FARGO, N.D. — BMO Harris Bank N.A. failed to prove that bankrupt farmer Ron G. McMartin, Jr., of St. Thomas, N.D., intended to defraud them.

Bankruptcy Judge Shon Hastings in Fargo on Feb. 26 ruled that BMO had not made its case of “falsity,” even though McMartin — in one the region’s largest modern-day farm failures — lacked “credibility” in some transactions.

Hastings said BMO was at least in part to blame for a “lack of clarity” and accounting “misunderstandings,” but didn’t prove fraud. The bank has 14 days to appeal, which would be March 11.

McMartin’s farm — McM Inc., based at St. Thomas, N.D. — filed for Chapter 7 liquidation on Feb. 10, 2017. McMartin filed personal bankruptcy relief on Sept. 11, 2017. There were $62 million in claims, including $43 million owed to BMO Harris. Four years later, both cases are near closing.

In the personal bankruptcy, BMO, on Feb. 28, 2018, filed the “adversary action.”

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Personal bankruptcies allow debtors to “discharge” debts, unless a fraud is involved. BMO Harris alleged McMartin failed to give them accurate financial information when obtaining the loan, which, they claimed, constituted fraud.

The core of the case is accounting.

Significantly, McM historically had used “cash basis” accounting, using QuickBooks, a common software for the purpose. Most farms use cash accounting because it allows flexibility in timing the entering of obligations and recognition of income to match the rhythms of farming.

Accrual accounting means entering obligations on balance sheets as soon as they are incurred, not when they’re due. The limitation has increased, but at the time, Internal Revenue Service required “accrual” for businesses that handle more than $5 million, but farming was an exception to the rule.

BMO Harris became McMartin’s lender in 2012 and required accrual accounting.

McMartin said he never got the message.

BMO’s big play

McMartin started farming in 1985, with 200 acres of land.

In 1995, he formed McM. In 2012 and 2013, McMartin expanded to 59,000 acres, according to documents. McMartin raised crops like sugarbeets and potatoes that are higher value and include more management than cereal grains.

As he grew, Martin went through a series of banks: Bremer Bank, Ramsey National Bank and Rabo Agrifinance. He used Mortenson and Rygh, a Park River, N.D.-based accounting firm.

In 2012, he switched to BMO Harris.

Gary Sloan, BMO loan officer and senior vice president for commercial, food and agribusiness at BMO Harris Bank from Minneapolis, contacted McMartin. Sloan had been vice president for CoBank from 1999 to 2006, vice president for the St. Paul Bank for Cooperatives from 1988 to 1999, and a Farm Credit Administration examiner before going to BMO.

Sloan pursued large agricultural “credits” for the bank.

He told McMartin that BMO “recognized McM’s potential to further expand its farming operation.” (McM was twice the size of any other cropping farm loan Sloan had managed, although Sloan said he’d managed other “agricultural loans.”)

In spring of 2012, Sloan visited the McM farm to observe potato planting. McMartin said he was “satisfied” with Rabo. Sloan offered a better interest rate. McMartin provided financial statements for 2009, 2010 and 2011.

BMO and McM entered a “Master Loan Agreement,” dated July 31, 2012. BMO extended a $25 million revolving line of credit.

Accrual vs. cash

Mary Jo Richard, a CPA and partner at Fargo-based Eide Bailly, said the difference was “immense.” In July 2012, BMO hired Richard as a “consultant” for McM.

With 33 years of experience with ag clients, Richard quickly determined McM used cash basis accounting. Richard testified she told McMartin that BMO required accrual accounting. Richard wrote a report to BMO, indicating McM’s use of cash basis accounting, indicating that accrual accounting would be put in place in the future.

McMartin said he didn’t remember Richard bringing it up..

McM didn’t change and McMartin never discussed it with his in-house accountant, Heidi Beck.

On May 14, 2013, BMO increased its loan to McM to $31 million, up from $25 million and added $1.5 million for a “hedging line of credit.” Sloan determined McM’s “collateral supported an increased loan amount,” even though a regional senior credit officer, in memo said the “quality of financial information” was a “significant hurdle” for increasing the bank’s “exposure.”

