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What is involuntary bankruptcy?

What is involuntary bankruptcy?

In some cases, creditors can force involuntary bankruptcy on debtors

People who are trying to avoid bankruptcy, but have substantial debts owed to several creditors, may find that deciding to file has been taken out of their hands. In a court action called involuntary bankruptcy, the petition for relief in U.S. Bankruptcy Court can be made by the individual's creditors.

However, the United States Bankruptcy Code places several significant limits on those who choose to force involuntary bankruptcy on individuals and small businesses in order to recoup at least a portion of their losses.

According to federal bankruptcy law, a single creditor may file a case only if the debtor has fewer than 12 creditors. If there are more than a dozen, at least three of them must work together in filing an involuntary case. In addition, $14,425 must be owed in unsecured claims.

Such proceedings can only be filed under Chapter 7, a liquidation process in which an individual's non-exempt property can be sold to pay creditors, and Chapter 11, to allow small businesses to reorganize their debts while continuing to operate.

Typically, people who are self-employed or have personally guaranteed business debts are the ones most often affected by involuntary cases. Small businesses that agree to participate in a Chapter 11 action must make monthly payments to creditors while the business is maintained.

"Creditors may chose this rather aggressive option because it forces a debtor to confront all his creditors at once, instead of forking over money only to those who press the hardest," writes Michigan attorney Drew Broaddus for the National Bankruptcy Forum. "Additionally, involuntary proceedings keep a debtor from draining all his assets before finally giving up and filing bankruptcy."

Charging unfair practices

Involuntary bankruptcy actions generally are filed when creditors suspect - and can prove - that debtors are squandering their assets instead of paying bills or that they are guilty of unfair practices. These include making fraudulent transfers of property or not paying bills as they come due because preferential payments are being made to one creditor at the expense of others.

At the same time, the court will dismiss an involuntary action if there is reason to believe that the case was filed to benefit certain creditors, as a harassment tactic against a debtor or to avoid filing the claim under state law. In such cases, debtors may be able to recover damages if they can prove that creditors filed their case in bad faith.

Because of the adversarial nature of an involuntary case, individuals who are forced into them often resist the filing. But trying to obstruct the case may mean that debtors will lose more assets than if they cooperate in court.

Particularly in Chapter 7 involuntary bankruptcy, people must take advantage of exemptions they are allowed to claim against some of their property or all of it could be sold to pay creditors. As with other Chapter 7 cases, creditors will only be paid with the amount earned in the sale of the debtor's property and the balances that remain will be discharged by the court.

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