In 1856, in Fitchburg, Massachusetts, fire extensively damaged a number of retail stores.
One of the merchant tenants took what he could salvage of his inventory and advertised in the town newspaper, “Extraordinary fire sale; customers are invited to call and examine goods which are still warm.” Over the years, the term “fire sale” has come to mean more than a sale at steep discounts of products damaged by fire, smoke or water. It means any heavily discounted sale of goods for any reason at distress. As always happens at such sales, capital and equity flee with the goods.
“Fire sale” aptly describes the prices producers are forced to sell their milk today. In most, if not all, cases it is estimated that milk will be sold at or below the cost of feed, let alone other costs. If things do not improve enough and fast enough, heifers, feed and whole farms will join the fire sale of assets as dairy farmers strive to survive or at least maintain some dignity as they move out of the business.
Passing through a fire is, however, not necessarily a bad thing. The process of burning away the unneeded and burdensome can leave a leaner, meaner and more fire-proof business ready to better profit from the better times that are certainly ahead. Rather than be forced into a fire sale in which you are not in control, doing a controlled “fire sale” can refine your dairy and additionally ensure it against being forced into the fire pit.
In the real word, fire sales often happen in the context of bankruptcies. The overriding characteristic of bankruptcies is that each asset and each debt is brutally reviewed under harsh standards so that in the end there is almost always a reduction in the value of both. There is no sentimentality. A heifer is worth a discounted market price and it makes no difference that you missed your daughter’s tournament game and a night of sleep helping its dam give birth. That your family has been on the farm for generations has no value at all in bankruptcy. The compressor you jerry-rigged one day with wire and duct tape and has a healthy appetite for oil may be expensive to replace but it is only worth what another person would pay for your basically an unrepaired compressor. Your dreams about passing the dairy onto your children, too, are valueless. It is a dollars and cents world.
In this cold-hearted, black-and-white and red environment, emotionless strangers strip assets down to their lowest value, reduce the debts sometimes to zero, remove liens, abandon property, cancel leases and contracts and a whole number of hard steps until the value of what is left equals what is owed – in both cases, zero. To watch this process on property and debts is like watching a combine rip through a corn field cutting, chomping and chewing tall corn plants until only the small kernels are separated from everything else, leaving a bare field in its wake. It is not pretty, it is not clean, but the true asset is isolated into the form of its highest value.
But the result for businesses that survive the process is they are better able to benefit from profits and weather losses in the future. As painful as a real bankruptcy can be, looking at your operation as if it was subject to fire sale provides not only a more realistic look at what you really have and for what you are at risk, but it arms you with ammunition you can use to bring your costs and debts in line with your income and assets. In the end, like the fire of a bankruptcy, your operation will be refined but done with allies rather than strangers and without the cost, embarrassment and loss of control a bankruptcy brings.
The process is fundamentally simple: Find the liquidation value of your assets, accurately determine enforceable limits of your obligations, adjust your assets and obligations so that the assets can support the obligations. In the process your goals, life and even your ego, will be altered as well. This article cannot begin to explain all of the techniques and nuances used individually and together to work through this process. It requires the assistance of an attorney experienced in such transactions to analyze your individual situation and reach your realistic goals. This article will only suggest some of the things that can be done in order to give an idea of the range of options available to farmers trying to reorganize.
The first step is to identify all of the property including land, equipment, livestock, inventory, growing crops, cash, life insurance, – all of it. Now comes the tough issue – valuation. Forget what you paid for it or have invested in the property or even what you owe on it. Fire burns up the concepts of how long you and your family have been there, what you paid for it, what your dream was, that you need to get your children through college, that it is your livelihood, etc. Instead answer this question: If I had to unload this today at an absolute auction, what would it bring? Or, better yet, look at it from a disinterested buyer – what would she offer to purchase it? This is no time to inflate values with wishes; only values of what you can do.
There will be some assets that have gone up in value, but most will have depreciated even to the point of being a cost for removal. To get the right values, employ an auctioneer or appraiser. Let them know you are not asking to help your vanity, you want to know what the assets will really bring. From that sobering number, subtract 10 percent for the costs of the sale.
