What is Involuntary Bankruptcy?

Mary McMahon
Mary McMahon

Involuntary bankruptcy is a bankruptcy which is initiated by creditors, rather than the debtor. This situation is rare, for a number of reasons, and most commonly occurs in the business world. If a petition for involuntary bankruptcy is granted, the bankruptcy proceeds through court in exactly the same way as it does when a debtor initiates bankruptcy proceedings. Creditors generally only take this measure as a last resort because they can be penalized if the petition is denied by the court.

Creditors rather than a debtor initiate an involuntary bankruptcy case.
Creditors rather than a debtor initiate an involuntary bankruptcy case.

Creditors may opt to file against a debtor if they believe that they may suffer losses unless bankruptcy proceedings commence immediately, as for example if a company appears to be in the process of distributing its assets so that there will be nothing to collect. The creditor or creditors who file the petition must be able to demonstrate that the debtor is routinely not paying debts and is unable to do so. Simply missing a single utility payment, for example, is not grounds for involuntary bankruptcy.

If fewer than 12 creditors are involved, one creditor alone can file against a debtor. More than 12 creditors, and the case must be filed by at least three of the creditors filing jointly. The judge will hear the involuntary bankruptcy petition and determine whether or not to grant it. If it is granted, the court begins bankruptcy proceedings. The business may be liquidated, in which case it will be broken apart and all remaining assets will be used to settle debts. It can also be reorganized.

There are some restrictions on creditors who attempt to initiate involuntary bankruptcy proceedings against their debtors. If someone has already sued to recover debt and the debtor is appealing the judgment, for example, that person cannot file an involuntary bankruptcy petition. Likewise, creditors must be owed a certain amount of money for the petition to proceed in most regions, which is designed to prevent situations in which people are forced into bankruptcy by trivial debts.

For creditors, once notice is received that in involuntary bankruptcy petition has been filed, it is advisable to retain a lawyer if this has not been done already. If the petition is denied, the creditors may be forced to pay the debtor's attorney fees and they can possibly be obliged to pay compensation as well. Having a lawyer active in the beginning can increase the chances of successfully fighting the petition and recovering damages.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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