In re Knudsen

• Decision Date: 12 June 2008
• Docket Number: No. C07-3011-MWB.,C07-3011-MWB.
• Citation: 389 B.R. 643
• Parties: In re Anders H. KNUDSEN, doing business as A & C Knudsen Farms, and Cynthia Knudsen, Debtors/Appellants.
• Court: U.S. District Court — Northern District of Iowa

389 B.R. 643

In re Anders H. KNUDSEN, doing business as A & C Knudsen Farms, and Cynthia Knudsen, Debtors/Appellants.

No. C07-3011-MWB.

United States District Court, N.D. Iowa, Central Division.

June 12, 2008.

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MEMORANDUM OPINION AND ORDER REGARDING APPEAL OF BANKRUPTCY COURT'S ORDER DENYING CONFIRMATION OF DEBTOR'S FIFTH AMENDED AND SUBSTITUTED PLAN OF REORGANIZATION

MARK W. BENNETT, District Judge.

TABLE OF CONTENTS

I. INTRODUCTION............................................................................648
                    A. Factual Background................................................................. 648
                    B. Procedural Background...............................................................649
                       1. The Knudsens' petition in bankruptcy and reorganization plan ....................649
                       2. The bankruptcy court's denial of plan confirmation...............................650
                       3. The cross-appeals................................................................650
                II. LEGAL ANALYSIS.........................................................................651
                    A. Standard Of Review .................................................................651
                    B. Rules For Statutory Interpretation..................................................651
                    C. The Farmers' Issues On Appeal.......................................................653
                       1. The statute at issue.............................................................653
                       2. Treatment of taxes on the sale of slaughter hogs.................................654
                          a. The bankruptcy court's decision...............................................654
                          b. Arguments on appeal...........................................................655
                          c. Analysis......................................................................658
                              i.  Interpretation of "any farm asset........................................658
                

ii.  Interpretation of "the debtor's farming operation...."...................659
                             iii.  Interpretation of "used in" the debtor's farming
                operation...........................................................661
                              iv.  Applicability of the statute............................................664
                         3.  Allocation of tax claims entitled to beneficial treatment.....................665
                             a. The bankruptcy court's decision............................................665
                             b. Arguments on appeal........................................................665
                             c. Analysis...................................................................667
                        D. The IRS's Cross-Appeal..........................................................669
                           1. The pertinent part of the bankruptcy court's ruling..........................669
                           2. The scope of the IRS's cross-appeal..........................................671
                           3. Arguments on appeal..........................................................672
                           4. Analysis ....................................................................674
                              a. Applicability of § 1222(a)(2)(A) to post-petition transactions.......675
                              b. Treatment of post-petition taxes as administrative expenses of
                                          the bankruptcy estate .................................................677
                       III. CONCLUSION ....................................................................682
                

Can family farmers, who liquidated their slaughter hogs to convert their farming operation from a farrow-to-finish hog operation to a custom hog-raising operation, obtain the benefits of an amendment to 11 U.S.C. § 1222(a)(2) under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), Pub.L. No. 109-8,119 Stat. 23, that would allow the taxes generated by the sale of their slaughter hogs to be treated as an unsecured claim against their bankruptcy estate subject to discharge?This and other questions are raised on cross-appeals by the family farmers and the United States, on behalf of the Internal Revenue Service, from an order of the bankruptcy court denying confirmation of the family farmers' Chapter 12 plan for reorganization.Few—or no—courts have passed on the questions presented here, so that the court finds itself writing on a nearly clean slate, guided by statutory language, legislative history, and bankruptcy policy.

I.INTRODUCTION

A.Factual Background

The pertinent facts in this appeal from the bankruptcy court's denial of confirmation of the debtors' Chapter 12 plan are undisputed.Anders Knudsen and Cynthia Knudsen, the debtors and appellants in this bankruptcy case, are husband and wife and the owners of a 160-acre farm in Mitchell County, Iowa, near St. Ansgar, Iowa.The farm includes their 40-acre homestead, which they claim as exempt.Anders has a bachelor's degree in agricultural business with a minor in farm management from Iowa State University.Anders is a farmer and has been engaged in farming since he was a high school student.One component of the Knudsens' farming operation over the years has been a hog operation.In the early 1990s, the Knudsens expanded their hog operation, so that during 1992-1993 their sow herd numbered 250.They also built a farrowing house and started selling feeder pigs.Although the Knudsens initially hired others to fatten their hogs, the Knudsens eventually built two finishing barns, the first in 1995 and the second in 1996.Thus, by 1996, the Knudsens were operating a farrow-to-finish hog operation and were selling their own hogs as their main source of income.

