How a Small Business Can Invoke the Power of Involuntary Bankruptcy to Get Paid

Yes, you read that right – a creditor can force a business debtor (and sometimes, a wealthy individual) into bankruptcy under certain circumstances. If a business debtor owes your company money, consider filing an involuntary bankruptcy case on its behalf.

Involuntary bankruptcy

Read on to find out when filing an involuntary bankruptcy petition is advantageous for a creditor, and how to do so.

The Debtor Company Must Have Assets

So your company is owed money, and the debtor has assets. This is the perfect reason to file a Chapter 7 bankruptcy case on behalf of the debtor. What ideally happens next is that the Chapter 7 Trustee will seize and sell the assets of the debtor business for the benefit of that business’ creditors, including you. In this way, the debtor business is forced to liquidate and cease business operations.

If the debtor business does not have significant business assets, or if the debtor has many creditors and it is unlikely that you will be able to recover that debt, filing an involuntary petition might not be the best move to get paid.

When an Involuntary Bankruptcy Filing is Permitted

An involuntary bankruptcy petition must indicate which of two circumstances warrants the filing:

  1. The debtor business is not paying debts as they come due;
  2. Within the last 120 days, the debtor’s property was frozen to enforce a lien.

If the business debtor has more than 12 unsecured creditors, at least three of the creditors must join the petition and those three must have at least $16,750 in unsecured debt (as of January 2020). A single creditor may also file an involuntary petition if that creditor is owed at least $16,750 and there are less than 12 unsecured creditors. If additional creditors are discovered after the case is filed, the bankruptcy court will give those creditors an opportunity to join in the petition.

Creditors’ claims must not be disputed, nor may they be conditioned on some future event.

Involuntary bankruptcy petitions may not be filed against banks, insurance companies, not-for-profits, credit unions, farmers, or family farmers.

The Procedure for Filing an Involuntary Bankruptcy Petition

Once an involuntary bankruptcy petition is filed, the debtor is served with the petition and a summons and has 21 days to respond with an answer, objection, or motion to dismiss.

When a debtor objects to an involuntary bankruptcy petition the court will schedule a hearing to determine whether the bankruptcy should go forward. If the debtor fails to respond within 21 days, the bankruptcy court will issue an order for relief and allow the bankruptcy to go forward.

A bankruptcy judge has the power to dismiss an involuntary case if the bankruptcy does not comply with the aforementioned requirements, and order the filing creditor(s) to pay for the debtor’s costs and fees to defend if the creditor(s) acted in bad faith. Creditors can also be ordered to pay punitive damages to the debtor if the bad faith behavior was particularly egregious. On the other hand, the judge can entertain the debtor’s objection and still order that the case go forward, forcing the business debtor to participate.

A contested involuntary bankruptcy case can involve protracted litigation, including but not limited to:

  • Status conferences;
  • Document and deposition discovery;
  • Motions for summary judgment;
  • Motions to compel the production of evidence or to suppress evidence;
  • Evidentiary hearings;
  • Additional pleadings.

This can be expensive and time-consuming for both the creditor(s) and the debtor.

Petition for bankruptcy

The Differences Between Involuntary and Voluntary Business Bankruptcy

Unlike voluntary bankruptcies, in involuntary bankruptcies:

  • The debtor continues business operations;
  • The debtor can use, acquire, or dispose of business assets freely;
  • The court rarely appoints an interim trustee or imposes other restrictions;
  • The debtor can consent to an involuntary Chapter 7 filing or respond with a voluntary Chapter 11 filing.

Involuntary Bankruptcy is a Rare, but Available, Remedy for Creditors

Only when the potential for collecting debt is great and the risk of having the case dismissed or of protracted litigation small should creditors file an involuntary petition. Often these cases occur when creditors suspect fraud or other criminal activity on the part of the debtor.

In lieu of filing an involuntary bankruptcy petition, a creditor might consider filing a lawsuit in state or federal court, obtaining a money judgment against the debtor, and commencing in collection efforts.

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