CASE SUMMARY: U.S. Tobacco Cooperative Files Chapter 11 After Termination of Federal Tobacco Price Support Program

Relevant Documents:
Voluntary Petition
First Day Declaration
Cash Collateral Motion

Summary
U.S. Tobacco Cooperative is a vertically integrated tobacco cooperative
Files in wake of an adverse ruling in North Carolina state court class-action litigation brought by cooperative members that resulted in default under the debtors’ first lien credit agreement and acceleration of all tranche A revolver notes
Seeks use of cash collateral of the prepetition bank group and is “cautiously optimistic” it will reach consensus

Raleigh, N.C.-based U.S. Tobacco Cooperative, the “largest tobacco cooperative in the United States” and the “most vertically-integrated company in the industry, operating leaf receiving stations, green leaf threshing and redrying, primary blending, cigarette manufacturing, and wholesale distribution,” filed for chapter 11 protection on Wednesday, July 7, in the Bankruptcy Court for the Eastern District of North Carolina along with several affiliates. The bankruptcy filing follows a series of lawsuits and an adverse ruling in a North Carolina state court class-action brought by co-op members resulting in a default under the debtors’ first lien credit agreement and the acceleration of all amounts due under tranche A revolver notes in the outstanding amount of $99.6 million. For access to the relevant documents above as well as our First Day by Reorg team's coverage of all U.S. chapter 11 cases filed since 2012 with over $10 million in liabilities including the US Tobacco Cooperative chapter 11 filing click here to request a trial. 

The litigation followed changes in the debtors’ business structure in response to the passage of the Fair and Equitable Tobacco Reform Act, which cut back the federal Tobacco Price Support Program under which growers agreed to limit production in exchange for guaranteed minimum prices set by the federal government. The debtors say the unpopular program had been under “political attack” throughout its history.

The debtors seek the use of cash collateral and say they are “cautiously optimistic” that the prepetition bank group will consent.

The first day hearing has been scheduled for Monday, July 12, at 10 a.m. ET.

The company’s prepetition capital structure includes:

• Secured debt:
  
  
  
  • Syndicated credit facility:
    
    
    
    • Revolving credit facility:
      
      
      
      • Tranche A: $99.6 million
      
      
      • Tranche B: No outstanding balance
      
      
      
      
    
    
    
    
  
  
  
  


• Trade and other unsecured debt: $2.5 million

• Equity: 553 co-op members

As of July 1, the lenders under the first lien credit facility were Truist Bank (the agent); AgCarolina Farm Credit, Agricultural Credit Association, or ACA; CoBank, Agricultural Credit Bank, or ACB; Fifth Third Bank NA; and Pinnacle Bank. The credit facility, under which the cooperative had access to a revolver with availability of $105 million under tranche A and $35 million under tranche B, is secured by a first lien on all or substantially all of the debtors’ personal property. The cooperative and co-debtor subsidiary US Flue-Cured also granted first-priority mortgages on their corporate offices, Timberlake facility, 913 Bridge Street facility and 608 Wilbon Road facility. The credit facility is also guaranteed by debtor subsidiaries Premier Manufacturing, Big South and Franchise Wholesale and King Maker.

The debtors are represented by Cozen O’Connor in Wilmington, Del., and Chicago, and by Hendren, Redwine & Malone in Raleigh, N.C., as co-counsel.

Events Leading to the Bankruptcy Filing

Under the Tobacco Price Support Program, if buyers did not purchase members’ tobacco above a price floor, the debtors would purchase the tobacco using funds borrowed from the Commodity Credit Corporation, or CCC, a division of the U.S. Department of Agriculture. Every flue-cured farmer seeking to sell tobacco to the cooperative was required to be a member and pay $5 for a stock certificate, each of which was assigned an “FC number,” of which 800,000 were issued to the cooperative’s member-growers.

The 2004 Fair and Equitable Tobacco Reform Act terminated the Tobacco Price Support Program. As a result, the debtors began purchasing members’ tobacco directly, and the cooperative implemented a vertical integration strategy in order to promote and sell the tobacco.

The debtors say that they had “long been aware of [the Tobacco Price Support Program’s] unpopularity” and had notified their members on multiple occasions of the practical necessity of building a reserve in the event the program was terminated. From 1979 through 2005, the debtors accumulated reserves of approximately $300 million.

