Debtors. In their Schedule F, the Debtors listed their liability to Ag Direct as "unknown," with Mr. Packer acknowledging personal liability but lacking specifics regarding the equipment involved. The Bank's assertion of fraud was based on an invoice that followed the initial filing of Schedule F, lacking contemporaneous evidence of intent to deceive.

The Bank alleged that the Debtors overrepresented their assets to inflate their income and secure cash collateral; however, this claim was deemed speculative. The Debtors’ schedules accurately disclosed their interests in non-debtor entities and identified related assets and liabilities. While the schedules contained errors, such as failing to mark liabilities accurately, proving fraud requires more than identifying mistakes. Courts have recognized that errors in bankruptcy schedules can result from negligence or misunderstandings rather than fraudulent intent. Although multiple errors may suggest recklessness, in this case, they primarily pertained to the proper scheduling of corporate assets and liabilities.

The court determined that the Bank failed to prove the Debtors committed fraud in their financial submissions. Similar to the case Spohn v. Carney, the Debtors’ errors in their schedules stemmed from a misunderstanding about corporate ownership rather than reckless indifference. Mr. Packer's credible testimony supported this finding. The initial cash collateral motion accurately projected expected proceeds from farm product sales and did not misrepresent ownership of property. The Bank could not demonstrate that the Debtors intentionally misrepresented their assets or that they acted fraudulently regarding the use of proceeds from a USDA subsidy check. While the Bank objected to a salary payment to Mrs. Packer from these proceeds, it did not prove that court approval was necessary or that the payment was part of a fraudulent scheme. Additionally, the Bank's argument about misleading creditors regarding the automatic stay lacked evidence of any actual misrepresentation or misleading actions by the Debtors. The Debtors were required to list claims for which they were jointly liable, in accordance with the broad statutory definition of "claim" under 11 U.S.C. 101(5)(A).

The court concluded that the Bank failed to demonstrate that the Debtors were not jointly or secondarily liable for the debts listed in their schedules, resulting in the denial of the Bank's motion to convert the Chapter 12 case. The evidence did not support the Bank’s claim of fraud, which is necessary for conversion under 11 U.S.C. § 1208(d). Additionally, converting the case would undermine the statutory framework designed to address family farmers' debts. The Bank sought conversion rather than dismissal, hoping a Chapter 7 trustee could investigate potential assets from the 18 months preceding the petition date. The initial motion claimed the Debtors had no reasonable chance of rehabilitation due to their debt and income levels; however, a stipulation was made that the hearing would not address the confirmability or feasibility of any proposed Chapter 12 Plan, leaving those issues reserved for future consideration. The Chapter 12 Trustee supported this stipulation. The trustee's objections, citing incomplete schedules and missing disclosures, were not substantiated with evidence during the trial. Among the Debtors' listed assets was a Disney timeshare, along with farm equipment designated as "Packer Farms."

A variety of farm equipment is listed, including multiple cultivators, soil finishers, mowers, a semi tractor, a trailer, and a litter spreader, some designated under "Midwest Agri Services." The "Fenton" farm is identified as a 12-acre parcel in Fenton Township, Illinois, and the "Peat" farm as a 30-acre parcel in Morrison, Illinois, both of which are jointly owned by the Debtors and leased to Rusty Packer's father under a cash-rent farm lease. The Bank claims the Debtors misrepresented crop ownership to secure cash collateral use, but evidence suggests that the crop proceeds belonged to Genesys, indicating that bankruptcy court approval was necessary for their use. The court refrains from addressing the Chapter 12 trustee's objection to confirmation and the potential for case dismissal, emphasizing that the standard of proof for fraud-related claims in this context requires clear and convincing evidence, as derived from prior case law, including In re Caldwell. The court notes that historically, farmers have had protections against involuntary bankruptcy since 1898, which predates current bankruptcy statutes.

A Chapter 12 bankruptcy plan can include property liquidation, but only the debtor is authorized to file such a plan. In this case, the Bank did not prove that the Debtor received an invoice from Ag Direct relevant to his bankruptcy filings. During cross-examination, it was established that the Debtor had reviewed his files and produced available documents regarding personal liability, but no specific documentation was presented. The Bank contends that some creditors may have been confused by the bankruptcy notice, leading to improper claims; however, this argument overlooks the absence of actual confusion and the protections against improper claims established in the case. The notice clearly identifies the debtors and advises consultation with an attorney, while parties have the right to object to improper claims. Moreover, claimants are required to conduct a reasonable inquiry to substantiate their claims per Bankruptcy Rule 9011, which emphasizes the necessity for factual and legal support for claims filed in bankruptcy.