The vast majority of bankruptcy filings are “voluntary”, in the sense that the process is initiated by the debtor with the filing of a petition, accompanying schedules and forms, and if applicable, a Chapter 11, 12, or 13 plan or reorganization.  There are, however, a small minority of “involuntary” bankruptcy filings, in which the process is initiated by a creditor or creditors of a debtor.  The major requirements can be found in 11 U.S.C. Section 303, or Section 303 of the Bankruptcy Code.  In an involuntary filing, a petition is filed in court, in which the court is basically asked if the individual or corporation can be put into bankruptcy.

First, there are some rules regarding the number of creditors.  The Bankruptcy Code (Section 303) specifies the minimum number of creditors and amount of their claims.  If a company has 12 or more creditors, an involuntary bankruptcy petition requires (a) three or more creditors whose claims are not contingent as to liability or subject to a bona fide dispute as to either liability or amount to file the petition, and (b) those qualifying claims must total, in the aggregate, at least $10,000 if unsecured or $10,000 more than the value of any liens securing those claims if any are secured.  If the company has fewer than 12 creditors, it only takes one qualifying creditor to file an involuntary petition.

Additional creditors can join the petition later,  If only one creditor files and it turns out that the company has more than 12 creditors, the bankruptcy court will give other creditors an opportunity to join.  If the company timely objects to the involuntary filing, for the company to be placed in bankruptcy, the company or person also must:  (1)  generally not be paying its debts as they become due unless those debts are subject to a bona fide dispute as to liability or amount, or (2) have had a custodian appointed within the past 120 days to take possession or control of substantially all of its assets.

In the involuntary petition, the petitioning creditors must state on the petition which chapter (Chapter 7 or Chapter 11) they wish to force the person or company to into.  These two chapters are the only ones available for involuntary cases.  In other words, you can’t have an involuntary Chapter 13 or Chapter 12 case.

There are some big differences between involuntary and voluntary cases.  In an involuntary case, the automatic stay does begin when the petition is filed, just as in a voluntary case.  But there are some major differences between the two types of scenarios after that.  In an involuntary case:

1.  After an involuntary petition is filed (Chapter 7 or 11), a company can still continue to operate its business until the court has actually ruled that the company should be in bankruptcy.  The petition is served together with a summons.  The involuntary petition is more like a request to a court asking that the company or person be declared to be bankrupt.  So, due process here is an issue.

2.  In an involuntary case, a trustee is not automatically appointed.  It can be sought by motion, but the court may not grant this request.

3.  The debtor has the power to respond to the involuntary petition and propose counter-remedies.  For example, in an involuntary Chapter 7 filing, the debtor could respond with its own Chapter 11 filing and resume control over the company or personal affairs as a debtor in possession.

4.  A debtor has the power to contest an involuntary petition, usually by means of an answer or motion to dismiss (or both) and must do so within required time limits (21 days after service of the summons, under the Federal Rules of Bankruptcy Procedure).

5.  In an involuntary case, there is normally a significant amount of litigation right in the beginning to determine whether the proper requirements of an involuntary case have been met.  Companies and persons do not usually like to be “forced” into bankruptcy court by the filing of an involuntary petition.  If the bankruptcy court finds in favor of the petitioning creditors, an order of relief is entered and the debtor is “placed” into bankruptcy.  And at that point, the provisions of the Bankruptcy Code governing debtors and creditors will come into play.

Involuntary petitions are also rare because there can be unpleasant consequences to creditors who frivolously attempt to put an entity or person into bankruptcy case without a very good reason.  A debtor who has been hit with an involuntary petition without good reason is not going to take kindly to this type of extreme collection activity.  Consider the following:

1.  An involuntary petition cannot be dismissed once filed without a notice and opportunity for hearing, even if all parties agree.

2.  If an involuntary petition is dismissed, the creditors who brought the action can be liable for the debtor’s fees and costs.

3.  If the bankruptcy court determines that the petition against the debtor was filed frivolously or in bad faith, the creditors who initiated the action can be liable for damages, and in some situations, even punitive damages.

It is clear from the foregoing that involuntary cases are very different from the standard bankruptcy process.  The possibility that creditors can be found liable for damages and costs for vindictive filings means that few creditors are willing to take the plunge into this “nuclear option” in the debt collection world.  In addition, it may be that the prospect of financial recovery for creditors is outweighed by the difficulties of litigation or the likelihood of finding assets.  But involuntary cases do happen.  Sometimes, an unusual circumstance or event can make it worthwhile for a creditor or creditors to go forward with it.

They seem to most often happen in situations where some sort of fraud, malfeasance, or significant hiding of assets may have taken place, or situations where some sort of Ponzi scheme has been discovered by creditors.  We have also seen it in situations where large amounts of equity exist in commercial or residential real estate that cannot be tapped into by aggressive judgment creditors.  In most situations, aggressive collection activity by creditors individually or in concert will be enough to force a debtor to simply file a case on his own.  If you have questions with this area of the law, you need an experienced bankruptcy attorney.

Read More:  Debts From Ponzi Schemes:  Dischargeable In Bankruptcy?