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Understanding Involuntary Bankruptcy: A Guide for Debtors and Creditors
Bankruptcy is often used by both individuals and businesses to “wipe the slate clean” and get out from often crippling amounts of debt. Most bankruptcies filed are done so voluntarily by the debtor. In certain circumstances, however, it may be necessary for creditors to take legal action and file for bankruptcy on behalf of a debtor. This is known as an involuntary bankruptcy.
What is Involuntary Bankruptcy?
Involuntary bankruptcy is a legal process by which creditors can file a bankruptcy petition against a debtor who owes the creditor money. This is typically initiated when creditors have determined that the debtor is unable to meet their financial obligations in repaying the debts to the creditors, and bankruptcy is the best option to recover those debts.
Unlike voluntary bankruptcies, where debtors can file for themselves to liquidate or reorganize, involuntary bankruptcies are entirely initiated by creditors. The bankruptcy code requires specific criteria and procedures that ensure fairness to all parties and protects the rights of both the debtor and creditors. Involuntary bankruptcies can only be commenced under Chapter 7 or Chapter 11.
Requirements for Filing Involuntary Bankruptcy
Under the Bankruptcy Code, certain criteria must be met to allow a creditor to file an involuntary bankruptcy against a potential debtor. These requirements primarily revolve around the number of creditors and the amounts of to those creditors by the debtor.
For an involuntary bankruptcy to be initiated, certain requirements must be met, including the following:
- The debtor must be able to be a debtor under whichever chapter of bankruptcy the creditor is attempting to force the debtor into.
- The case must be a Chapter 7 or Chapter 11.
- The debtor must have debts that, in the aggregate, amount to at least $18,600.
There are some other applicable requirements. The potential creditor must show that the debtor is not paying debts as they are due, and that a custodian, receiver, or agent took control of the debtor’s property with a lien within the last 120 days.
If a debtor has more than 12 unsecured creditors, at least three of them must join the petition. Additionally, those three creditors must have at least a combined $15,775.00 combined in unsecured outstanding debt.
If an individual debtor is trying to file an involuntary bankruptcy, that creditor must be owed at least $15,775.00. Additionally, in this scenario, the debtor must have fewer than 12 unsecured creditors in this scenario. The amount of debt must be known at the time of the filing, and cannot be conditioned on a future event, such as a lawsuit.
Process of Filing Involuntary Bankruptcy
The first step in an involuntary bankruptcy is the creditor filing the formal petition with the bankruptcy court where the debtor resides or operates their business. The petition must include specific information about the debtor, the debt, and the reasons for seeking involuntary bankruptcy. It also must enumerate the requirements stated above.
Next, once the bankruptcy is filed the debtor will be notified of the involuntary bankruptcy filing. The debtor could respond to and contest the petition if they believe it to be unjustified.
Finally, the bankruptcy court will assess the case to determine its validity. The court will essentially determine that the case was not filed in bad faith, and that the proper documents and claims were filed by the debtor. At this point, the court will evaluate the petition to ensure the above requirements are met. This is when the debtor may oppose the actual bankruptcy.
One drawback to keep in mind is these proceedings cannot be brought against certain types of businesses. This includes banks, insurance companies, non-profit organizations, farmers, family farmers, or credit unions.
What happens if a creditor files an involuntary bankruptcy against you? In cases like this, the Debtor is recommended to hire an attorney and respond to the filing. There are various reasons a debtor can get an involuntary case dismissed such as:
- The bankruptcy wasn’t filed in good faith. You are convinced that the true purpose for filing the involuntary bankruptcy is to close your business and not to force liquidation of your assets so you can make debt repayment.
- If you do send money to pay your debts, then that’s good material for your defense, especially if the creditor has no proof of cessation of payments to counter your evidence of debt payments.
- The creditor who filed involuntary bankruptcy against you is not qualified to do so. An experienced bankruptcy lawyer can review the bankruptcy case and determine if the creditor is qualified or not to file for involuntary bankruptcy.
It is heavily suggested that a debtor seek legal help in filing their response. If the debtor fails to respond, the court will continue on with the case without the participation of the debtor.
A Warning to Creditors
Creditors should be aware, there is a major caveat to the above test. If the bankruptcy court dismisses an involuntary petition after it determines that it was filed in bad faith, the court may impose sanctions on the petitioning creditors. This includes damages proximately caused by the filing, such as attorney’s fees, and even punitive damage. A creditor should only file for involuntary bankruptcy against a debtor when they are sure they will meet the threshold.
An involuntary bankruptcy is meant for an individual creditor to recoup their losses, even if substantial and legitimate. Courts have been very consistent in finding that an involuntary bankruptcy should be a last resort, when multiple creditors have exhausted all other avenues of collection. Additionally, a third party who steps in to defend the debtor will not be able to request the debtor be awarded costs, reasonable attorneys’ fees, or damages.
As always, it cannot be overstated how necessary an experienced bankruptcy attorney can be in a situation like the one described above. Scura, Wigfield, Heyer, Stevens & Cammarota, LLP, can be your complete bankruptcy law firm. We serve individuals and owners of privately held corporations throughout eastern New Jersey and the New York City metro region.
I have a passion for what I do. There are few things I enjoy more than helping good people and viable businesses find solutions to overwhelming debt.
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