Involuntary Bankruptcy Explained

In this article, we explain involuntary bankruptcy, discuss how the involuntary bankruptcy process works, the petitioning process, and the limitations on involuntary bankruptcy.

Involuntary bankruptcy is a legal process by which creditors can “force” an individual or business to enter into bankruptcy. The creditor must petition the courts to initiate the bankruptcy proceedings and the indebted party can file an objection to force a case. Having this option gives creditors some degree of protection against individuals or businesses who may otherwise take advantage of the business.

It’s rare that a business will petition for involuntary bankruptcy against an individual because the effort of getting enough money from one person versus the assets of a business is low, but it does still happen. The creditor may feel they won’t get any money out of the indebted party unless forcing them to enter into bankruptcy proceedings, and so the creditor must seek legal grounds in order to collect on the debt. Involuntary bankruptcy can’t be brought forward against an individual or business for any amount of money, the indebted party must have a significant amount of unmet debt. The amount of debt warranting a petition of involuntary bankruptcy is dependent on whether the debtor is an individual or business.

Understanding the Involuntary Bankruptcy Process

Involuntary bankruptcy is different from traditional bankruptcy where an individual or business is either unable to pay their debt at all due to poor cash flow, or debt continues to accumulate at a rate that is impossible to reverse due to the debtor’s financial situation. Traditional bankruptcy, such as Chapter 7 or Chapter 13, allows the individual to wipe the debt slate clean while giving creditors the opportunity to collect on some portion of the debt. Often, involuntary bankruptcy is brought against a business because the creditor feels the business is able to pay its debt but refuses, or has enough assets to liquidate that would satisfy the debt. 

Ultimately, creditors want to get paid, so forcing bankruptcy onto an individual or small fledgling company can be a bad move, tying the creditor’s legal resources up in a process that likely won’t net them much reimbursement. This is why involuntary bankruptcy is usually only brought forward against a business with assets, or in some cases a wealthy individual. If it’s determined the business or individual doesn’t own much or has limited income/cashflow than the creditor is better off collecting what it can outside of bankruptcy. Once bankruptcy is initiated the automatic stay—a legal order prohibiting creditors from collecting debts on their own—goes into effect and the creditor can only collect their share discovered through the bankruptcy proceedings.

‍

The Involuntary Bankruptcy Petitioning Process

The first step, and the start of the involuntary bankruptcy process, is when the creditor files a petition with the bankruptcy court. The petition lays out the requirements to be satisfied by the creditor and indicates whether the creditor is seeking Chapter 7 or Chapter 11 bankruptcy. Chapter 12 and Chapter 13 bankruptcy are not options under involuntary bankruptcy. The petition must list the reason for initiating the involuntary bankruptcy, such as:

• The debtor has failed over whatever period of time to pay debts as they come due;
• Another entity took control of the debtor’s property to force a lien; or
• The creditor holds a claim against the debtor that is not contingent as to liability and is in the amount of $16,750 or more
  

After the creditor has filed the involuntary bankruptcy petition the debtor can file their response to the petition. If the debtor fails to respond the bankruptcy will proceed, however in most involuntary bankruptcy situations the debtor will file an objection to the petition to force the bankruptcy into a formal case.

Depending on the number of qualifying creditors, the involuntary bankruptcy petition can be brought against the debtor by one creditor (less than 12 creditors) or a minimum of 3 creditors in agreement (more than 12 creditors).

If the debtor responds to the petition there will be a hearing and the court will decide if the bankruptcy moves forward. The judge presiding over the case will either rule in favor of the debtor, dismissing the bankruptcy and sometimes ordering the creditor to pay for the debtor’s costs and fees, or ruling in favor of the creditor, allowing the involuntary bankruptcy to proceed.

Involuntary Bankruptcy Limitations

The debtor has 21 days to respond to the involuntary bankruptcy petition; failing to respond will result in the bankruptcy proceedings moving forward where an order of relief is entered and the debtor is placed into whatever bankruptcy was indicated by the creditor, or that which the court deems appropriate. 

Creditors cannot petition for involuntary bankruptcy under Chapter 12 or Chapter 13 bankruptcy, and their claim cannot be based on an unknown amount of debt or future event, such as the ruling on a lawsuit or some other case. 

Certain businesses exempt from involuntary bankruptcies include banks, insurance companies, not-for-profit organizations, credit unions, and farmers.

If you feel you’re business has a legitimate claim for involuntary bankruptcy against an individual or another company or you’re the target of an involuntary bankruptcy claim, don’t hesitate to give us a call at 630-324-6666 and speak with one of our qualified bankruptcy attorneys.