Now look at the debts and obligations. Debts include obligations such as leases, contracts to purchase feed over time, unpaid but not yet due taxes, any obligation. Debts, for this analysis, come in two forms – secured and unsecured. A secured debt is one that is linked to one or more items of property and, in simple terms, gives that creditor the first right to the property or the proceeds from its sale. Unsecured debts are everything else. Match the secured debts to the items securing the debt. The positive difference of asset value less debt will be treated as unencumbered money. The negative amount will be added to the unsecured debts.
The previous paragraph is important because too often all of the assets are added up and all of the debts are subtracted for a “net value.” What you are looking for is not “net value” but unobligated assets with which to bootstrap your operation into the next phase. The more of the assets you can decide how they are used, the better able you are to survive or at least retain capital. Each asset must be matched with its own secured debt, if any, and individually analyzed as to how much the creditor is secured. Unsecured debts are worth very little if anything. The ideal is that your debts are unsecured.
As part of the analysis of the secured as well as any obligation, the attorney must analyze to see if it is truly as enforceable as the creditor thinks it is. In bankruptcy, the law provides that the trustee stands in the position as a purchaser for value without notice. What that means is that unless there is some enforceable agreement against the property, the trustee takes the value ahead of that debt. This is the time when legal documents meet the refiner’s fire. Not all survive. Over the years I have seen mortgages become worthless with wrong legal or no legal descriptions, amounts on notes and agreements with the decimal point further to the left than intended and a whole host of issues a professional can find out. By doing this process outside of bankruptcy, your ability to negotiate a future is placed in your hands instead of a bankruptcy trustee.
As for other obligations such as milk marketing agreements, leases, feed purchases and other contracts have them analyzed as to both their profitability to you and their enforceability. Keep in mind that your creditors or the parties on the other side of those contracts have only as much value in the contracts as you can perform. If your business fails, the contracts are worthless.
To be sure, over the years other things have entered the picture. Parents or other family members or friends may have guaranteed one or more of the debts. Asset evaluation may show that your title is not clear. Getting rid of a debt here may have a consequence over there. That is why professional assistance is necessary.
Now you have a realistic inventory of what you have and what you owe and what they are worth. Using this information you can do a housecleaning by removing property you no longer need or use. Consider for each secured the cost/benefit of just selling the asset or even walking away from it. With the asset can also go not only the debt but the need to service it. It is a common technique. Creditors will see the value of assets in recovery against debts at less than your liquidation value. Think of yourself as the buyer of those assets, not the owner or seller. What would you realistically pay for that item in that condition today? Then offer that in any kind of re-negotiations. In a sense you are “buying” it from the lender at that price. For example, you may have paid 3 million dollars for the farm and borrowed $2.5 million but today it is only worth $2 million. That is what should be financed, not the full amount.
In cases of leased equipment, talk to the lessor about replacing the piece with a less expensive item at a lower rate. Your leverage comes because most creditors want the cash flow from the equipment, not the equipment. Additional leverage comes when the seemingly “secured” lender finds out it is not so secured. Getting the documents in order can be worth an adjustment in the terms.
Next, go over each of the contracts that can be terminated and, if they are not performing, terminate them. Question every single contract as to whether or not it provides the service you are paying for, you need or you could obtain elsewhere. The contract may provide for a longer term, but the damages you have to pay for early termination are so small or nonexistent that it makes no difference. Again, good counsel could help.
Just because you have these agreements and these assets does not mean you have to continue in the same way. The economy has changed dramatically in the last few months. Everything needs to be reevaluated in light of today’s prices for milk and the current forecast for tomorrow’s pricing levels. Agreements have to make sense today to be viable tomorrow. It makes no difference how they looked when they were formed. We are in a new environment, and it is necessary to get the assets and debts adjusted today. Using a fire sale approach can help you get there, but you have to do it while they’re still warm. PD
Ben Yale
Attorney at Yale Law Office