In September 2013, Beck would leave McM but trained in Melissa Gauthier, not trained as an accountant. Gauthier continued to enter expenses as Beck had and as she was told. McMartin didn’t “tell staff how to do their jobs because he assumed they were receiving directions from the accountants.”

Fall from grace

McM had a “fabulous” year in 2012, and a “good” year in 2013, Sloan said.

The farm’s gross income rose to $41.4 million in 2013, with annual profits topping at $3.5 million when commodity prices were high.

But like many in the area, McM suffered net losses of over $4 million in 2014 but remained current. McM lost another $4 million in 2015.

McM had entered into three- and five-year land leases at “inflated” rates. The farm had three headquarters and was well known for being highly competitive for land rent.

On April 30, 2014, BMO increased its loan to $36 million.

In the fall of 2014, BMO urged McM to go to Eide Bailly for accounting. Richard was in charge of the account and McMartin offered full access.

On April 13, 2015, BMO extended another $8 million to McM. That month, BMO assigned the loan to Laurie Mueller, a “senior relationship manager” with BMO’s Special Assets Management Unit, who offers “shadow support” for credits with “financial challenges.” Mueller has 35 years in banking. She had worked in agricultural loans since 1997.

From August to October 2015, McM became tardy on $4 million loan payments. In mid-September, Mueller and the unit took over BMO’s credit management from Sloan.

But somehow, Mueller never verified a change from cash to BMO’s required accrual basis accounting.

In the bankruptcy, McMartin “asserted he would have remembered” if anyone had insisted he go to accrual accounting. It would have been “a major change.”

The last loan

On March 4, 2016, McM asked BMO for a $10 million operating loan to farm 38,000 acres of land. It would be McM’s last year.

Mueller said she relied on his year-end financial statements that showed a net loss of nearly $4.8 million in 2015. Mueller identified “six specific loan covenant violations.” (Mueller said she planned to tell McM to close an account at Ramsey National Bank, primarily used for payroll, and process payroll through BMO.)

Using cash accounting, McM did not indicate about $3 million of debts would carry over and not be paid until March 2016. (McMartin owed CPS over $2 million and had other large debts to Columbia Grain and Johnson Potato Co.)

As of March 9, 2016, McM owed $33 million to the bank. Bank officials weighed whether they would lose more if they didn’t extend 2016 crop credit. On March 21, 2016, McM sent Mueller and Sloan an email, estimating 2016 farm revenue totaling $31.4 million. Of this, nearly $11 million was from red potatoes.

On March 28, 2016, McMartin signed a “compliance certificate,” acknowledging he’d failed on certain loan covenant provisions. Among other things, he’d agreed to have a net worth of no less than $11.5 million and instead had $6.7 million. He was supposed to have had end-year working capital of no less than $3.5 million, and his was a negative of nearly $1.2 million. Real estate lease obligations weren’t to exceed $9.5 million. His were nearly $10.8 million.

Against the clock

As planting neared, McMartin pressed BMO.

McMartin emailed Mueller and Sloan on April 11, 2016, saying landlords were “demanding delinquent land rent payments.” McM could not “in good faith seed crops on land in which rents have not been paid.” He said he didn’t think he would be able to “hold much of this land past this week as landlords are concerned and tired of being pushed back,” McMartin wrote to Mueller.

He needed to purchase fertilizer and seed. He was liquidating “anything I do not need to generate cash.” He was paying “partial rents to keep these folks content.” And, if he lost the acreage, he’d lose “investments of millions of dollars in equipment payments, labor and prepaids.”

“I feel that if something is not done very quickly, I should plan on some sort of liquidation actions,” he wrote. “There is really nothing else I can do but to stop investing in a crop that isn’t going to be planted and inputs that cannot be recovered,” he said.

