What Is Involuntary Bankruptcy? Explained: How It Works, Types, and Examples
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Summary:
Involuntary bankruptcy is a legal process where creditors can request a person or business to go into bankruptcy if they believe they won’t be paid. This is often used when a debtor can pay but chooses not to. Involuntary bankruptcy is relatively rare, and it can only be filed under Chapters 7 or 11 of the Bankruptcy Code. Creditors must meet specific requirements to initiate this process, and debtors have a chance to respond before bankruptcy proceedings begin.
What is involuntary bankruptcy?
Involuntary bankruptcy is a legal process through which creditors request that a person or business be compelled to declare bankruptcy. It’s typically employed when creditors believe they won’t receive payment unless bankruptcy proceedings are initiated. The debtor, in this case, is usually capable of paying their debts but refuses to do so for various reasons.
For involuntary bankruptcy to be pursued, the debtor must have a certain amount of serious unpaid debt, and creditors must meet specific legal requirements to force them into bankruptcy.
How involuntary bankruptcy works
Involuntary bankruptcy is a relatively uncommon form of bankruptcy and differs significantly from voluntary bankruptcy. In a voluntary bankruptcy, the debtor initiates the process by filing a petition with the courts. This offers individuals and businesses a chance to find relief by reorganizing or forgiving debts that are impossible to repay. Creditors may also recover some of their claims based on the debtor’s available assets.
However, in the case of involuntary bankruptcy, it is the creditors who initiate the process. They must petition the court to start the proceedings, and the debtor has the option to file an objection to contest the case. A petitioning creditor, as defined by Title 11 of the U.S. Bankruptcy Code, can initiate this process by filing an involuntary petition against an individual or business. The decision to proceed or dismiss the case lies with the bankruptcy court.
Involuntary bankruptcies are more commonly filed against businesses, especially when creditors believe the business can pay its debts but is refusing to do so. They are less common against individuals, primarily because individuals often have fewer recoverable assets.
Requirements for involuntary bankruptcy
Involuntary bankruptcy can only be filed under Chapters 7 or 11 of the Bankruptcy Code. It is not available under Chapter 12, which pertains to family farmers or family fishermen with regular income, or under Chapter 13, known as a “wage earner’s plan” for individuals with regular income.
Additionally, involuntary bankruptcies cannot be filed against specific entities, including banks, insurance companies, not-for-profit organizations, credit unions, farmers, or family farmers.
A petitioning creditor must meet specific qualifications to file an involuntary petition. They must hold a claim against the debtor that is not contingent and does not involve a bona fide dispute about liability or the amount owed, as stated in the Bankruptcy Code. The debt must be at least a certain amount (as of April 2022), and the creditor must demonstrate that the debtor is generally not paying their debts on time.
If the debtor has fewer than 12 qualifying creditors, a single qualifying creditor can file an involuntary petition. However, if there are 12 or more creditors, at least three creditors must join the petition. The debtor has 21 days to respond to this filing before bankruptcy proceedings can commence.
If the debtor fails to respond or the bankruptcy court rules in favor of the creditors, an order for relief is issued, and the debtor is placed into bankruptcy. Debtors also have the option to convert an involuntary case into a voluntary one.
Frequently asked questions
What is the main objective of involuntary bankruptcy?
The main objective of involuntary bankruptcy is to provide creditors with a legal recourse to recover debts they are owed, especially when the debtor is capable of paying but refuses to do so.
Can an individual file for involuntary bankruptcy?
While involuntary bankruptcy is more commonly used against businesses, it can also be filed against individuals if they meet the criteria and have the required number of creditors backing the petition.
What happens if the debtor doesn’t respond to the involuntary petition?
If the debtor fails to respond to the involuntary petition or if the court rules in favor of the creditors, an order for relief is issued, and the debtor is placed into bankruptcy.
What Is the Main Objective of Involuntary Bankruptcy?
The main objective of involuntary bankruptcy is to provide creditors with a legal recourse to recover debts they are owed, especially when the debtor is capable of paying but refuses to do so.
Can an Individual File for Involuntary Bankruptcy?
While involuntary bankruptcy is more commonly used against businesses, it can also be filed against individuals if they meet the criteria and have the required number of creditors backing the petition.
What Happens if the Debtor Doesn’t Respond to the Involuntary Petition?
If the debtor fails to respond to the involuntary petition or if the court rules in favor of the creditors, an order for relief is issued, and the debtor is placed into bankruptcy.
Key takeaways
- Involuntary bankruptcy is a legal process initiated by creditors to force a debtor into bankruptcy.
- Creditors must meet specific legal requirements to initiate involuntary bankruptcy.
- It is a relatively rare form of bankruptcy, more commonly used against businesses than individuals.
- Debtors have a chance to respond to the filing before bankruptcy proceedings begin.
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