In re Gerke

634 B.R. 104

IN RE: Robert E GERKE, Coleen R Richardson, Debtors.

Case No. 21-14171 EEB

United States Bankruptcy Court, D. Colorado.

Signed October 28, 2021

James T. Markus, Zachary Sanderson, Markus Williams Young & Hunsicker LLC, Denver, CO, for Debtors.

Daniel A. Hepner, Broomfield, CO, Trustee, Pro Se.

ORDER ALLOWING USE OF CASH COLLATERAL IN PART AND DISALLOWING IT IN PART

Elizabeth E. Brown, Bankruptcy

THIS MATTER is before the Court following an evidentiary hearing on the Debtor's Motion to Use Cash Collateral and the Objection of Bankwest of Kansas (the "Bank"), the Debtor's primary secured lender. In exchange for their use of cash collateral, the Debtors have offered the Bank adequate protection in the form of replacement liens on future cash, crops, and livestock. The Bank urges this Court to hold that this offer is insufficient as a matter of law and, alternatively, under the facts and circumstances of this case. To resolve this dispute, the Court must explore the purpose and contour of adequate protection.

I. BACKGROUND

The Debtors filed a chapter 12 petition on August 11, 2021. Farming and ranching have been the businesses of not only these debtors, but of past generations of both their families. Currently, they raise cattle and crops of wheat, alfalfa, and millet in the Burlington, Colorado area. They live on the farm and they do the vast majority of the work themselves, only contracting out some custom planting. Mr. Gerke also contracts out his services for custom swathing and bailing to local farmers and receives in exchange a combination of cattle feed and cash payments. Together these Debtors devote at least eight to ten hours per day, seven days a week, toward their farming and ranching operations (referred to collectively as "farming" hereafter).

But hard work and dedication do not guarantee success every year in farming. Severe weather conditions, disease, other natural disasters, low commodity prices, high interest rates, declining land values, rising costs of production, unstable markets, and inconsistent governmental policies all beset this industry. In the past two years, these Debtors have had to endure a severe drought in the area. In addition to its direct impact on crop yields and cattle grazing, drought stress can cause both pasture forages and weeds to accumulate toxic levels of nitrates. One day, Ms. Richardson drove the cattle onto a different area to pasture. When she checked on them at day's end, she found the cattle were dying. They had eaten "pigweed," which they later discovered had unusually high nitrate concentrations. She immediately called her husband who was out of town, he told her to move the cattle immediately, and she did so. But the damage was done. The Debtors lost approximately twenty-five percent of the herd to poisoning. It killed mature cows, caused many bred cows to abort, and produced a high mortality rate among the young calves.

At trial, the Bank first cast doubt on whether the Debtors’ cattle actually died, implying the Debtors may have sold them "out of trust." But the Court finds these allegations were completely unfounded. Mr. Gerke testified that the Bank never even bothered to come inspect the fields to see their rotting carcasses and bones. Then the Bank claimed that these losses were attributable to "poor husbandry" practices of the Debtors. The only evidence they offered in support was the testimony of their expert, Mr. John Norwood, a retired banker who specialized in lending and portfolio management of big agri-business loans for First National Bank of Omaha and other regional banks. He testified to the methods used by big agri-business borrowers, such as futures contracts to hedge against changes in commodity prices, to protect against risk of loss. But then he strayed outside his field of expertise to opine that the Debtors were negligent in not preventing the growth of pigweed. Mr. Norwood has a small family farm himself, in which he raises wheat, millet, milo, and corn. But he demonstrated no expertise in raising cattle, animal husbandry, horticulture, or plant science. In fact, the longer he testified, the clearer it became that Mr. Norwood was willing to say anything to support the Bank's position, thereby losing his credibility with the Court.

The Court finds that the Debtors are experienced, honest, hard-working farmers, who have suffered losses due directly and indirectly to a severe drought. Before the drought hit, they had never been late on any loan payments to the Bank, despite the many years they have had loans with this Bank. The Bank was willing to work with the Debtors through the first year of the drought, but when it realized the loan had become undersecured, it embarked on a new approach.