BMO’s Credit Officer Wood was concerned that if the bank loaned $8 million in 2016, McMartin could spend some of it for the 2017 crop, “without our knowledge and consent.” But BMO approved the loan April 14, 2016, and funded it April 22, 2016. Executives giving the nod included. Edmund Burke, managing director of SAMU, and Nadim Hirji, head of SAMU for Canada and the U.S.

Mueller told Wood she would “closely monitor McM to ensure it spent no funds on prepaid expenses for 2017.”

‘Blood in the water’

Back at McM, Gauthier still “understood” that “some” of the new loan would be used to pay 2015 crop debts that were due in March and April 2016.

And — because BMO had approved $2 million less than budgeted — McMartin cut acres to 29,000 acres, rather than the 38,761 acres planned. Despite the 25% reduction, McMartin “did not advise BMO.”

On May 12, 2016, McM sent its first quarter statements. On May 24, 2016, Mueller sent a notice of default, based on McM’s failing on the six loan covenant failures.

In the spring and summer of 2016, the situation grew more dire. Suppliers filed lien notices, even though McMartin said they had made oral agreements they wouldn’t. By summer, McMartin said the “whole country knew” that McM hadn’t paid land rents on time, and “blood was in the water.”

June 20, 2016, BMO and McM executed the “Fifth Amendment,” with a $1 million extension. BMO required McM to hire a “turnaround consultant” and recommended he contract with Harney Management Partners, a company in Austin, Texas.

Jackson Davis was a CPA who worked independently for Harney. In July 2016, Davis “learned” that McM was not reporting accounts payable on an accrual basis. He reported this to Mueller.

On Aug. 9, 2016, Harney shifted from “advisor to chief restructuring officer” for McM, “responsible for the day-to-day management of McM, among other duties.” Later that month they “resigned.” Davis continued with McM as “interim chief financial officer.”

In September 2016, Martin sold a home and used $389,000 to pay McM expenses. McM hadn’t completed harvest, was delinquent on equipment payments. Suppliers were threatening to repossess equipment.

In November 2016 , McMartin opened a second account at Ramsey National Bank under McM’s name. BMO’s loan agreement didn’t permit this and McMartin didn’t tell them. He deposited beet crop payments from the 2015 beet crops that didn’t include BMO’s name. He used the funds for operating and the harvest that “collateralized BMO’s loan.”

Agweek surprise

Hastings said others were in the dark.

“Specifically, Richard read an article in Agweek in which the author claimed that McM owed $3 million in 2015 crop season payables in 2016,” Judge Hastings wrote.

“On Aug. 17, 2017, (Mueller) called Debtor and asked him why he did not tell her about the 2015 payables but he did not answer. She told him the payables should have been recorded on the YE 2015 financial statements because they related to 2015 crop inputs.”

Six months after the McM bankruptcy filing, Richard said she did not know some 2015 crop bills “were not due until March 2016.”

“When asked why he did not provide this accounts payable information to BMO, (McMartin) stated that BMO never asked for this information,” Hastings wrote.

In a deposition, McMartin explained he didn’t provide accounts payable to BMO because “unsecured debt recorded in accounts payable was not a threat to BMO” and that “McM’s net worth was sufficient to cover its obligations.” Besides, McMartin had “personally guaranteed McM’s debt.”

Hastings said some of McMartin’s dealings “reflected poorly” on his credibility.

At one point, he reported $3.082 million in his 2015 revenue from the potato crop, but it included $500,000 in a loan from Frayne Berg, of McVille, N.D., who he once partnered with on a Medora, N.D., western wear store, and $100,000 from Kenny Johnson, a Walhalla, N.D., businessman and farm landlord. McMartin explained the misrepresentation to Jackson as “the bank wanted to see potato revenue so I showed them potato revenue.”

In January 2019, BMO sued Eide Bailey for breaching its duty to BMO through “negligent acts, misrepresentations and omissions in connection with its work for McM and it failed to plan, review and deliver the final 2015 McM financial statements in accordance with generally Accepted Practices.” In its work with McM, and that it failed to “plan, review and deliver” the final 2015 McM financial statements.