Unsecured creditors often consider filing an involuntary bankruptcy petition against debtors who owe them money.  While this may initially seem like an attractive alternative to collections proceedings, and because there are a number of potential pitfalls in pursuing this path, creditors should proceed cautiously before commencing, or joining an involuntary petition. 

DEBT REQUIREMENTS OF AN INVOLUNTARY PETITION

Generally, when there are 12 or more creditors of a debtor, any three unsecured creditors holding claims that are "not contingent as to liability or the subject of a bona fide dispute" and aggregating at least $14,425 may participate in the involuntary petition. Where there are fewer than 12 creditors, a single unsecured creditor may file an involuntary provided the claim is not subject to a bona fide dispute and aggregates at least $14,425. 

BENEFITS OF FILING AN INVOLUNTARY PETITION

The two primary benefits of forcing an involuntary bankruptcy are 1) the ability to recover preferential transfers and fraudulent transfers and, 2) where the debtor is in selling its assets, the ability to require the debtor to conduct the sale in an open process, for hopefully a higher and better price.

If an order for relief [bankruptcy petition] becomes final against the debtor, the trustee (a term that is synonymous with "debtor in possession" under chapter 11) can reach back from the date that the involuntary is filed to recover preferential transfers or fraudulent conveyances.  The 'look back' period for preferential transfers is 90 to non-insiders, and one year to insiders.  The trustee can also reach back up to 2 years under the bankruptcy code to recover fraudulent conveyances, and reach back for even longer periods under certain state laws. 

An involuntary bankruptcy may also create the opportunity to obtain appointment of a trustee under either Chapter 7 or Chapter 11.

RISKS OF AN INVOLUNTARY

Successful Involuntary bankruptcy petitions are uncommon.  The debtor you seek to put into bankruptcy may contest the involuntary, which will force the Court to conduct a hearing on whether the debtor is paying its debts as they become due and/or whether the debts are subject to a bona fide dispute. The burden of proof is on the creditors and defeating the debtor's challenges can often be a difficult and expensive.

The Court may also require the creditors to file a bond to indemnify the debtor from damages, including the debtor's attorney fees. Should it rule in the debtor's favor and dismiss the involuntary petition, the actual creditors involved -- and not their lawyers -- may be required to reimburse the debtor for both its attorneys' fees and costs, and punitive damages, if the Court determines the involuntary was not brought in "good faith".  If the Court determines that the involuntary petition was filed to harass a debtor or as a substitute for state-law remedies, or is a two-party dispute that is better brought in another forum, it will likely dismiss the petition and impose a judgment against the petitioning creditors.

WHEN IS AN INVOLUNTARY BANKRUPTCY APPROPRIATE?

Despite the risks there still are circumstances when creditors should consider forcing an involuntary bankruptcy, such as:

• The debtor is transferring unsecured assets to a third party, or an insider in a secretive manner or for less than fair market value of the assets.
• The debtor is transferring assets to a creditor in consideration of an existing a debt, and leaving insufficient funds to pay its other creditors.
• The debtor is transferring most, or all of its assets to a successor company.
• The debtor is only paying debts that have been guaranteed by its principals, or paying only debts owed to other "insiders".
• The debtor's lenders have obtained additional collateral within the past 90 days to better secure their positions.
• An involuntary bankruptcy provides creditors with a powerful remedy that properly used, can provide substantial benefits.  The dangers to the petitioning creditors of filing an involuntary bankruptcy cannot be ignored, however. Petitioning creditors are urged to consult with competent legal counsel before undertaking an involuntary bankruptcy petition to fully evaluate the risks of an involuntary petition, or whether some other remedy is more appropriate. 

Scott N. Schreiber

Stahl Cowen Crowley Addis LLC

Chicago IL

www.stahlcowen.com

BANKRUPTCY PREFERENCE CLAIMS BY TRUSTEE

"I want to keep my money"

You have received payment from your customer and your file and relationship is now closed. Or is it? Several months later your customer files bankruptcy. You hear about it and feel lucky because you were paid and obviously many others weren't. Then, sometime later, you receive a letter from your customer's Bankruptcy Trustee, demanding return of the payment, claiming it was a preference. Now, what do you do?

First, it is necessary to understand what a preference is. In simple terms, it is a payment on account for a past due debt made within 90 days of the filing of the bankruptcy, or within one year if the debtor is a related concern. Often, the demand letter will relate not only the amount claimed, but the reason why the trustee believes it is a preference.  At that point, you should do two things immediately. First, gather all your records regarding your past relationship with your customer. Second, contact your collection agency and/or your attorney to analyze the situation and try to resolve it quickly.

There are a number of exceptions that make potential preferences not avoidable and which can be used to negotiate a settlement or defend a lawsuit. First, if the payment was made contemporaneously for new value, it is not a preference. Second, if the payment was made in the ordinary course of business, it is not a preference. This is a subjective standard, and someone with experience must review the business records regarding your business relationship with your customer to present the best arguments to prevail. Third, if you provided new value to the customer after the alleged preferential payments, in other words, you provided additional goods or services after receiving payment for past due goods or services, this may offset some or all of the claimed preference. There  are some other miscellaneous exceptions and defenses that rarely apply that will be considered by the person reviewing your particular situation.

In summary, dealing with and defending a preference is the same as collecting an account. Time is of the essence. Do not ignore initial demand correspondence and wait for a lawsuit to be filed. Defending a preference claim is generally done on an hourly basis rather than a contingency fee basis. Therefore, the more quickly it is dealt with, especially if the Trustee does not file a lawsuit, the more economical and probably more successful the defense and settlement can be.

As an aside, the earlier and quicker you collect your accounts, the better chance you have to be outside the 90 day preference period, and you may avoid this issue altogether.

William A. Rinehart

Rinehart, Scaffidi & Mathews

Milwaukee WI

www.rsmlaw.com

ROBBIE BURCH

DIRECTOR OF SALES AND SERVICE

[email protected]