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 who 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.

Key Takeaways

  • Involuntary bankruptcy is a legal proceeding that creditors may bring against a person or business that may force a debtor into bankruptcy. 
  • The main reason an involuntary bankruptcy might be granted is for a case in which a debtor has the ability to pay their debts but refuses to do so. 
  • It is a relatively rare form of bankruptcy.
  • A petition for involuntary bankruptcy can only be filed under Chapters 7 or 11 of the Bankruptcy Code.

How Involuntary Bankruptcy Works

Involuntary bankruptcy—which is relatively rare—differs significantly from a voluntary bankruptcy that a debtor initiates by filing a petition with the courts. Bankruptcy offers an individual or business a chance to start fresh by forgiving 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.

Involuntary bankruptcies are primarily filed against businesses, where creditors believe the business can pay its outstanding debts but refuses to do so for some reason. They are less common against individuals because most have few recoverable assets.

Requirements for Involuntary Bankruptcy

Involuntary bankruptcy can only be filed under Chapters 7 or 11 of the Bankruptcy Code. Other types of bankruptcy, such as Chapter 12 or Chapter 13, are not eligible. Involuntary bankruptcies can also not 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 $16,750 (as of April 2019) 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.