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Understanding involuntary bankruptcy in California

On Behalf of | Jan 18, 2023 | Bankruptcy

Bankruptcy is commonly considered to be a legal method of canceling burdensome debt, but an involuntary bankruptcy is a legal mechanism that creditors may use to compel a delinquent debtor to participate in a proceeding that will disclose the debtor’s assets and liabilities and compel payment of debts from the debtor’s assets.

The mechanics

Three or more creditors of an entity that owes money but is not making regular payments may file a petition in the bankruptcy court asking for a declaration that the debtor is in fact bankrupt and compelling the debtor to make the customary disclosures of assets and liabilities as in a voluntary proceeding under either Chapter 7 or Chapter 11. Some organizations are exempt from the involuntary bankruptcy proceedings, including banks, insurance companies, not-for-profit organizations, credit unions, farmers or family farmers.

The proceeding is commenced when a creditor files a petition with the bankruptcy court alleging that the debtor owes at least $18,600 and that the debtor is not making payments as the debts become due.

The creditor must hold a claim against the debtor that is non-contingent as to liability and is not the subject of a bona fide dispute. Creditors who meet these criteria are called “qualifying creditors.” If the debtor has fewer than 12 creditors, an involuntary petition can be filed by a single qualifying creditor; if the debtor has 12 or more qualifying creditors, the petition must be filed by three qualifying creditors.

The debtor must respond

The debtor has 21 days to answer the allegations of the petition. If the debtor fails to respond, the bankruptcy court will enter an order for relief and find that the debtor is bankrupt. If the court finds the debtor to be bankrupt, either procedurally or in fact, the debtor’s assets will be conveyed to a bankruptcy trustee and the proceeding will run the usual course of a voluntary proceeding.

Sound legal advice from a bankruptcy lawyer

Involuntary bankruptcy proceedings are very rare. Any business contemplating beginning an involuntary proceeding, or a business that is or may be the subject of an involuntary petition, may find that the advice of an experienced bankruptcy or business lawyer to be essential to a successful outcome.