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What is Involuntary Bankruptcy?

Involuntary bankruptcy is an interesting scenario because it is the reverse of what consumers do. Instead, a creditor can actually use bankruptcy to protect themselves from entities and individuals.

Everyone is rather aware that entities and individuals can use bankruptcy to protect themselves from creditors. It isn’t as common for a creditor to protect themselves using bankruptcy. They do this to protect themselves from entities and individuals preferring one creditor over another or from transferring assets. When a creditor initiates a bankruptcy case, it is called “involuntary bankruptcy.” It really is to the advantage of the creditor to pursue remedies covered under state law rather than turning to an involuntary bankruptcy, but there are certain circumstances in which the creditors may benefit from this process and it is something that happens in Minnesota.

What the creditor does is file an involuntary bankruptcy petition against the individual, corporation, or partnership. Three or more creditors holding unsecured claims that total more than $14,425 can do this. The claims of the creditor may not be subject to or contingent to a bona fide dispute. If there are fewer than 12 claimants against the debtor, which is not common, a single creditor holding an unsecured claim of more than $14,425 can move forward with the filing of the involuntary petition. They can choose to use Chapter 7 to liquidate the assets of the debtor or opt for a reorganization of the debtor’s liabilities and assets under Chapter 11 bankruptcy.

The rule of thumb is that involuntary bankruptcy is not an efficient debt collection tool because of the expense, time, and the burden it places on creditors. Many creditors prefer to go with state court or contractual remedies, which are pursued for the benefit of the individual creditor and no one else. Involuntary bankruptcy is used when there are circumstances that warrant it. The benefits that do exist include:

  • Control of venue – The creditor can choose the venue in which the bankruptcy case is carried out
  • Elimination of competing liabilities – Other dischargeable debts can be discharged so that the debtor has more income to pay the filing creditor’s account with their freed up future earnings
  • Transfers made by the debtor within 90 days can be void – This is a preservation of avoidance actions, so asset transfers up to one year before the filing can be recovered by the creditor
  • Enterprise value is preserved – If forced liquidations the choice, the creditor may file an involuntary petition to allow additional time to locate the person who may have purchased the debtor’s business, which gives the creditor more control over the asset liquidation, thus leading them toward greater recoveries as opposed to selling individual assets.
  • Automatic stay – Involuntary bankruptcy triggers an automatic stay. This means that other creditors cannot pursue the debtor through Minnesota state law remedies. This is also a way to keep a debtor from transferring assets that they are trying to keep away from creditors

There are risks involved in filing an involuntary bankruptcy petition. If the court feels the petition is not warranted, the judge will award the debtor the attorney fees incurred from opposing the petition. Furthermore, creditors are then held liable for any punitive damages if the court finds the petition was filed in bad faith.