Filing for bankruptcy is always a tough decision. Your credit is ruined and you're often put out of business. The decision can be even tougher when a company is contemplating bankruptcy because of the livelihood of more than just one person or family. Even when it is clear that bankruptcy is a company's best way forward, management may attempt to keep the sinking ship afloat. In these circumstances, the company's creditors may consider filing an involuntary bankruptcy petition.
Types of Bankruptcy
There are two types of bankruptcy for individuals: a liquidation or a repayment plan. In a Chapter 7 liquidation, the debtor gets to keep property that is exempt from bankruptcy, but the rest of his property, if any, is sold to pay off debts. In contrast, under a Chapter 13 plan, the bankruptcy court reduces the amount of debt owed, and the debtor pays off the reduced amount over a period of three to five years. Companies may file for liquidation under Chapter 7 or for reorganization under Chapter 11, which is the business version of a Chapter 13. The bankruptcy code also includes an alternative -- involuntary bankruptcy -- when a failing business refuses to seek liquidation or reorganization. This permits company creditors to force the debtor into bankruptcy.
The Forced Option
The bankruptcy code has specific requirements for involuntary bankruptcy petitions. If a company has fewer than 12 creditors, a single creditor can force a company into bankruptcy. If the company has at least 12 creditors, at least three creditors must join in the bankruptcy petition. Regardless of whether one or three creditors file suit, the company must owe at least $15,325 collectively in unsecured debt, meaning debt that is not secured by a lien. The bankruptcy petitioners must specify whether they are trying to force the company into a Chapter 7 liquidation or a Chapter 11 reorganization plan. If the company objects to the bankruptcy filing, the creditors must prove that the company is not paying its bills on time, or alternatively, that the company must have given up most of its assets to a custodian within the past 120 days. If the creditors don't prove one of these two alternatives, the involuntary bankruptcy petition might not be successful.
After the Filing
In a voluntary bankruptcy, a person or company is immediately considered to be in bankruptcy as soon as the bankruptcy petition is filed with the court. But an involuntary bankruptcy petition does not automatically place the company in bankruptcy. The involuntary bankruptcy petition is simply a request that the court order the company into bankruptcy. For this reason, the business continues to operate as usual, until the court grants the involuntary bankruptcy petition. In a voluntary bankruptcy, the court appoints a trustee who is responsible for the debtor's assets, because the debtor no longer has the right to sell them. The filing of an involuntary bankruptcy proceeding does not result in this loss of control by the debtor.
An involuntary bankruptcy suit might, or might not, be successful. If it's not successful, the consequences to the petitioners can be severe. If the court denies the request to force the company into bankruptcy, the court can order the creditors to pay the attorney's fees and costs the company incurred in defending the petition. If the court finds that the creditors filed the bankruptcy petition in bad faith, it can hold them responsible for resulting financial damages to the company and can even award punitive damages -- punishment for committing a wrongful act.