Involuntary Bankruptcy Requirements

Posted on Sunday, December 19, 2010

Requirements of an Involuntary Petition

The legal requirements for filing an involuntary bankruptcy petition are straight-forward and outlined in Section 303(b) of U.S. Title 11:

1. The creditors filing the petition must have total outstanding, unsecured debt of at least $13,475. Where there are 12 or more total creditors, three must participate in the involuntary petition. Where there are fewer than 12 creditors, a single creditor may file. The rules regarding partnerships are somewhat different (see Section 303(b)(3) of the Bankruptcy Code).

2. The debts must not be contingent or involve bona fide disputes.

For the court to find in favor of the creditors (order relief against the debtor), it must find that:

1. the debtor is not generally paying its debts as they become due; and

2. the creditor’s petition was made in good faith.

Benefits of Filing an Involuntary Petition

A primary benefit of forcing an involuntary bankruptcy is the ability to recover avoidable preferential transfers, as well as insider and fraudulent transfers, back into the debtor’s estate. The filing of the involuntary bankruptcy stops the clock, allowing the avoidance of:

· insider transfers made within 2 years prior to filing.

· fraudulent transfers made within 1 year prior to filing under the federal Code, but up to 4 years under Chapter 726 of the Florida Statutes.

· non-insider preferences made within 90 days prior to filing.

Another benefit is that the bankruptcy provides the opportunity for the automatic appointment of a Chapter 7 Trustee, or, for cause, the appointment of a Chapter 11 Trustee. Thus focusing attention on the conduct of the debtor – whether it be illegal or inadequate. A secondary benefit, if the petition is accepted by the bankruptcy court, is that Everbank can submit an administrative claim for “actual, necessary expenses” incurred up to the time of the order for relief. These expenses include attorney’s and accountant’s fees and costs, legal fees and costs for preparation and filing of the petition, time involved in contacting other creditors to join the filing, and any litigation directly related to the petition. Administrative claims receive first priority under U.S. bankruptcy law and, thus, are paid before any other claims.

Risks to a Bank for Filing an Involuntary Case

Involuntary bankruptcies are not common because they can be difficult and risky for the filing creditors. The debtor can resist the involuntary petition by filing, within 20 days, an opposition that disputes the issues of whether or not it is paying its debts as they become due, and/or that the debts are subject to a bona fide dispute.

The court may, for cause, require Everbank to file a bond to indemnify the debtor for potential damages. If the Court rules in the debtor’s favor, dismissing the involuntary petition, Everbank may be subject to:

1. A judgment for costs and attorneys’ fees incurred by the debtor.

2. Punitive damages if the Court feels the action was not brought in good faith.

The Bank has the burden of proving whether the debtor is not paying debts as they come due, and therefore, should conduct careful due diligence. The fact that a few creditors are not being paid is not enough to satisfy the requirement. To make a determination, courts have used factors such as the amount of debts that are long overdue, the age of the past-due accounts, and the debtor’s liquidity. “Generally not paying” means that the debtor is regularly missing a significant number of payments that are significant in relation to the debtor’s overall financial situation.

In the case of bona fide disputes (whether liability or amount), if the debtor can allege any legitimate defense, whether the defense has any merit or not, the bankruptcy court can disqualify the claim. The purpose of involuntary bankruptcy is to prevent unfair practices against creditors as a group. Therefore, if the Court determines that the petition was filed to favor specific creditors, or for reasons of malice or harassment, or as a substitute for state-law remedies, it will dismiss the petition.

Until an order for relief is filed by the bankruptcy court, the debtor can continue to operate as if an involuntary petition had never been filed. The Bankruptcy Code does contain provisions whereby a trustee can be appointed on an interim basis. However, the Bank will have to prove “gross mismanagement”, which is difficult. In addition, the involuntary case may result in further barriers to collecting the debt as the filing triggers the “automatic stay,”
which precludes creditors from taking any other course of action to collect.

Bottom line is that involuntary bankruptcy cases are very risky for the petitioning creditor. Feel free to call me directly with any questions.

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