Involuntary Bankruptcy

     Many people that I talk to are not aware that a bankruptcy of an individual or business can be commenced involuntarily.  An involuntary bankruptcy is commenced by the filing of an involuntary petition by one or more creditors of the debtor.  If the debtor has more than 12 creditors, an involuntary petition must be filed by three or more creditors holding noncontingent claims that are not disputed as to amount or liability.  The aggregate amount of their claims must be at least $14,425.  If there are fewer than 12 creditors, then a single creditor may file the involuntary petition.  A petitioning creditor bears the burden of showing that (1) its claim is not contingent as to liability or subject to a bona fide dispute as to amount or liability and (2) the debtor is not generally paying debts as they become due.
   
     When an involuntary petition is filed, a summons will be issued and the petition and the summons must be served on the debtor.  The debtor then has 20 days to file an answer.  A hearing will then be held and if the court determines that the requirements for an involuntary bankruptcy have been met, an "order for relief" will be entered, and the case will proceed as any other bankruptcy would.

Warning!

     Section 303(i) provides for damages against a petitioning creditor for an improper petition.  That section provides that if an involuntary petition is dismissed by the court without an order for relief being entered, the court may order the petitioning creditor to pay the debtor's costs and attorneys' fees whether or not the petition was filed in bad faith.  If the court determines that the petition was filed in bad faith, the petitioning creditors may be exposed to awards of compensatory and punitive damages.

The Bankruptcy Discharge

     Bankruptcy is intended to be a "fresh start for the honest but unfortunate debtor."  In order to grant that "fresh start," the Bankruptcy Code provides a "discharge" of certain debts for individual debtors.  The discharge acts as a permanent injunction for all dischargeable debts.  The discharge replaces the temporary injunction of the automatic stay.  

     A bankruptcy discharge releases the debtor from personal liability for all but certain specified types of debts.  In other words, the debtor is no longer legally required to pay any debts that are discharged.  The discharge is a permanent order prohibiting the creditors of the debtor from taking any form of collection action on discharged debts, including legal action and communications with the debtor, such as telephone calls, letters, and personal contacts.

     Although a debtor is not personally liable for discharged debts, a valid lien that has not been avoided in the bankruptcy case will remain after the bankruptcy is concluded.  Therefore, a secured creditor may enforce a lien to recover the property secured by the lien.   

Objections to Discharge

     Section 727 of the Bankruptcy Code provides several circumstances under which a debtor is not entitled to receive a discharge in bankruptcy.  For example, a debtor may not be entitled to a discharge if he destroyed or falsified records or transferred property prior to the bankruptcy filing "with intent to hinder, delay, or defraud a creditor.  An objection to the debtor's discharge under section 727 is, in effect, an objection to the bankruptcy as a whole.

     Creditors may also file a complaint to determine the dischargeability of a particular debt.  Section 523(a) of the Bankruptcy Code specifically excepts certain categories of debts from the discharge granted to individual debtors.  In most cases, the exceptions to discharge apply automatically if the language prescribed by section 523(a) applies.  The most common types of nondischargeable debts are certain types of tax claims, debts not listed on the debtor's schedules, debts for spousal or child support, and certain school loans.

    Other types of debt may be discharged unless a creditor files a lawsuit in the bankruptcy case (called an "adversary proceeding") seeking to except the debt for the discharge.  These debts include debts obtained by false pretenses or fraud, debts "for fraud or defalcation while acting in a fiduciary capacity," embezzlement or larceny, and debts "for willful and malicious injury by the debtor."

The Automatic Stay

     The automatic stay is an injunction that automatically stops all lawsuits, foreclosures, garnishments, and all collection activity against a debtor the moment a bankruptcy petition is filed.  A chapter 13 bankruptcy even protects co-debtors who are liable with the debtor on consumer debts.  The automatic stay remains in effect until (1) a judge grants relief from the stay at the request of a creditor, (2) the debtor receives a discharge, or (3) the item of property to be repossessed or foreclosed upon is no longer property of the bankruptcy estate.

     The automatic stay does not stop any criminal action against the debtor, nor does it stop a tax audit, a demand for tax returns, or the assessment of a tax (although the collection of taxes is stayed).  The automatic stay also does not stop actions for a domestic support order or the modification of such an order or actions to collect domestic support from property that is not property of the estate.

     A creditor who willfully violates the automatic stay may be liable for actual damages caused by the violation and sometimes for punitive damages.  Since the court usually takes several days to mail creditors notice of the bankruptcy, it is incumbent on the debtor or debtor's attorney to give actual notice to creditors who might take action without knowledge of the stay.  Creditor actions taken after the stay is in place are generally void or voidable.

     

The Bankruptcy Code

     Article I, Section 8 of the United States Constitution authorizes Congress to enact "uniform Laws on the subject of Bankruptcies."  Under this grant of authority, Congress enacted the "Bankruptcy Code" in 1978.  The Bankruptcy Code, which is found in title 11 of the United States Code, has been amended several times since its enactment, most notably in 2005 with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).

     The Bankruptcy Code consists of nine chapters - numbered 1, 3, 5, 7, 9, 11, 12, 13, and 15.  Chapters 1, 3, and 5 contain provisions that apply to all chapters.  Chapter 1 contains definitions, Chapter 3 sets forth rules for the administration of the bankruptcy estate, and Chapter 5 provides for the creditors' rights and claims, the avoidance powers of the Trustee, the effect of a discharge, objections to discharge, and property of the estate.  Chapters 9, 12, and 15 are rare and will not be discussed at length here.  Chapter 9 provides for the reorganization of a municipality.  Chapter 12 provides for a family farmer or family fisherman rehabilitation, and Chapter 15 is for cross-border bankruptcy proceedings.  The remaining chapters - 7, 11, and 13 - provide for the three most common types of bankruptcy cases and are explained in greater detail below.

     Chapter 7 is a straight liquidation and is usually what people think of when they think of bankruptcy.  A trustee is appointed who is charged with collecting and liquidating the debtor's non-exempt assets and distributing any funds to creditors.  Most individual chapter 7 cases are "no asset" cases, meaning that the Debtor does not own anything that the trustee can legally take, so the debtor will receive a discharge without having to pay anything to unsecured creditors.  If the debtor does have non-exempt assets, those assets will be sold and the proceeds will be distributed to creditors.  An individual debtor will then generally receive a discharge of remaining debts, while a business debtor will simply be shut down.

     Chapter 11 is a reorganization in which the debtor proposes a plan to repay creditors.  It is usually for corporations or wealthy individuals.  The debtor has a 120-day period during which it has the exclusive right to file a plan of reorganization.  After that, a creditor or the case trustee, if one has been appointed, can file a plan.  In the case of a small business, the "exclusivity period" is 180 days.  Any party in interest may file an objection to confirmation of a plan.  The Bankruptcy Code Requires the court, after notice, to hold a hearing on confirmation of a plan.  In order to confirm a plan, the court must find, among other things, that: (1) the plan is feasible; (2) it is proposed in good faith; and (3) the plan and the proponent of the plan are in compliance with the Bankruptcy Code.

     Chapter 13 is a rehabilitation that is available only to individuals with regular income and no more than $360,475 in unsecured debt and no more than $1,081,400 in secured debt.  Chapter 13 involves a plan to make payments to the trustee over 3 to 5 years.  Unless the court grants an extension, the debtor must file a repayment plan with the petition or within 15 days after the petition is filed.   A plan must be submitted for court approval and must provide for payments of fixed amounts to the trustee on a regular basis, typically monthly.  The trustee then distributes the funds to creditors according to the terms of the plan, which may offer creditors less than full payment on their claims.