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What is an involuntary bankruptcy?

Debt takes a heavy toll on those who owe and sometimes forces them to seek relief via bankruptcy. But there is a little-known tool that creditors can use to get their money -- involuntary bankruptcy.

Most people have never heard of this underused process creditors can use to recover their cash. But if a creditor feels that a debtor is frittering away assets without paying down debts, the creditor may use the bankruptcy courts to force debtors into involuntary bankruptcy proceedings.

When this occurs, the debtor is either compelled into a Chapter 11 reorganization or a Chapter 7 straight bankruptcy under the federal bankruptcy code at 11 U.S.C.§ 303. No other type of bankruptcy filing can be utilized through this process.

It is possible, however, for the bankruptcy court to rule against the creditors. If this occurs, the can face serious and negative consequences, which is the main reason why this is an absolute last resort for most creditors.

Involuntary bankruptcy is not an option when the borrower is a farmer, not-for-profit organization, bank, insurance company, credit union or a government unit or municipality.

Small businesses (and their assets) are the most frequent target of an involuntary bankruptcy, although it is possible for an involuntary bankruptcy petition against an individual debtor to be filed.

But in the latter case, individuals can claim some exemptions and protect a portion of their assets from their creditors. The exception here is if an individual has many unprotected assets. Involuntary bankruptcies against small businesses are more likely to satisfy creditors since they are not able to exempt any property.

In order to qualify to file an involuntary bankruptcy, a creditor must have what is known as "standing," i.e., the debt meets the following specific criteria:

  • It isn't subject to bona fide disputes regarding its existence or validity
  • It's not contingent as to liability

Debtors with no more than a dozen creditors may be the subject of a petition for involuntary bankruptcy by a single creditor if the debt owed to that creditor is at least $15,775, with a few limitations and exceptions.

For debtors with more than a dozen creditors, three of those creditors with a combined total of $15,775 in debt may file a petition for involuntary bankruptcy.

If you find yourself in this position, the time to act is now. learn more about your options to fight back against an involuntary bankruptcy.

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