Beginning in 2005, various members launched direct and class-action lawsuits against the cooperative in Georgia state court (which have been dismissed) and North Carolina federal and state courts (which suits are still pending). The suits allege that (i) the debtors failed to appropriately allocate funds held in reserve; (ii) as the cooperative’s primary purpose was administering the Tobacco Price Support Program, the program’s end meant the cooperative should have ended and/or distributed some or all of the reserve; (iii) the cooperative had improperly removed identification card numbers from the member registry; and (iv) the acts of the cooperative were ultra vires, “in breach of its agreements with its members, unfair and deceptive trade practices, or all three.” The debtors say that the number of class plaintiffs could reach the “hundreds of thousands.”

The cooperative reached a settlement of the North Carolina federal lawsuit in 2018, which would have also eliminated the state court litigation, but the Fourth Circuit reversed an order approving the settlement, and on remand, the district court dismissed the case. The plaintiffs have appealed that ruling, which remains pending. In April, the North Carolina state court entered an order (which the co-op has appealed) finding that:

• The cooperative improperly removed about 700,000 FC numbers from its registration rolls, resulting in damages of $5 per each FC number stock;


• Once the cooperative opened 1967 to 1973 capital equity credits for redemption in 2010, it could not close that redemption period, resulting in $21 million in damages;


• The cooperative’s capital reserve should have been allocated (resulting in certificates of interest to contributing members) as all the proceeds comprising the reserve were patronage income, including the post-tax net of $110 million resulting from the sale of tobacco ceded by the CCC in the 1990s and the pre-tax net of $126 million resulting from tobacco ceded by the CCC in 2005; and


• The cooperative committed an unfair and deceptive trade practice by not distributing $126 million in proceeds from the sale of tobacco “ceded to the Cooperative from the CCC at FETRA.”

On May 12, the prepetition agent notified the debtors that the order triggered a default under the credit agreement and a month later stated it had created a litigation reserve against the debtors’ tranche A and tranche B borrowing bases of $140 million. The prepetition agent asserts that the creation of the class-action litigation reserve created an overadvance under the terms of the credit agreement, obligating the cooperative to immediately repay the outstanding amounts under tranche A revolver notes and prohibiting the debtors from obtaining further funding under the credit facility.

Background

U.S. Tobacco Cooperative is a flue-cured tobacco processor, manufacturer of consumer tobacco products and merchant of processed tobacco leaf and byproducts to domestic and international cigarette manufacturers. The cooperative was established in 1946 under the North Carolina Marketing Act, and its owners represent over 500 flue-cured tobacco farmers in the Southeast region of the United States. The cooperative has 50 employees.

The cooperative and its subsidiaries sell tobacco leaf and byproducts to buyers across the world, process and distribute 10 consumer tobacco product brands in the U.S., perform contract manufacturing of consumer products for international brands and produce and sell cut rag and pipe tobacco. The debtors purchase tobacco crops from their co-op members through annual marketing agreements, pursuant to which members deliver a certain quantity of tobacco to the cooperative in exchange for a price set in advance by tobacco grade. The debtors return eligible profits back to their co-op members through cash patronage dividends in accordance with IRS regulations and the federal Capper-Volstead Act of 1922, which governs agricultural cooperatives.

The cooperative generated $28.8 million in revenue for the fiscal year ended April 30, 2021. After intercompany transaction eliminations, the debtors’ consolidated annual revenue in 2021 was approximately $260.4 million and net income was approximately $6.6 million.

The cooperative operates five marketing centers in Georgia, North Carolina and South Carolina where it receives, grades and weighs members’ tobaccos. The cooperative’s next anticipated purchases of approximately 36 million pounds of tobacco leaf will take place in August through November. The cooperative either processes the tobacco that it purchases for use in its own consumer products, or else processes it and sells it in bulk to third-party domestic and international cigarette manufacturers and tobacco leaf merchants.

The cooperative’s 500,000-square-foot manufacturing facility in Timberlake, N.C., is the only facility in the tobacco industry with all aspects of manufacturing under a single roof: green leaf tobacco processing (stemmery), primary blending and secondary cigarette manufacturing, the debtors say. Included in this facility is a green storage climate-controlled warehouse with a storage capacity of up to 10 million pounds of green leaf tobacco prior to processing.

The company’s corporate organizational structure is shown below:

The debtors’ largest unsecured creditors, on a consolidated basis, are listed below: