Can Creditors Force a Business into Involuntary Bankruptcy?

Despite your best efforts, you may someday find that your business is unable to pay debt in a timely manner. One solution is to declare bankruptcy, a legal proceeding in a federal court that releases your company from the obligation to pay some or all of the debt owed. Bankruptcy can provide something of a fresh start for your business, but it is not a perfect solution. A history of bankruptcy can affect your business's credit rating, which will make it difficult to obtain credit in the future. In some cases, your business may be forced out of existence when the proceedings finally end.

There are two ways that your business can become the target of an involuntary bankruptcy. The first arises when your company is simply not paying up (aside from any disputed arrears). This includes regularly missing a significant number of payments or regularly missing sizable payments. The second is if a custodian was appointed or took possession of your company property within 120 days before the petition was filed. Involuntary bankruptcy can be initiated only under Chapter 7 or Chapter 11 of the Bankruptcy Code. Creditors begin an involuntary bankruptcy case by filing a petition and a summons with the clerk of the U.S. Bankruptcy Court. You'll have 20 days to file objections. If that happens, the case can go to trial. If not, the bankruptcy proceeds.

Most commercial bankruptcies are voluntary, but they can also occur when creditors band together and try to force the debtor company into bankruptcy. A minimum number of creditors and amount of debt are required for an involuntary bankruptcy. If creditors attempt to force a business into bankruptcy for invalid reasons, and the court agrees with the debtor that the attempt was without merit, creditors may be liable for the debtor's costs and attorney fees, and they may also face stiff fines.

According to the Bankruptcy Code, one creditor can file a petition for involuntary bankruptcy against a debtor with less than 12 creditors. If there are more than 12 creditors, any three can file the petition. However, it is difficult for creditors to get petitions granted. The only creditors eligible to file a petition against a debtor are those with final judgments that are not in the process of being appealed.

The fact that a debtor is not paying one or two creditors does not warrant involuntary bankruptcy. Creditors must be able to prove that the business is habitually not paying its debts. The technique of one creditor aggressively soliciting others to cosponsor a petition for involuntary bankruptcy as a means of collection will result in denial by most courts. These petitions are seen by the courts as a serious remedy to be used only in the most extreme cases. Examples of legitimate use of this procedure are to ensure fair distribution of assets among a large group of creditors, and/or to prevent a debtor from dissolving or dispersing their assets for the purpose of avoiding payment.

As the debtor, you have the right to contest any involuntary bankruptcy filing. If you choose to contest the bankruptcy, the court will look at whether your business is paying its debts as they become due and whether you have assigned a property for the benefit of creditors, or agreed to the appointment of a receiver to take charge of your property. The involuntary petition in itself merely alleges that you, the debtor, should be in bankruptcy.

The petition will not curtail your ability to deal with your assets any way you see fit, until and unless a bankruptcy court determines that you are in fact "bankrupt" and enters what is known as an "order for relief." Only in highly unusual circumstances, usually involving accusations of dishonesty, is a trustee appointed to take over the debtor's business affairs prior to these legal proceedings. A normal bankruptcy case begins only if and when there is a court order for relief, issued by the judge.