Bankruptcy doesn’t just help those in debt—it protects creditors, too. One of the powers given to creditors is the ability to force an unwilling debtor into involuntary bankruptcy.
Involuntary bankruptcies don’t occur frequently, and creditors usually bring them against a business organization rather than an individual. Creditors follow a procedure that includes filing a bankruptcy action on behalf of the person or company that owes the money.
Creditors Target Assets for Involuntary Bankruptcy
Creditors want to get paid and forcing the bankruptcy of a person or business without any assets can be a bad move.
So it shouldn’t come as a surprise that the focus of involuntary bankruptcy will likely be either on:
• a business with assets or, in more unusual cases,
• a wealthy individual.
When an individual or business doesn’t own much, a creditor is better off trying to grab all of whatever money and property might be available outside of the rules of bankruptcy. Once a debtor is in bankruptcy, the automatic stay—an order prohibiting collection activities—stops creditors from attempting to collect the debt on their own, leaving the creditor to share whatever gets recovered by the bankruptcy trustee appointed to the case.
How Involuntary Bankruptcy Works
An involuntary bankruptcy starts when one or more creditors file a petition with the bankruptcy court. A creditor can file an involuntary bankruptcy case under Chapter 7 or Chapter 11. Cases under Chapter 13 and Chapter 12 cases aren’t permitted.
The bankruptcy petition must indicate which of two circumstances justifies the involuntary bankruptcy:
• the debtor isn’t paying debts as they come due, or
• within the last 120 days, a custodian, receiver, or agent took control of the debtor’s property to enforce a lien.
Once filed, the debtor can respond to the petition. If the debtor fails to do so, the court will allow the matter to move forward, and the debtor will have to participate in the bankruptcy. If the debtor responds, the court will set a hearing and decide whether the bankruptcy should go forward. A judge who finds in favor of the debtor will dismiss the case. The judge might also require a filing creditor to pay the debtor’s costs and fees.
(You can find the official forms for involuntary petitions (individual and non-individual) on the Utah Court’s bankruptcy form page.)
Involuntary Bankruptcy Limitations
Most involuntary bankruptcies are a collaboration between several creditors. In fact, if the debtor has more than 12 unsecured creditors, at least three of these creditors must join the petition, and the three must have, altogether, at least $15,775 in unsecured debt outstanding from the debtor.
A solitary creditor can only file an involuntary petition if that creditor is owed at least $15,775 (as of April 2016) and if the debtor has fewer than 12 unsecured creditors total. The creditors’ claims for debt cannot be disputed, and they cannot be contingent—that is, the amount of the debt must be known and not conditioned on some future event, such as a lawsuit judgment.
Involuntary bankruptcies can’t be filed against banks, insurance companies, not-for-profit organizations, credit unions, farmers, or family farmers.
How Involuntary Bankruptcy Works
Not all entities can be put into an involuntary case. Involuntary bankruptcy is off limits if the borrower is a bank, insurance company, not-for-profit organization, credit union, farmer, family farmer, municipality, or other government unit. The majority of involuntary cases are filed against business borrowers. Involuntary cases against individuals are rare.
Unless the individual is well off and has lots of unprotected assets, an involuntary bankruptcy won’t be worthwhile. Involuntary bankruptcies against businesses are much more likely to bring satisfaction to creditors because businesses cannot exempt property.
Creditors with “standing” can file an involuntary bankruptcy. To have standing, the creditor’s debt must meet certain criteria:
• The debt cannot be contingent as to liability. In other words, there are no conditions that must be met before the borrower will be liable on the debt. For instance, the debt could be contingent if it’s based on a guarantee that is not yet activated.
• The debt is not subject to a bona fide dispute as to the debt’s validity or existence.
How Many Creditors Are Necessary?
If the borrower has 12 or fewer creditors, the involuntary petition can be filed by one creditor with a debt of at least $16,750. The creditor cannot be an employer, insider, or the transferee of an avoidable transfer. If the borrower has more than 12 creditors, three creditors with an aggregate of $16,750 in debt can file the petition. If the borrower is a partnership, there are additional criteria for bringing the involuntary action.
Can the Borrower Oppose the Involuntary Petition?
The borrower can oppose the petition. Once the creditors have filed, the borrower has 20 days to respond. The borrower will often attack the creditors’ standing to bring the petition, claim that the debts are subject to dispute or would otherwise not be eligible, attempt to bring evidence that they are paying their debts, or that the petition was brought in bad faith.
Borrowers can also choose to convert the petition from an involuntary case to a voluntary one, or negotiate with the creditors to allow the case to move forward as a Chapter 11 reorganization if the creditors filed it as a Chapter 7.
Alternatives to Involuntary Bankruptcy
Borrowers can choose to convert the petition from an involuntary case to a voluntary one, or negotiate with the creditors to allow the case to move forward as a Chapter 11 reorganization if the creditors filed it as a Chapter 7. The bankruptcy court can find that the involuntary case was not properly brought and can dismiss it. The court has the authority to enter a judgment against the petitioning creditors for the borrower’s costs and attorney’s fees. If the court finds that the filing was made in bad faith, it can also award compensatory or even punitive damages.
Requirements for Involuntary Bankruptcy
Involuntary bankruptcy can only be filed under Chapters 7 or 11 of the Bankruptcy Code. Involuntary bankruptcy is not available under Chapter 12 which pertains to family farmers or family fishermen with regular income, or under Chapter 13, which is available to individuals with regular income and often characterized as a “wage earner’s plan.” Involuntary bankruptcies cannot be filed against banks, insurance companies, not-for-profit organizations, credit unions, farmers, or family farmers.
