How Creditors Can Put a Company Into Bankruptcy – The Involuntary Petition Process

An operating company can be hit with an unusual surprise:  being served with an involuntary bankruptcy petition. Most of the time companies file for voluntary bankruptcy relief. But on occasion a group of creditors can come together and force a company into bankruptcy. Some likely reasons would be if creditors think a bankruptcy proceeding would ensure a more orderly distribution of the remaining corporate assets, if there is a risk that assets would be lost or transferred, of if a bankruptcy trustee would be better suited to operate the business. Corporations can resist the involuntary petition, and the Code provides for standards and procedures that govern the resulting decisional process. The Code requires that the involuntary debtor be in financial distress and that a sufficient number of undisputed creditors request involuntary relief.

Section 303 of the United States Bankruptcy Code (11 U.S.C. et seq.) authorizes the filing of an involuntary petition against a corporation.

See 11 U.S.C. § 303(a).  The petitioning creditors must elect on the petition form whether they are seeking to place the company in Chapter 7 or Chapter 11.  The petition must allege that the company is generally not paying its debts as they become due, unless they are the subject of a bona fide dispute as to liability or amount.   The requirement is that there must be at least 3 creditors that hold claims against the company that are not contingent as to liability or amount and in aggregate total more than $15,775 (amount indexes periodically for inflation).   Other creditors can join in the petition so long as that creditor holds an unsecured claim that is not contingent. After a petition is filed, the company can still continue to operate, and the debtor may continue to use, acquire, or dispose of property as if an involuntary case had not been commenced.   The same officers and directors would be in charge.  Note however that the court, on request of a party in interest, after notice to the debtor and a hearing, and if necessary to preserve the property of the estate or to prevent loss to the estate, may order the United States trustee to appoint an interim trustee to take possession of the property of the estate and to operate any business of the debtor.

When the involuntary petition is filed, the court issues a Summons to Debtor in Involuntary Case.

The company has 21 days after service of the summons to file an answer either agreeing with the petition or contesting the petition. If the petition is not timely controverted, the court orders relief against the debtor in the involuntary case under the chapter under which the petition was filed. The bankruptcy then proceeds in the same way as a case would if a voluntary petition were filed. Otherwise, after trial, the court can order relief against the debtor in an involuntary case, only if it finds that  the debtor was generally not paying its debts as such debts become due unless such debts are the subject of a bona fide dispute as to liability or amount.  If the matter is contested, petitioning creditors bear the burden of proof.

If for some reason it is agreed to dismiss the petition, the court can do so but only after notice to all creditors and a hearing.

The petitioning creditors can file a motion or there could be a consent arrangement between the petitioning creditors and the company.   In addition, the court could dismiss the petition for lack of prosecution.  Note that the company could reply to the petition and seek dismissal.  If the court dismisses a petition in that scenario, the court could grant judgment against the petitioners and in favor of the debtor for costs and reasonable attorney's fees.  If the court further found that the filing was in bad faith, the court could award the company any damages proximately caused by such filing and punitive damages.

Navigating the complexities of an involuntary petition requires the assistance of a certified specialist in bankruptcy law. David A. Arietta has been counseling businesses for over 25 years. Call him at (925) 472-8000.