Last June, the house of representatives passed a bill to amend
the section of the Bankruptcy Code that governs a legal maneuver
you may not know about-involuntary bankruptcy. The Bankruptcy Code
allows two forms of bankruptcy for businesses in desperate
financial straits. In Chapter 7 straight bankruptcy, a business is
usually liquidated, and the creditors divide up the assets. In
Chapter 11 reorganization, the bankruptcy court declares a
moratorium on debt payments while the business realigns its
financial obligations. The goal is for the business to work out a
way to pay back as much as possible while still remaining
alive.
Both forms are drastic measures. Chapter 11 reorganization
isn't much easier to swallow than Chapter 7 liquidation, and
the majority of businesses that go into it never successfully
reemerge. Reorganization involves submitting your plan and every
business decision to the scrutiny of a committee of creditors that
has the right to second-guess your proposals. That's why
businesses try every kind of negotiation and deal-making they can
to stave off declaring bankruptcy.
What you might not know is that creditors can get together and
petition the court to declare a business bankrupt under Chapter 7.
Involuntary bankruptcy is a tool creditors can use when they fear
the debtor will dissipate the remaining assets or pay certain
creditors but not others. It forces the debtor to face all the
creditors at once, paying debts in an orderly manner, according to
the bankruptcy laws and under court supervision.
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Creditors can initiate involuntary bankruptcy only if the debtor
has regularly missed a significant number of payments, especially
large ones, or if a custodian has been appointed or has taken
possession of the debtor's assets within the previous 120 days.
If there are 12 or more creditors, at least three of them have to
sign the petition. Otherwise, it can be signed by any creditor owed
at least $10,775.
The debtor has 20 days to respond. If the debtor objects, it
turns into a lawsuit to determine whether the problems will be
resolved through bankruptcy. Otherwise, the court may declare the
business bankrupt-and require the debtor business to pay the legal
expenses of the petitioning creditors. However, a judge who
believes the creditors filed their petition in bad faith can
require creditors to pay damages and the debtor's legal fees.
That's why creditors typically file for involuntary bankruptcy
only when they're confident of winning.
So why is Congress reforming the laws? Certain tax protestors
and other extremists have been abusing the system to take vengeance
on public officials and people who oppose them, filing a petition
to force individuals into involuntary bankruptcy. Eventually, the
court discovers it's fraudulent and dismisses it, but it stays
in the court records and destroys victims' credit records.
The new law would direct courts to dismiss false, fictitious or
fraudulent petitions and expunge all references to them from the
court files.
If your business is being strangled by debt, the very existence
of the bankruptcy laws can help you negotiate with creditors,
because it's normally in the creditors' interest that your
business not go bankrupt. Don't ignore debt problems, or your
creditors might force you into a bankruptcy you might have
otherwise avoided.
Jane Easter Bahls is a writer in Rock Island, Illinois,
specializing in business and legal topics.