Involuntary Bankruptcy

Bankruptcy doesn't just help those in debt. It protects creditors, too. One of the powers given to creditors is the ability to force unwilling debtors into bankruptcy against their will in what's known as an involuntary bankruptcy.

Involuntary bankruptcies don't occur often, and creditors usually bring them against business organizations rather than individuals. The involuntary bankruptcy process begins when creditors follow the procedure for filing a bankruptcy action on behalf of the person or company owing money. You can start with the basics of business bankruptcies by reading Small Business Bankruptcy.

Creditors Target Debtors With Assets for Involuntary Bankruptcy

It shouldn't be surprising that creditors file involuntary bankruptcies against companies and individuals with assets, carefully investigating the potential bankruptcy target's finances before initiating an involuntary bankruptcy. The reasoning makes sense.

Creditors want to get paid, and forcing an involuntary bankruptcy on a person or business without sufficient assets to pay all creditors involved would be a poor move, resulting in additional lost revenues. Learn when someone might be personally liable for business debts.

Creditors Avoid Involuntary Bankruptcy When a Debtor Has Limited Assets

The strategy is different when an individual or business doesn't own much. When there isn't enough to go around, a creditor is better off grabbing whatever money and property is available outside of bankruptcy.

In this situation, creditors who act quickly understand that once bankruptcy is initiated, the automatic stay order prohibiting collection activities will stop creditors from collecting the debt independently. The creditors must share whatever gets recovered by the bankruptcy trustee appointed to the case.

However, creditors who recover assets before bankruptcy might have to return the funds after a bankruptcy filing. Learn about the trustee's "clawback" power in bankruptcy.

What Happens If a Creditor Files an Involuntary Bankruptcy Petition Against an Individual or Company With Limited Assets?

A creditor should consider the practical effects of an involuntary bankruptcy when the available assets might not adequately repay the creditor's debt, the most salient issue being the ability to collect the debt after bankruptcy.

Depending on the debt and chapter type, the bankruptcy will likely cut off the creditor's future ability to collect. However, some exceptions exist.

• Nondischargeable debts. Debts based on fraud and other criteria will survive the bankruptcy. However, the creditor might need to initiate litigation to have the court declare the debt nondischargeable.
• Debts owed by a company. Businesses aren't entitled to a debt discharge in bankruptcy, so collection after bankruptcy might be possible if the company continues to exist or emerges as another company engaging in essentially the same business (a debtor can't avoid an obligation by changing business names). However, selling company assets in bankruptcy typically liquidates the business, effectively closing it and shutting off the ability to collect later.

Learn when an individual can discharge personal liability for business debt.

How Involuntary Bankruptcy Works

An involuntary bankruptcy starts when one or more creditors file a petition with the bankruptcy court. A creditor can file an involuntary bankruptcy case under Chapter 7 or Chapter 11. Cases under Chapter 13 and Chapter 12 cases aren't permitted.

The bankruptcy petition must indicate which of two circumstances justifies the involuntary bankruptcy:

• the debtor isn't paying debts as they come due, or
• within 120 days, a custodian, receiver, or agent took control of the debtor's property to enforce a lien.

Once filed, the debtor can respond to the petition. If the debtor fails to do so, the court will allow the matter to move forward, and the debtor will have to participate in the bankruptcy.

If the debtor responds, the court will set a hearing and decide whether the bankruptcy should go forward. A judge who finds in favor of the debtor will dismiss the case. The judge might also require a filing creditor to pay the debtor's costs and fees.

The official individual and non-individual involuntary petition forms are on the U.S. Court's bankruptcy form page.

Involuntary Bankruptcy Limitations

Most involuntary bankruptcies are a collaboration between several creditors. If the debtor has more than 12 unsecured creditors, at least three of these creditors must join the petition. The three must collectively have at least $18,600 in unsecured debt outstanding from the debtor (effective from April 1, 2022, through March 31, 2025).

A solitary creditor can only file an involuntary petition if owed at least $18,600 and if the debtor has fewer than 12 unsecured creditors total (effective from April 1, 2022, through March 31, 2025). Also, the creditors' claims for debt cannot be disputed or contingent. The debt amount must be known and not conditioned on some future event, such as a lawsuit judgment.

Involuntary bankruptcies can't be filed against banks, insurance companies, not-for-profit organizations, credit unions, farmers, or family farmers.

Consult a Business Bankruptcy Lawyer

Involuntary bankruptcy cases can be complicated and fraught with litigation. Anyone facing or considering initiating an involuntary bankruptcy should meet with a qualified business bankruptcy lawyer.

Need More Bankruptcy Help?

Did you know Nolo has made the law easy for over fifty years? It's true, and we want to ensure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.

Updated October 10, 2023