Getting served with an involuntary bankruptcy petition is frightening. Before you do anything else, it’s crucial that you understand exactly what an involuntary bankruptcy petition is, and how it affects you and your company. Basically, involuntary bankruptcy is when the creditors of a business ask the bankruptcy court to force the business into bankruptcy. This occurs even if the business owner does not want to go through the bankruptcy process. If you’re reading this, that’s probably you. At Delancey Street we negotiate with merchant cash advance funders, lenders and other business creditors on behalf of owners under debt pressure. Often, the panic subsides quickly once you understand the process and your legal rights.
It also helps to know what an involuntary petition is not. Sometimes a business will claim it was forced into bankruptcy but, in fact, it filed a voluntary bankruptcy petition (either Chapter 7 or Chapter 11) itself, as a response to a creditor taking action. For example, a creditor might file a lawsuit against the business, win the lawsuit and get a judgment against the business. A lender declaring a default and starting foreclosure is another. When a company files a voluntary bankruptcy petition, it is in bankruptcy immediately. An involuntary petition works differently, and that difference shapes the five things you should do.
Order for Relief
The first is to understand where you actually stand. Despite the filing, your company is not actually bankrupt yet. An involuntary petition works just like a complaint in other litigation. The petition must be served (that means the creditors had to deliver it to you) with a summons. In other words, unless the judge said so, your business is not in bankruptcy. This decision, known as the order for relief, must come from a judge. Until that happens, it’s business as usual. Filing an involuntary petition triggers an automatic stay, which is meant to prevent creditor actions against the company, but that is where the similarity with a voluntary bankruptcy ends.
The second is to move fast. If your company’s creditors file an involuntary bankruptcy, the company has a 21-day window to respond, either by answering the petition or filing a motion to dismiss. The clock runs from service of the summons. Miss that window and you’ve given the petitioners a major advantage. When it comes to handling creditors, you must be alert to your timing. Get counsel. Delancey Street is not a law firm, so this is the point where an owner who calls us needs a bankruptcy attorney, and we refer owners to a vetted independent attorney for that work.
Creditors Actually Qualify
The third is to check whether the creditors actually qualify. If the company has 12 or more creditors, the filers need at least 3 creditors with claims that are neither contingent (dependent upon some future event) nor disputed. The claims must add up to a certain amount. If there are 11 creditors or fewer, a single creditor with a qualified claim is enough. Additional creditors can join the petition later. The creditors have to specify whether they want a liquidation or reorganization. If you object on time, they must also show that there is a general failure to pay debts that are due (and not because they are disputed), or that within the past 120 days a custodian took control of substantially all of the company’s assets. Figure out whether the petitioners can even qualify. All the documentation needs to be gathered and vetted. In short, a vigilant response to an involuntary filing can prevent your company’s entry into bankruptcy altogether.
The fourth is to keep running the business while you prepare for a fight. The company may continue operating and using, buying, and selling its property, just like any other company, while this lawsuit is pending. If the creditors want the court to appoint an “interim trustee” or impose any restrictions on the company, they have to ask for them and they do not get imposed automatically. The request for an interim trustee can be denied. If you contest the petition, a process can follow with pleadings and evidence, motions and hearings. Sometimes each side produces documents and testimony from witnesses. Status conferences, summary judgment motions and even a trial are possible. If, after this, the judge decides that the creditors can proceed with their case, the company is subject to bankruptcy law and the court’s control.
Taking a Risk
The fifth is to remember that the creditors are taking a risk too. Once an involuntary petition is filed, it can only be dismissed with notice and an opportunity for a hearing. Even if the creditors and the company agree. Just because they want to drop the bankruptcy doesn’t mean the bankruptcy goes away. And if the bankruptcy is dismissed, they can be on the hook for the company’s attorneys’ fees and costs, and if the bankruptcy was brought “in bad faith” they can be on the hook for damages and maybe even punitive damages. They are taking a risk. That is why creditors usually do not file involuntary petitions. They sue you. Most often, unsecured creditors use involuntary petitions when they suspect you are operating a scam, e.g., a Ponzi scheme, or they have some other extraordinary reason.
That last point matters for most of the owners we hear from. Just because your creditors take action against you, that does not mean they will force you into bankruptcy. There is nothing automatic about that. When a creditor is suing to collect, negotiating with a funder or a lender could help turn the tide. Talking with them is possible, and so is working through other debt solutions, including bankruptcy. Our first consultation is free and confidential, and if bankruptcy counsel, such as a Subchapter V case, is the better path for your business, we will say so on the first call. What we will not do is pretend we are bankruptcy attorneys, or pretend bankruptcy is always the right answer.
