Involuntary Bankruptcy Collections

Involuntary Bankruptcy as Economical and Efficient Collection Tool
Most companies seeking to collect on receivables or judgments utilize traditional methods to collect – calls/letters/lawsuits/judgment/postjudment collection – but have not considered involuntary bankruptcy as a collection strategy.

If liability is not really the issue and the account debtor is merely using litigation to forestall the inevitable –an involuntary bankruptcy action is an excellent option to collect the amounts due. If you are not being paid because of financial problems of the account debtor, odds are that they are not paying their other vendors as well. A well-organized involuntary bankruptcy filing by the creditors can reshift the focus from useless litigation over liability to solving the account debtor’s problems so that you can be paid.

Involuntary Bankruptcy Overview

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 $14,425.00 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 $14,425.00 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.

*Culhane Meadows is ranked by U.S. News/Best Law Firms in Technology Law, Bankruptcy/Reorganization Law, and Information Technology Law. This website and the communications herein may be considered attorney advertising. Previous results are not a guarantee of future outcome. This website is for informational purposes only and does not constitute legal advice. The information herein is not intended to create an attorney-client or similar relationship. Until you establish such a relationship and receive an engagement letter, you have not hired a Culhane Meadows attorney nor become a client of the firm. Whether you are a new or existing client of the firm, Culhane Meadows must determine that there is no conflict of interest and that it is willing and otherwise able to accept the new engagement before representing you on a new matter. Only if and after Culhane Meadows has informed you it is willing and able to accept your new matter should you send the firm any information or documents that you consider private or confidential. Such information will not be treated as private, confidential or otherwise protected from disclosure until Culhane Meadows has communicated in writing that it is willing and able to accept your new matter and provide you with legal counsel. Whether you need legal services and which lawyer or law firm you select are important decisions that should not be based on this website alone.