INVOLUNTARY BANKRUPTCY PETITIONS: A COLLECTION LAWYERS MOST POWERFUL TOOL

 

Sometimes creditors are faced with recalcitrant companies who refuse to respond to demand letters and requests to work out their obligations consensually.  In that case, one option in our arsenal as collection attorneys is to threaten to file an involuntary bankruptcy petition.  In order to do so, it is necessary to have 3 or more bona fide creditors.

Filing an Involuntary Petition. An involuntary bankruptcy is commenced by the filing of an involuntary petition by a "petitioning" creditor.  

A petitioning creditor is qualified to file an involuntary petition if it satisfies the following requirements: (1) it holds a claim against the debtor that (a) is "not contingent as to liability or the subject of a bona fide dispute as to liability or amount" and (b) equals at least $16,750; and (2) it demonstrates that the debtor is "generally not paying such debtor's debts as such debts become due" (unless such debts are the subject of a bona fide dispute as to liability or amount).

An involuntary petition may be filed by a single qualifying creditor (if the debtor has less than 12 qualifying creditors) and three or more qualifying creditors (if a debtor has 12 or more creditors).

After Filing the Petition.  A company has 21 days to answer the petition or seek its dismissal after service of the petition and summons.

Debtor Defenses to Involuntary Petitions. The two most litigated potential defenses to an involuntary bankruptcy are whether (1) the claim is subject to "bona fide dispute"; or (2) the debtor is "generally not paying [its] debts as they become due." These terms are not defined in the Bankruptcy Code.

Claims must not be subject to bona fide dispute.  A claim is subject to a bona fide dispute if "there is an objective basis for either a factual or a legal dispute as to the validity of [the] debt."  When making this determination, a court is not required to resolve the dispute; but only to ascertain whether a dispute exists. The petitioning creditor has the burden to establish a prima facie case that no bona fide dispute exists, after which the debtor must present evidence sufficient to rebut the prima facie case.  Courts have found the existence of pending litigation or the filing of an answer, or counterclaim, standing alone, insufficient to establish the existence of a bona fide dispute.  A debtor's previous recognition of a debt, such as listing the debt on a balance sheet or accounts payable ledger, has been found to be conclusive evidence that a debt is not in bona fide dispute.  Judgments obtained by default or otherwise are not considered subject to bona fide dispute in the Second Circuit.

Whether a debtor is "generally not paying such debtor's debts as such debts become due" calls for the consideration of four factors: 

  • (1) the number of unpaid claims;

  • (2) the amount of such claims;

  • (3) the materiality of the non-payments; and

  • (4) the debtor's overall conduct of its financial affairs.

Involuntary can be filed by a single creditor.  An involuntary petition can be filed by a single creditor where a company has less than 12 creditors. However, in such cases, the involuntary draws greater scrutiny from the Bankruptcy Court out of concern that the courts will be used as "collection agencies." 

Appointment of a Trustee

If a Company fails to answer an involuntary petition or a Bankruptcy Court determines the standards are met in an involuntary bankruptcy petition, a Trustee is appointed to investigate transfers and recover assets for the benefit of creditors.  The Bankruptcy Code allows a trustee to liquidate a debtor's assets in a cost-effective, expeditious manner. Because of this, involuntary bankruptcy is a powerful tool that can expedite and maximize payments to affected creditors.