The Bank has let the Court know that the Debtors have unencumbered assets, other sources of income, and family resources from which it believes the Debtors could and should turn this ordinary farm loan into a more risk-free loan. Mr. Gerke owns a business, known as Gerke Trucking, LLC, for which he drives a truck hauling freight (mostly cattle and farm products) approximately three days per week. His business has been successful and produces additional income for the Debtors. Apparently, the Bank had a lending relationship with Gerke Trucking in the past, but it paid off its loan in full. The Bank would now like to obtain a lien on the assets of this business to ensure full repayment of its otherwise undersecured farm loan. The income the Debtors receive from Gerke Trucking and their interest in the company are property of this chapter 12 estate, but Gerke Trucking's assets are not. In addition, Ms. Richardson is one of three adult siblings, who are each beneficiaries of a family trust that owns substantial farmland. And finally, the Debtors own their residence free of any encumbrances.

Whether the Debtors will need to tap any or all these resources in order to confirm a plan is a question for another day. The focus of the present inquiry is only whether the Bank's undersecured loan is threatened with further erosion due to the Debtors’ proposed use and sale of the Bank's collateral during a four-month period before they propose their plan. At present, the case is already two months into this four-month period, as the Court has authorized the interim use of cash collateral, leaving only the remaining two months at issue.

II. THE CONCEPT OF ADEQUATE PROTECTION

The Bankruptcy Code does not define its use of the phrase "adequate protection." Undoubtedly, this was intentional. By leaving it undefined, Congress has signaled that it is intended to be a flexible concept. See H.R. Rep. No. 95-595, at 339 (1978). So flexible in fact that courts can interpret it or adapt it to meet the needs and competing interests of both the debtor and other parties with an interest in the debtor's property—most commonly the debtor's secured creditors.¹ And a flexible approach allows it to adapt to future changes in financial relationships and commerce in general. Its purpose is to balance the interests of both debtor and secured creditors in order to promote chances for reorganization but not by placing secured creditors at further risk of loss. The evolution of this concept over time, both in the various statutory enactments and court interpretations of them, lends additional insight into its nature.

A. Statutory Enactments

1. Pre-Code

Initially, America's bankruptcy system focused only on involuntary filings aimed at liquidation. It was not until the Bankruptcy Act of 1867 that Congress introduced the concept of reorganization, known then as a "composition agreement." But nothing in the 1867 Act required adequate protection. In fact, this concept did not surface until Congress passed the Chandler Act in 1938 during the Great Depression. It first required adequate protection, but only as a means of protecting the dissenting creditors who had objected to confirmation of the plan. See Andrew N. Karlen, "Adequate Protection Under the Bankruptcy Code, Its Role in Business Reorganization , 2 Pace L. Rev. 1, 3 (1982). It bore no relationship to the debtor's use of estate property pre-confirmation.

Thus, in pre-Code cases, without a statutory anchor of "adequate protection" in a pre-confirmation context, courts struggled to balance the reorganizational interests of the debtor and the public, on the one hand, with the interests of secured creditors in depreciating assets, on the other hand. In Fruehauf Corp. v. Yale Express System, Inc. (In re Yale Express System, Inc.) , 384 F.2d 990 (2d Cir. 1967), the secured creditor held the equivalent of a purchase money security interest in the debtor's vehicles. After defaulting on its loan, the debtor filed a reorganization petition. Its lender responded with a reclamation proceeding to recover the vehicles. The court allowed the debtor's use of the collateral. The Second Circuit, however, remanded the case for a determination of whether "the equities" favored the debtor's continued use of the vehicles in its business and, if so, whether there were any protections that the court could afford the secured creditor, such as a requirement of rental payments. On remand, the court refused to impose rental payment protection and found that use of the vehicles was critical to reorganization, reorganization was reasonably possible and, if the secured creditor was harmed by the collateral's use, then the plan could grant it an administrative priority in compensation.

This case received biting criticism. Karlen, supra , at 5 (citing Murphy, Use of Collateral in Business Rehabilitations: A Suggested Redrafting of Section 7-203 of the Bankruptcy Reform Act , 63 Cal. L. Rev. 1483, 1494 (1975)). It was a virtual certainty that the value of the vehicles would depreciate with continued use and, given only the speculative hope of special treatment under a future plan, the secured lender's fifth amendment property rights may well have been violated. Id....