What Is Involuntary Bankruptcy?

Definition & Examples of Involuntary Bankruptcy

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Involuntary bankruptcy is a tool creditors use to deal with unreliable borrowers by forcing them to file for bankruptcy as allowed by law.

What Is Involuntary Bankruptcy?

Involuntary bankruptcies are sought by creditors unwilling to wait for borrowers to make the decision to file for bankruptcy on their own. They may be faced with a borrower who is squandering assets or isn’t paying their debts as they come due, but has assets that could be used to satisfy those debts.

The vast majority of bankruptcy cases are filed by people and entities voluntarily, meaning that the individual or company suffering financial difficulty will make the decision to file a bankruptcy case and will initiate the case by filing a voluntary petition with the bankruptcy court.

Faced with a borrower who should be in bankruptcy but refuses or otherwise fails to take action on their own, creditors can use this tool to force the borrower into either a Chapter 7 straight bankruptcy or a Chapter 11 reorganization bankruptcy.

Other types of bankruptcy are not available. Involuntary bankruptcies are authorized under the U.S. bankruptcy code.

How Involuntary Bankruptcy Works

Not all entities can be put into an involuntary case. Involuntary bankruptcy is off limits if the borrower is a bank, insurance company, not-for-profit organization, credit union, farmer, family farmer, municipality, or other government unit.

The majority of involuntary cases are filed against business borrowers. Involuntary cases against individuals are rare.

Individuals can claim exemptions to protect at least some of their assets and keep those assets out of the hands of the creditors in a bankruptcy case.

Unless the individual is well off and has lots of unprotected assets, an involuntary bankruptcy won't be worthwhile. Involuntary bankruptcies against businesses are much more likely to bring satisfaction to creditors because businesses cannot exempt property.

Creditors with “standing” can file an involuntary bankruptcy. To have standing, the creditor’s debt must meet certain criteria:

  • The debt cannot be contingent as to liability. In other words, there are no conditions that must be met before the borrower will be liable on the debt. For instance, the debt could be contingent if it’s based on a guarantee that is not yet activated.
  • The debt is not subject to a bona fide dispute as to the debt’s validity or existence.

How Many Creditors Are Necessary?

If the borrower has 12 or fewer creditors, the involuntary petition can be filed by one creditor with a debt of at least $16,750 (as of April 2019). The creditor cannot be an employer, insider, or the transferee of an avoidable transfer.

If the borrower has more than 12 creditors, three creditors with an aggregate of $16,750 in debt (as of April 2019) can file the petition. If the borrower is a partnership, there are additional criteria for bringing the involuntary action. 

Can the Borrower Oppose the Involuntary Petition?

The borrower can oppose the petition. Once the creditors have filed, the borrower has 20 days to respond. The borrower will often attack the creditors’ standing to bring the petition, claim that the debts are subject to dispute or would otherwise not be eligible, attempt to bring evidence that they are paying their debts, or that the petition was brought in bad faith.

It is up to the bankruptcy judge to decide whether to allow the involuntary petition and whether the case will move forward under Chapter 7 or Chapter 11. If the case goes forward, the borrower is bound by it.

Borrowers can also choose to convert the petition from an involuntary case to a voluntary one, or negotiate with the creditors to allow the case to move forward as a Chapter 11 reorganization if the creditors filed it as a Chapter 7. 

Alternatives to Involuntary Bankruptcy

Borrowers can choose to convert the petition from an involuntary case to a voluntary one, or negotiate with the creditors to allow the case to move forward as a Chapter 11 reorganization if the creditors filed it as a Chapter 7. 

The bankruptcy court can find that the involuntary case was not properly brought and can dismiss it. The court has the authority to enter a judgment against the petitioning creditors for the borrower’s costs and attorney’s fees. If the court finds that the filing was made in bad faith, it can also award compensatory or even punitive damages.

Key Takeaways

  • Involuntary bankruptcy is a tool creditors can use to force action against a borrower who is not paying their debts.
  • The tool allows for a Chapter 7 straight bankruptcy or Chapter 11 reorganization.
  • A judge can determine that the filing is invalid and penalize the creditor.
  • The majority of borrowers file voluntary bankruptcy when faced with insurmountable debts.

Article Sources

  1. Cornell Law School. "11 U.S. Code § 303. Involuntary Cases." Accessed Sept. 22, 2020.

  2. U.S. Code. "Adjustment of Dollar Amounts." Accessed Sept. 22, 2020.