What is Involuntary Bankruptcy?

Most people who end up in bankruptcy choose that path. That's why it's sometimes called "voluntary bankruptcy." However, there is another, much-lesser-known, type of bankruptcy which can be useful for creditors known as "involuntary bankruptcy."

Section 303(b) of the Bankruptcy Code provides that an involuntary petition may be filed against a debtor who's not generally paying its debts as they come due by three creditors who hold claims that: (a) are not contingent as to liability or the subject of bona fide dispute as to liability or amount, and (b) aggregate at least $14,425. See 11 U.S.C. § 303(b).

However, when a bankruptcy is filed against a company or person, it does not automatically bankrupt them. The "alleged" debtor is given a chance to rebut the allegations in the petition before an order for relief enters and they are a bankruptcy debtor subject to the duties and rights of the Bankruptcy Code. The primary dispute is often whether the claims held by the petitioning creditors are in bona fide dispute.

When determining whether a bona fide dispute exists, once prima facie claims have been established, an alleged debtor in an involuntary case cannot rely on simple denials as to the validity of a claim, but must demonstrate substantial factual or legal questions that bear upon the issue liability. If there is a genuine issue of material fact about the debtor's liability, or a legitimate dispute of law pertaining to disputed facts, then the involuntary bankruptcy will be dismissed.

Once an involuntary bankruptcy is allowed, a separate order for relief will enter, and the case will proceed more-or-less like if the debtor had filed the case on its own.

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