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Involuntary Bankruptcy - Who, What, When?

There are two ways to commence a bankruptcy case: filing or either a voluntary or involuntary petition.  An involuntary bankruptcy is commenced by filing an Involuntary Petition against the debtor.  See Fed. R. Bankr. P. Form 5.  Involuntary bankruptcy is limited to chapter 7 and 11 cases.  11 U.S.C. §303(a).  An involuntary petition may be filed against a debtor by three unsecured creditors holding claims in an aggregate of $13,475.00 (As adjusted under 11 U.S.C. §104 effective April 11, 2007) of non-contingent, non-disputed claims against the debtor.  11 U.S.C. § 303(b)(1).  If there are fewer than 12 creditors of the debtor holding claims against the debtor - excluding employees, insiders, or recipients of fraudulent transfers or preferences - then the involuntary petition may be filed by one or more creditors who hold $13,475.00 or more in claims.  11 U.S.C. § 303(b)(2).  Note, however, that partnerships have a special means of invoking involuntary bankruptcy cases.  Generally, fewer than all general partners can only file an involuntary petition or if all general partners have filed a single general partner or its trustee may file the partnership bankruptcy.  11 U.S.C. § 303(b)(3).

In an involuntary case, the “petitioning creditor(s)” must allege and prove: (a) the debtor is not generally paying its debts as they become due (unless the debts are the subject of a bona fide dispute); or (b) within 120 days before the filing of the involuntary petition, a custodian, receiver, or the like was appointed or authorized to take possession of less than substantially all of the property of the debtor for the purpose of enforcing a lien against the property.   11 U.S.C. § 303(h).

As with proofs of claim, there is an Official Form for filing an involuntary petition.  See Official Form 5.  The fees for filing a voluntary petition are the same for filing an involuntary petition - $299.00 for a chapter 7 and $1039.00 for chapter 11.  Also, remember, like proofs of claim, involuntary petitions are made under oath subject to criminal penalties.

Only a qualified creditor may participate in the filing of an involuntary petition.  Further, the number of qualified creditors of the debtor will determine whether 3 or 1 creditor may file the involuntary petition.  A fully secured creditor - e.g., a judgment creditor whose claim passes preference muster - may participate in the filing of an involuntary petition.  The fully secured creditor may be a petitioning creditor without waiving any portion of its security if the other petitioning creditors’ claims exceed by $13,475.00 the value of any lien as provided in section 303(b)(1). Paradise Hotel Corp. v. Bank of Nova Scotia, 842 F.2d 47, 49-50 (3rd Cir. 1988); In re Crabtree, 32 B.R. 837, 839 (Bankr. E.D. Tenn. 1983).

The filing of an involuntary petition is like commencing a lawsuit against the “alleged” debtor.  The petition must be served on the debtor, Fed. R. Bankr. P. 1010, and the debtor may file an answer to the petition within 20 days following service. 11 U.S.C. § 303(d); Fed. R. Bankr. P. 1011(b).  If no answer is filed, the bankruptcy court is directed to enter an order for relief on the next day or as soon thereafter as practicable.  Fed. R. Bankr. P. 1013(b).  If an answer is filed, the bankruptcy court is directed to determine the issues “at the earliest practicable time and forthwith enter an order for relief.” Fed. R. Bankr. P. 1013(a).

After notice and a hearing, the court may require the petitioning creditors to file a bond “to indemnify the debtor for such amounts as the court may later allow under subsection (i) of this section.” 11 U.S.C.  § 303(e).  And, until an order for relief is entered (i.e., the debtor is adjudicated bankrupt) the debtor may continue to operate its business affairs, including the right “to use, acquire, or dispose of property as if an involuntary case concerning the debtor had not been commenced.” 11 U.S.C. § 303(f).

Sarah Grace Chastain