Requirements And Risks In Petitioning For An Involuntary Bankruptcy Case

• Jurisdiction: United States,Federal
• Law Firm: Lowenstein Sandler
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy
• Author: Jordana L. Renert and Colleen M. Restel
• Published date: 24 July 2023

Abstract

This article provides an overview of the requirements petitioning creditors must satisfy to commence an involuntary process and discusses certain circumstances under which an involuntary filing may be contested by a putative debtor.

Aside from the traditional path of pursuing a judgment against the putative debtor in state court, one or more creditors'if certain criteria are met'can force a delinquent debtor into a bankruptcy proceeding through the filing of an involuntary bankruptcy petition. Commencing an involuntary bankruptcy is a powerful remedy to secure payment. However, involuntary bankruptcy cases account for less than one percent of bankruptcy proceedings in the United States each year.¹

An involuntary bankruptcy "exists as an avenue of relief for the benefit of the overall creditor body . . .[I]t was not intended to redress the special grievances, no matter how legitimate, of particular creditors . . . ." Wilk Auslander LLP v. Murray (In re Murray), 900 F.3d 53, 59-60 (2d. Cir. 2018) (citation omitted). For example, an involuntary bankruptcy is an appropriate tool to prevent funds and assets from being dissipated to the detriment of creditors or to ensure certain creditors are not receiving preferential treatment or payments. Commencement of an involuntary proceeding is also an effective way to provide a supervised forum to review the debtor's prepetition transactions and implement an orderly liquidation. On the other hand, the case law and Bankruptcy Code are clear that an involuntary bankruptcy filed for the purpose of settling a two-party dispute will be dismissed. While a creditor may be in technical compliance with the Bankruptcy Code, the risk of dismissal remains where the bankruptcy court determines the petition was filed in bad faith'for example to harass or exercise leverage over the putative debtor.

This article provides an overview of the requirements petitioning creditors must satisfy to commence an involuntary process and discusses certain circumstances under which an involuntary filing may be contested by a putative debtor.

I. The Bankruptcy Code Requirements for Involuntary Petitions

The Bankruptcy Code's requirements for commencing an involuntary proceeding are straight forward. The eligibility requirements, set forth in Section 303(b)(1) of the Bankruptcy Code, direct that the requisite number of petitioning creditors holding non-contingent, undisputed, unsecured claims must hold an aggregate debt across all petitioning creditors totaling at least $16,750.² The petitioning creditors bear the initial burden of establishing a prima facie case that they meet the eligibility requirements set forth in Section 303(b) of the Bankruptcy Code. See, e.g., In re Persico Contracting and Trucking, Inc., No. 10-22736 (RDD), 2010 WL 3766555, at *3 (Bankr. S.D.N.Y. Aug. 10, 2010).

A. Eligible Debtor:

With certain exceptions, any "person"³ who is eligible to file a voluntary bankruptcy petition may be the putative debtor in an involuntary bankruptcy petition. Notably, courts have also held that involuntary petitions cannot be filed against nonprofit organizations or municipalities. See, e.g., Official Comm. of Unsecured Creditors v. Archdiocese of Saint Paul & Minneapolis (In re Archdiocese of Saint Paul & Minneapolis), 888 F.3d 944 (8th Cir. 2018). Similarly, an involuntary petition cannot proceed against a farmer, unless the farmer consents to entry of an order for relief.

B. Number of Petitioning Creditors:

If the putative debtor has twelve or more creditors, at least three qualifying creditors must join as petitioning creditors to collectively file the involuntary petition. However, the Bankruptcy Code requires only one petitioning qualifying creditor in instances where the putative debtor has...