A creditor holding an unsecured debt may be able to force his debtor
into bankruptcy, even if the debtor refuses to file bankruptcy on his own behalf. The
process is called an "involuntary bankruptcy" and is covered by Section 303 of
the Bankruptcy Code.
Who can use involuntary bankruptcy?
Not just any creditor can use involuntary bankruptcy. The creditor
must hold an unsecured claim of at least $5,000.00 against the debtor, and the debtor must
have fewer than twelve unsecured creditors. Otherwise, the creditor will have to join with
other creditors to file the lawsuit. In that case, there must be at least three creditors
with unsecured claims totaling at least $5,000.00 against the debtor. Additionally,
involuntary bankruptcy is not permitted against certain debtors. Those exempt from
involuntary bankruptcy proceedings include insurance companies, banking institutions,
farmers and charitable corporations. And while many creditors find the use of involuntary
bankruptcy procedures invaluable, it is helpful to know that the process is further
limited in that it may be used for Chapter 7 (liquidation) and Chapter 11
(rehabilitation), but not Chapter 13 (individuals).
How does involuntary bankruptcy work?
A creditor meeting these prerequisites can file a petition for
involuntary bankruptcy. However, simply filing the lawsuit does not entitle the creditor
to any type of relief as it does in the case of a voluntary bankruptcy. In an involuntary
case, the debtor has the right to file an answer with the court and dispute the
bankruptcy. If the debtor does not timely answer the petition, the court will
automatically grant the relief sought by the creditor. But if the debtor timely answers
the petition, the court will grant the relief requested only if the creditor can show the
court a ground for granting the relief. There are two different grounds a creditor may
show the court to receive involuntary bankruptcy relief. The creditor need only show one
of these two grounds. The first is "equitable insolvency." To show equitable
insolvency, the creditor must show the court that the debtor is generally not paying his
debts as they come due. The second possible ground is that of receivership. Here, the
creditor must show the court that a receiver, assignee, or custodian took possession of
substantially all of the debtor's property, or was appointed to take charge of
substantially all of the debtor's property, within 120 days of the creditor filing his
involuntary bankruptcy petition. The term "substantially all" is very strictly
adhered to by the courts. For example, the appointment of a receiver to take possession of
a debtor's building (as in a mortgage foreclosure action) would not be a basis for
involuntary relief, because less than substantially all of the debtor's property would be
involved.
How quickly can I get an involuntary
bankruptcy order of relief?
There is normally an interval of at least several weeks between the
creditor's filing of an involuntary petition and the order of relief against the debtor.
During this period, the debtor may continue to buy, use or sell property and operate his
business unless the court has stated otherwise. Sometimes, the court may appoint an
interim trustee to take possession of the debtor's property or operate the debtor's
business if it finds this a necessary measure to preserve the property during this interim
period. If an interim trustee is appointed, the debtor may regain possession of his
property by posting a bond.
Why not use this against all my debtors?
A creditor must contemplate the possibility of involuntary
bankruptcy very carefully. Because the filing of an involuntary petition could severely
and adversely affect the debtor's financial reputation and business operations, the courts
take the filing of groundless petitions very carefully. If your petition for involuntary
bankruptcy is dismissed by the court, the court may award you to pay the debtor's costs
and reasonable attorney's fees for defending the suit. Additionally, if an interim trustee
took possession of the debtor's property, the court may grant judgment for "any
damages proximately caused by the taking." And if the court finds that your petition
for involuntary bankruptcy was filed "in bad faith," the court may award the
debtor his actual damages caused by your filing as well as punitive damages.
Polk & Associates
February 1997