Involuntary Bankruptcies
Los Angeles has recently seen a spate of involuntary bankruptcies. What is an involuntary bankruptcy? An involuntary bankruptcy is a bankruptcy filed not by the debtor, but by the debtor’s creditors. Thus the “involuntary” bankruptcy.
There are certain circumstances which must exist for a creditor or group of creditors to be allowed to put their debtor into bankruptcy. First, these petitioning creditors must have claims which are both (a) not contingent as to liability, and (b) not subject to a bona fide dispute as to liability or amount. Also, if the debtor has 12 or more such creditors, then at least 3 of the creditors must sign the bankruptcy petition. However, if the debtor has fewer than 12 such creditors, then only one of them is required to sign the petition. This process attempts to ensure that only legitimate creditors holding claims that are certain can put a debtor into bankruptcy.
In addition to the bankruptcy petition having to be signed by the requisite number of eligible creditors, a further requirement is that the debtor must generally not be paying his debts as they become due. The purpose of this is to create yet another safeguard against an overzealous creditor, as the fact that a particular creditor is not being paid is insufficient to allow an involuntary bankruptcy to be filed if the debtor is generally paying creditors. Presumably, the unpaid creditor already has other remedies, which include suing the debtor in state court, obtaining a judgment, and collecting on the judgment.
Why would a creditor want to put a debtor into an involuntary bankruptcy? We already learned in a prior blog that the bankruptcy filing creates an automatic stay of collection actions; for this reason, creditors generally do not want to see a bankruptcy. The answer is that an involuntary bankruptcy can be useful in certain circumstances. One such circumstance is where a creditor believes that assets are being depleted by the debtor and that by the time a judgment is obtained, the debtor will have no assets from which to collect. A bankruptcy can freeze the status quo and stop the debtor from secreting assets.
After an involuntary bankruptcy is filed, the debtor has an opportunity to oppose the petition. Filing an improper involuntary bankruptcy can result in punitive damages against the petitioning creditors. Therefore, while it is a useful tool for creditors under the right facts, creditors must use caution and be certain that they can meet the requirements for putting a debtor into bankruptcy before filing.
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