Involuntary Bankruptcy: What it is, How it Works

What Is an Involuntary Bankruptcy?

Involuntary bankruptcy is a legal proceeding through which creditors request that a person or business go into bankruptcy. Creditors can request involuntary bankruptcy if they think that they will not be paid if bankruptcy proceedings don't take place. They must seek a legal requirement to force a debtor to pay their debts. Typically, the debtor is able to pay their debts but chooses not to for some reason.

For involuntary bankruptcy to be brought forward, the debtor must have a certain amount of serious unmet debt.

How Involuntary Bankruptcy Works

Involuntary bankruptcy—which is relatively rare—differs significantly from a voluntary bankruptcy. A debtor initiates a voluntary bankruptcy by filing a petition with the courts. Bankruptcy offers an individual or business a chance to start fresh by forgiving or reorganizing debts that simply cannot be paid while offering creditors a chance to obtain some measure of repayment based on the debtor's assets available for liquidation.

Creditors seeking involuntary bankruptcy must petition the court to initiate the proceedings, and the indebted party can file an objection to force a case. A petitioning creditor, as defined by Title 11 of the U.S. Bankruptcy Code, can initiate an involuntary bankruptcy by filing an involuntary petition. The petition sets forth requirements for the creditor to satisfy and can be filed against an individual or business. A bankruptcy court decides whether or not to proceed or dismiss an involuntary case.

Requirements for Involuntary Bankruptcy

Involuntary bankruptcy can only be filed under Chapters 7 or 11 of the Bankruptcy Code. Involuntary bankruptcy is not available under Chapter 12 which pertains to family farmers or family fishermen with regular income, or under Chapter 13, which is available to individuals with regular income and often characterized as a "wage earner's plan." Involuntary bankruptcies cannot be filed against banks, insurance companies, not-for-profit organizations, credit unions, farmers, or family farmers.

A petitioning creditor is qualified to file an involuntary petition if they hold a claim against the debtor that is not contingent as to liability or the subject of a bona fide dispute regarding the liability or its amount, according to the Bankruptcy Code. The debt must be at least $18,600 (as of April 2022) and the creditor must demonstrate that the debtor is generally not paying debts as they become due.

If the debtor has fewer than 12 qualifying creditors, an involuntary petition can be filed by a single qualifying creditor. If a debtor has 12 or more creditors, at least three creditors must join an involuntary petition.

A debtor has 21 days to respond to a filing before bankruptcy proceedings can start. If they fail to respond—or if the bankruptcy court rules in favor of the creditors—an order for relief is entered and the debtor is placed into bankruptcy. Debtors also have the option to convert a petition from an involuntary case to a voluntary case.