Two occurrences of swine disease in 1999 impaired the growth and profitability of the Knudsens' hog operation.Between 2000 and 2003, both the Knudsens and their lender, St. Ansgar State Bank, became concerned about the financial direction of the Knudsens' farming operation to the point that the bank became increasingly unwilling to lend money to finance that operation.These circumstances led the Knudsens to investigate a reorganization of their farming operation.To that end, the Knudsens explored the possibility of becoming custom livestock operators.In December 2003, the Knudsens entered into two ten-year contracts to raise hogs for Squealers Pork, Inc.("SPI"), a Minnesota corporation.Under the terms of the contracts, SPI would provide baby pigs to the Knudsens, which the Knudsens would raise to market weight.Because SPI was concerned about swine disease, SPI required the Knudsens to liquidate completely their own swine herd before they started to raise hogs for SPI.Accordingly, in 2004, the Knudsens sold the last of their breeding sows and all of their slaughter hogs.The Knudsens used the proceeds of the sale of their hogs to make a payment on a loan from St. Ansgar State Bank, which was secured by the hogs.In addition, because of the change in their hog operation, the Knudsens sold a livestock trailer and their interest in some farrowing equipment.The Knudsens also ended their grain farming operations and leased their 160 acres to a friend for cash rent.

In their joint 2004 federal income tax return, the Knudsens reported $525,384 of farm income attributable to the sale of "livestock, produce, grains and other products."This figure included the sale of slaughter hogs.The Knudsens reported net farm income of $65,336 for 2004.The Knudsens reported the sale of their breeding sows as a capital gain of $34,077.Finally, they reported the proceeds of the sale of the farrowing equipment and the livestock trailer as an ordinary gain of $21,659.On their initial 2004 federal tax return, the Knudsens' total tax for 2004 was $19,550.

On June 21, 2005, the Knudsens filed an amended 2004 tax return, which showed the Knudsens' 2004 federal tax to be $55,839.The increase in the Knudsens' 2004 federal tax was due in part to their decision to revoke an election to treat the costs of remodeling their hog buildings as expenses rather than to depreciate the costs over time.¹This revocation had the effect of decreasing farm expenses for 2004 and causing a corresponding increase in the Knudsens' income.Shortly after filing their amended 2004 tax return, the Knudsens filed a petition in bankruptcy.

B.Procedural Background

1.The Knudsens' petition in bankruptcy and reorganization plan

The Knudsens filed a bankruptcy petition under Chapter 12 of the Bankruptcy Code on July 1, 2005, seeking bankruptcy protection to reorganize their farming operation.The Knudsens ultimately filed a Fifth Amended and Substituted Plan of Reorganization, which they subsequently modified twice to make "technical" changes.In its Decision Re Plan Confirmation (docket no. 1-37), dated November 20, 2006, the bankruptcy court found that "[t]he essence of the proposed plan is to take advantage of 11 U.S.C. § 1222(a)as amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (`BAPCPA'), Pub.L. No. 109-8,119 Stat. 23."In re Knudsen,356 B.R. 480, 483(Bankr.N.D.Iowa2006).More specifically, the bankruptcy court found that the Knudsens hoped to obtain favorable treatment of the gains on the sale of machinery, equipment, and farmland pursuant to § 1222(a)(2)(A), such that a portion of the income taxes on such gains would be treated as unsecured debt rather than as priority debt to the Internal Revenue Service, and if the Knudsens perform their plan successfully, the unsecured portion of the taxes, including penalties and interest, will be discharged.Id. at 483-84.As the bankruptcy court also noted, the "Knudsens contend that the same favorable treatment should apply to their prepetition restructuring sales of fat hogs, sows, and equipment."Id. at 484.

2.The bankruptcy court's denial of plan confirmation

In its Decision Re Plan Confirmation, In re Knudsen,356 B.R....