A petitioning creditor is qualified to file an involuntary petition if they hold a claim against the debtor that is not contingent as to liability or the subject of a bona fide dispute regarding the liability or its amount, according to the Bankruptcy Code. The debt must be at least $16,750 and the creditor must demonstrate that the debtor is generally not paying debts as they become due.
If the debtor has fewer than 12 qualifying creditors, an involuntary petition can be filed by a single qualifying creditor. If a debtor has 12 or more creditors, at least three creditors must join an involuntary petition.
A debtor has 21 days to respond to a filing before bankruptcy proceedings can start. If they fail to respond or if the bankruptcy court rules in favor of the creditors an order for relief is entered and the debtor is placed into bankruptcy.1 Debtors also have the option to convert a petition from an involuntary case to a voluntary case.
When a Creditor Forces You Into Bankruptcy Involuntarily
If this happens to you, you have options.
Contest the Involuntary Bankruptcy
You’ll start by checking that the creditors filed the involuntary bankruptcy properly. Here are the requirements:
• An involuntary petition must be a Chapter 7 bankruptcy filed against an individual or corporation, not a married couple or a family farmer or fisherman.
• The petitioning creditors must have debt claims that meet the current threshold of approximately $15,000 to $20,000.
• Only one creditor is needed to start the process if the debtor has less than twelve unsecured creditors. Otherwise, three or more unsecured creditors must agree to file an involuntary action.
You’ll likely want to object to the filing if it doesn’t satisfy all of the requirements, but you’ll probably need a bankruptcy lawyer to do this. A bankruptcy lawyer will also explain the likelihood of success and whether you have other reasons to contest the involuntary filing.
Creditors often do worse in bankruptcy than if they pursued their debts outside of bankruptcy which is why it’s rare for creditors to file an involuntary bankruptcy. So if you’re struggling to pay your bills, a Chapter 7 bankruptcy might not be a bad option. The automatic stay will prevent creditors from collecting outside of the bankruptcy action. If you’re an individual, you’ll likely be able to protect at least some property using bankruptcy exemptions.
But Chapter 7 works differently for individuals and businesses, so if a company is involved, you’ll want to explore the effects of Chapter 7 bankruptcy on small businesses. And keep in mind that small businesses other than sole proprietors aren’t entitled to a Chapter 7 debt discharge. If you personally guaranteed business debts, your assets might be at risk.
Convert the Involuntary Chapter 7 Bankruptcy to Chapter 13 Bankruptcy
Chapter 13 works well for people who want to keep property they’d lose in Chapter 7 bankruptcy. If you’re an individual or sole proprietor, you can convert to Chapter 13 if you think it would be a better choice. But you’ll need enough income to support a Chapter 13 repayment plan. And this chapter isn’t available to businesses other than sole proprietors. If you are a sole proprietor, be sure to review the differences between Chapters 13 and 11.
Voluntary bankruptcy occurs when someone petitions the court to declare bankruptcy. This is different from involuntary bankruptcy, wherein a creditor or a group of creditors petition a court to declare bankruptcy on a debtor due to their inability to pay.
A person can declare voluntary bankruptcy in two different ways: Chapter 7 and Chapter 13 of the Bankruptcy Code. Chapter 7 bankruptcy discharges all or almost all of your debt by liquidating your assets to repay your outstanding debt. If you don’t have a lot of assets, Chapter 7 is a relatively quick process, taking a few months from start to finish. Chapter 13 bankruptcy, on the other hand, doesn’t completely discharge your debt, but it does restructure it. The restructuring process could take many years to complete.
The Process of Filing for Voluntary Bankruptcy
Before a person can file for bankruptcy, they’ll need to receive credit counseling within 180 days prior to submitting a petition. This gives the bankruptcy court a chance to review your finances and see if you’ve exhausted all your options before getting a fresh start.
Once a person files for bankruptcy both with Chapter 7 and Chapter 13—they’ll need to prove to a court that they don’t have the means to pay their outstanding debt. To do so, they must provide:
• Proof of current income
• Proof of current expenses
• Outstanding assets, debt, and liabilities
• Recent tax returns
• Certificate of credit counseling
• Statement of financial affairs
Once a voluntary bankruptcy is filed, most debt collection will stop due to an automatic stay until the bankruptcy process is complete. At this point, the bankruptcy court or designated trustee will appoint an impartial case trustee to administer the case. Under Chapter 7, the debtor can keep certain exempt assets, but the trustee then liquidates the remaining assets. In this case, the trustee will sell (or liquidate) the debtor’s property, if applicable, to pay off the qualifying debt.
While Chapter 7 liquidates, Chapter 13 rearranges, as previously noted. With Chapter 13, people who own assets like a home or car won’t lose their belongings. But the process takes much longer to complete and there are debt restrictions. For instance, unsecured debts must be less than $394,725 and secured debts need to be less than $1,184,200. These limits are changed periodically to reflect adjustments in the consumer price index.
A Chapter 13 filing requires a person (or, in the case of a small business, a sole proprietorship) to outline their own repayment plan. Even if a plan hasn’t been approved, debtors are required to start making payments to the trustee within a month of filing for a Chapter 13 voluntary bankruptcy. All creditors need to agree to the plan ahead of time. When payments are made, they either go through the individual or through payroll deductions to make sure payments are on time.
The process is complete when a discharge releases a debtor from personal liability for most of their debt. That means creditors can’t go after people who have had a successful bankruptcy discharge, although this varies based on each person’s individual bankruptcy discharge.
Note that there are some cases where a discharge is denied. Because the scope of Chapter 13 bankruptcy is so complex, debtors should seek legal counsel before reaching that point of the process.
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