Many business owners are shocked to find out that they could be forced into filing involuntary bankruptcy under certain conditions. True, only a relatively small portion of business bankruptcies fall under the involuntary category, but business owners should be aware of the potential risks to their company. A creditor of your business—if they meet all applicable criteria—can file a petition to start the bankruptcy process whether you are in agreement or not. There are specific factors which apply in these involuntary bankruptcies such as the fact that three creditors are needed to initiate an involuntary bankruptcy when the business debtor has twelve or more creditors. In the case of twelve or less creditors one creditor can initiate the involuntary bankruptcy proceedings. Employees of the company or those with claims who have an interest in not seeing the business go bankrupt are not considered in the total creditor count.
Types of Involuntary Bankruptcy
Involuntary bankruptcy can only be initiated under Chapter 7 or Chapter 11 bankruptcy proceedings. In the case of a Chapter 7 involuntary bankruptcy—also known as liquidation—the business will be required to close, all assets will be liquidated and creditors will be paid to the extent possible. Chapter 11 bankruptcy will allow the business owner to keep his or her business operating, however a reorganization plan will be implemented and all creditors will be paid from the proceeds of the normal business activities.
Cases of involuntary bankruptcy are almost always reserved for businesses, although technically the principle can apply to individuals as well. There are certain exemptions in implementation of involuntary bankruptcy including farming or ranching businesses, banks, non-profit groups, insurance companies, credit unions or savings and loans and railroads. A farmer is generally considered any individual who received more than 80% of their income from a farming or ranching operation owned by the individual. Farming or ranching operations can include but are not limited to tilling of dry soil, dairy farming, the raising of crops, poultry or livestock and other generally accepted farming or ranching activities.
No matter whether an involuntary bankruptcy is started by one creditor or many, it falls to the creditors to prove the debtor owes a minimum of $14,425 in unsecured debt—meaning there is no physical collateral which secures the debt. The claims for the debt must not be in dispute, meaning there must be no disagreements regarding the validity of the debt and there cannot be a lawsuit regarding such a dispute. Involuntary bankruptcy is generally considered a measure of last resort when a business debtor refuses to pay legitimate debts or if the business is in receivership.
Risks to Creditors in an Involuntary Bankruptcy
The goal of the involuntary bankruptcy is to force the business to address debts to all creditors equally, giving preference to no single creditor. The creditor may also be attempting to preserve the business assets before the debt situation worsens and the business owner files bankruptcy on their own. The factors involved are the relative amounts owed, the number of debts which are unpaid and the nature of the business in question. Involuntary bankruptcy is hardly an absolute way of getting paid since the business owner can object or may claim bad faith in the petition. The court could potentially award the business owner monetary damages as well as attorney fees should bad faith on the part of the creditor be proven. A business owner who has received notice that one or more creditors are attempting to force them into involuntary bankruptcy should immediately seek the services of a qualified bankruptcy attorney. Such a bankruptcy may not be in the best interests of the business and legal guidance is definitely recommended before the debtor proceeds.