Involuntary Petitions – Forcing a Deadbeat into Bankruptcy
The ultimate step in creditor collection brinkmanship is the decision to start an involuntary bankruptcy petition against a debtor. There are myriad reasons to commence an involuntary petition against a debtor. For example, the involuntary may be used as a last resort after all other efforts to obtain payment have been exhausted or appear useless; or, the involuntary may be used as an emergency measure to invoke the powers of the Bankruptcy Code to prevent precious funds and other assets from disappearing into the pockets of insiders and/or other preferred creditors.
The basic requirements of the Bankruptcy Code for filing an involuntary petition are rather simple, although it must be kept in mind that each new case presents different facts and other special issues and considerations. Legal counsel must be enlisted in each case to assess the issues and prepare the petition, if appropriate. The most common ground for an involuntary petition is that the debtor is generally not paying its debts as they come due, although debts which are subject to bona fide dispute (as to liability or amount) are not counted in the assessment of the debtor’s payment default. However, the debtor cannot simply claim that the unpaid debts are disputed, but must show real issues concerning the enforceability of the claim. Another basis for an involuntary petition is that substantially all of the assets of the debtor have been placed in the control of a custodian (i.e. a receiver for an assignment for the “benefit” of creditors).
If the debtor has fewer than 12 creditors, an involuntary petition may be commenced by only one creditor, so long as the creditor is owed at least $18,6001 and the claim is not contingent or the subject of a bona fide dispute (as to liability or amount) with the debtor. If the creditor’s claim totals say $3,000.00, then the creditor must seek out another creditor to join in the petition so that the aggregate claims of the petitioning creditors are at least $18,600. If the debtor has 12 or more creditors, an involuntary petition must be filed jointly by three or more creditors with aggregate claims of $18,600.
If the debtor does not timely answer the petition, then the Bankruptcy Court may enter an order for relief for the Chapter 7 liquidation. As an alternative to contesting the petition, the debtor may choose to voluntarily convert the case to a Chapter 11 reorganization. If the debtor contests the petition, the debtor will seek to attack the eligibility of the petitioning creditors (i.e. whether there are sufficient numbers of petitioning creditors or whether the claims are disputed) and the grounds for the involuntary (i.e. whether the debtor is generally not paying its debts).
A delicate issue can arise for a lone creditor who is pretty sure the debtor has more than 12 creditors, but the creditor does not know who they are and the debtor won’t share its list of creditors. Does the creditor stand by while all of the accounts receivable proceeds go to insiders? Or, does the creditor file the involuntary petition alone? If the debtor contests the petition and the Bankruptcy Court dismisses the petition for failure to have the required number of petitioning creditors, then the Bankruptcy Court could assess the debtor’s costs and attorneys’ fees in defending the petition against the creditor. Worse yet, if the Court finds that the creditor filed the petition in bad faith, the Court could grant judgment against the creditor for any damages proximately caused by the filing of the petition, or for punitive damages. Courts have bent the rules a bit where creditors made reasonable efforts to locate other creditors and where the creditors were seeking to preserve preference claims and fraudulent transfer actions for the benefit of all creditors. Also, courts have allowed additional eligible creditors to come on board to join the petition after it is filed so as to retroactively fulfill the three-creditor requirement.
An involuntary petition can be an effective means to provide a supervised forum to scrutinize the debtor’s pre-petition transactions and the orderly liquidation of the assets. The involuntary petition can be prepared and filed very quickly and when used in the correct circumstances can catch substantial assets for the benefit of all creditors.
For more information on this article or other bankruptcy related matters, please contact KMK Attorneys Samuel C. Wisotzkey (swisotzkey@kmksc.com), or Attorney Eric R. von Helms (evonhelms@kmksc.com). Both can be reached at (414) 962-5110.
[1] All of the figures stated in this paragraph have been updated effective 4/1/22. See Doc. 2022-02299, published 2-04-22, and available here. The Numbers are adjusted with the Consumer Price Index (CPI) every 3 years, and are next scheduled to adjust on 4/1/2025.
About KMK
At Kohner, Mann & Kailas, S.C. (KMK), the attorneys in the Business & Financial Services group are prepared to provide coordinated legal counsel across a wide array of creditors’ rights activities. KMK is a value-driven law firm, combining the resources necessary to serve the complex needs of its Fortune 500 clients with the personal care and superior customer service expected by all its clients. Founded in Milwaukee in 1937, KMK has successfully developed a local, national, and international reputation for legal excellence, continually recognized by U.S. News & World Report as one of the nation’s Best Law Firms. For more information, visit www.kmksc.com.