Involuntary Bankruptcy

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 What Is Bankruptcy?

Bankruptcy doesn’t only help those who are in debt – it protects creditors. One of the powers given to creditors is to force an unwilling debtor into involuntary bankruptcy.

Bankruptcy offers an individual or business an opportunity to start fresh by forgiving debts that cannot be paid. It also offers creditors an opportunity to obtain some measure of repayment based on the assets of the debtor,, which are available for liquidation (sale) in the bankruptcy process.

Once a debtor is in bankruptcy, there is an automatic stay on their obligation to repay their debts. The automatic stay is a court order prohibiting collection activities. It prevents creditors from attempting to collect the debt on their own. The law does not want that to happen because if one creditor gets paid ahead of time, something unfair occurs – it leaves fewer assets to be divided up among the other creditors.

What Is Involuntary Bankruptcy?

Involuntary bankruptcy is a proceeding through which creditors request (or force) an individual or business to go into bankruptcy, even if the individual or business does not want to declare bankruptcy. Creditors want to get at least part of their money back, so they want the debtor’s finances scrutinized in bankruptcy court so that the debtor’s assets remain as plentiful as possible.

Every bankruptcy petition is run by a trustee (an administrator appointed by the court). The trustee is mandated to investigate the debtor’s affairs, collect and liquidate the debtor’s property, and distribute the proceeds to the creditors.

If prior to the bankruptcy the debtor engaged in actions that were intended to deplete the assets so that the creditors couldn’t get them, the trustee will invoke the Bankruptcy Code’s “strong arm” powers to sue and recover the property. The recovery of pre-bankruptcy transfers is often the predominant focus of involuntary bankruptcy proceedings.

Creditors who feel that they will not be paid if bankruptcy proceedings are not entered into can request an involuntary bankruptcy, which will legally force the debtor to pay back as much as possible. This will happen because the bankruptcy trustee (the administrator, who the court appoints) has the power to take money out of the debtor’s banking and investment accounts and to sell some or all of the debtor’s assets so that the creditor can be repaid.

Involuntary bankruptcies are largely filed against businesses when the creditor believes the business can pay but refuses to do so. Because most individuals in debt have few recoverable assets, involuntary bankruptcies against individuals are rare. Also, individuals can claim exemptions to protect at least some of their assets and keep those assets out of the hands of creditors in a bankruptcy case. It is generally not worth the creditor’s time, money, or effort to force an individual into bankruptcy.

What Are the Laws Regarding Involuntary Bankruptcy?

Involuntary bankruptcies are governed by Title 11 of the United States Code, also known as the Bankruptcy Code. A creditor can commence an involuntary bankruptcy by filing an appropriate petition. The petition itself describes the requirements that the creditor has to satisfy.

A creditor cannot file an involuntary bankruptcy under Chapter 12 or Chapter 13 of the Bankruptcy Code; it can only be filed against an individual or business under Chapter 7 and Chapter 11.

A debtor has 21 days to respond to a filing before the bankruptcy proceedings can begin. If the debtor fails to respond to the petition for involuntary bankruptcy, or if at the end of the bankruptcy proceedings, the bankruptcy court rules in favor of the creditors, then an order of relief is entered by the court, and the debtor is placed into bankruptcy.

A petition for involuntary bankruptcy filed by a creditor has to meet the following conditions:

  • It holds a claim against the debtor that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount. In other words, there is no real dispute about the fact that the debtor owes the money and about how much the debt is
  • The debt in question equals at least $16 750 (as of March 2022)
  • The petition states that the debtor is generally not paying debts as they become due
  • There are 12 or fewer unsecured creditors. If there are more than 12 creditors, then at least 3 of them have to file a joint petition for involuntary bankruptcy

Once the debtor responds to the petition for involuntary bankruptcy, the court will set a hearing and decide whether or not the bankruptcy should go forward. A judge who finds in favor of the debtor will dismiss the case and may also require a filing creditor to pay the debtor’s costs and fees.

If the debtor and a creditor reach a deal, they must inform the court and get its blessing. The court may dismiss the petition only after giving notice to all creditors, including those who did not join in filing the petition. Those other creditors can oppose dismissal if they prefer to see the bankruptcy case move forward.

What Are the Options for Debtors if Someone Files for Involuntary Bankruptcy Against Them?

Debtors can oppose the petition for involuntary bankruptcy. A debtor may often challenge the creditor’s standing to bring the petition, claiming that whether the debt is owed and how much it is worth is disputed or otherwise, it is not eligible for involuntary bankruptcy. They can attempt to bring evidence that they are paying their debts so bankruptcy is not needed.

They can also assert that the petition was not brought in good faith – if the creditor fails to reasonably investigate the debtor’s affairs prior to filing the bankruptcy, that can constitute “bad faith,” and the judge will deny the creditor’s petition. There will be no bankruptcy.

The bankruptcy judge will have an expedited trial to determine whether to allow the involuntary petition to go forward based on the arguments of both sides. Debtors can also choose to convert the petition from an involuntary to a voluntary one, or the debtor can negotiate with the creditors to change the petition from a Chapter 7 case (a liquidation) to a Chapter 11 (reorganization) case.

The difference is that in a Chapter 11 bankruptcy, the debtor is allowed to reorganize rather than shut down. The business will be able to keep more assets than in a Chapter 7 bankruptcy, allowing them to restructure their debts to become profitable again.

What Are the Limitations of Involuntary Bankruptcy?

As mentioned, involuntary bankruptcies are primarily filed against businesses that have assets available for liquidation in the bankruptcy proceedings. It is uncommon for involuntary bankruptcies to be filed against individuals unless they are wealthy and have a lot of property not exempt from capture by the creditor under bankruptcy laws.

Creditors cannot pursue an involuntary bankruptcy under any circumstances against farmers or certain types of organizations, such as non-profits, credit unions, insurers, and banks

Should I Contact a Lawyer If I am Facing an Involuntary Bankruptcy?

Bankruptcy laws can be complex, and involuntary bankruptcies can be declared against businesses and certain individuals who are not paying their creditors.

If you are facing an involuntary bankruptcy, it is important to consult an experienced bankruptcy attorney who can help you understand your rights and the process. An experienced attorney will try to get your creditors to reduce your liability and help you hold on to as much property as possible.

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