What is voluntary and involuntary bankruptcy?

A bankruptcy case begins when either a debtor voluntarily files for bankruptcy or creditors petition to subject a business debtor to bankruptcy.

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What is a Voluntary Bankruptcy? 

Any business may voluntarily file for a liquidation or reorganization bankruptcy at any time. While a liquidation bankruptcy causes a business to dissolve, a reorganization bankruptcy allows a business to continue operating. For an individual to file for reorganization bankruptcy under Chapter 13, she must have regular income and have unsecured debts not exceeding $307,675 and secured debts of less than $922,975. 

The requirements for a business to undertake a reorganization bankruptcy under Chapter 11 are discussed in greater detail below. In a liquidation bankruptcy under Chapter 7, the primary limitation is that an individual (not a business) must meet a means test. The means test limits the ability of individuals to file for bankruptcy if the individual has recurring revenue (income) above a certain amount. The amount is determined by the states median income for its citizens. The purpose of this test is to prevent individuals who have sufficient income to pay debts from using a liquidation bankruptcy to wipe away debts and defraud creditors.

Note: The means test does not apply to business liquidations. A business may file for liquidation bankruptcy at any time.

What is an Involuntary Bankruptcy?

An involuntary bankruptcy, as the name implies, is involuntarily imposed upon the debtor. One or more creditors of a business debtor may commence an involuntary bankruptcy action against a debtor by filing a chapter 7 or chapter 11 petition with the bankruptcy court. To commence this action, the following conditions must be present:

• three or more business creditors must have good faith, non-contingent claims against the debtor totaling $15,325 or more (beyond the amount of any secured debt), or
• if the debtor has fewer than 12 creditors, a single creditor holding a good faith, non-contingent claim against the debtor of $15,325 or more.

These provisions are in place to make certain that no single creditor can undermine a businesss operations by petitioning for involuntary bankruptcy without meeting minimum standards. The court may award damages against a creditor for filing an involuntary bankruptcy in bad faith. If the debtor fails to successfully defend a petition for involuntary bankruptcy, the court will order relief against the debtor. If the debtor contests the involuntary filing, the court will only subject the debtor to bankruptcy if:

• The debtor is not paying its debts as they come due, or
• Within 120 days prior to filing the action, the court appoints a custodian over the assets of the debtor with the purpose of enforcing a lien.

It is important to remember that any debts that the debtor fails to pay in a timely manner must be good faith debts that are not subject to dispute or controversy. The danger for a creditor seeking to place the debtor in involuntary bankruptcy is, if the court dismisses the action (other than pursuant to agreement of all parties), the court may award court costs and attorneys fees against the creditor. If the creditor acted in bad faith, she may be subject to actual damages suffered by the debtor, as well as punitive damages.

Discussion: What do you think about the unlimited ability for businesses to file a voluntary bankruptcy? What do you think about the ability of creditors to force a debtor into involuntary bankruptcy? Are the requirements for an involuntary bankruptcy sufficient to protect a debtor? Why or why not? Do they offer a valid option for creditors in enforcing debts against a debtor? Why or why not? Does the ability of the creditor to receive damages for a bad-faith, involuntary filing affect your opinion?

Practice Question: ABC Corp is a large corporation that produces farm chemicals. ABC owes over $1 million to 123 Corp for services rendered and supplies. ABC has continuously failed to respond to 123s collection efforts. ABC Corp does not seem to have outstanding debts owed to any other businesses. What are 123s options to collect this debt through the bankruptcy process?