When it comes to a chapter 7 bankruptcy, there are two options available: 1.) it can be filed voluntarily by the debtor; or, 2) it can be filed by a debtor’s creditors, thereby resulting in an involuntary bankruptcy. This post discusses both voluntary and involuntary bankruptcies, and when involuntary bankruptcies may occur (which is rare).
The vast majority of chapter 7 bankruptcy cases are voluntarily filed; a person has decided that he or she wants to file bankruptcy, and does so. However, there is a second, yet very uncommon type, of filing: an involuntary chapter 7 bankruptcy. Involuntary bankruptcy filings usually involve a business as the debtor. In the common situation, the business owes creditors money and has defaulted on contracts with the creditors. The creditors are having difficulty getting paid or pursuing the business’s assets. Faced with the difficulty of recovery, some creditors may file an involuntary bankruptcy for the business. This is particularly true if the creditors know the business can repay or liquidate assets to pay its debts, but refuses to do so. It is extremely rare that creditors would file an involuntary bankruptcy for an individual, though.
Once the creditor files a bankruptcy petition “for” the business, the business will receive notice of the bankruptcy filing. The business will then have 20 days to respond. If the business does not respond, the bankruptcy court will allow the bankruptcy to proceed. But if the business does respond, there will be a hearing before a bankruptcy judge to determine whether the petition was filed in good faith and if the business has failed to pay its debts. If the court determines that the bankruptcy petition was indeed filed in good faith and that the business is refusing to pay its creditors, the chapter 7 bankruptcy proceeding will continue. If the judge, however, rules for the business, the bankruptcy case will be dismissed and the business may be entitled to any damages as a result of the involuntary bankruptcy filing.
If the bankruptcy moves forward, however, a Chapter 7 Trustee will be appointed to administer the bankruptcy estate for the business. The Chapter 7 Trustee will be in a position to liquidate the assets of the business in order to pay some (if not all) of the debt owed to the creditors. Such assets would include, but are not limited to, accounts receivables, investments, inventory, goodwill (selling the business name), tools, intangible property such as copyrights, patents, and other various assets. As a result of a chapter 7 bankruptcy, creditors may be in a better position to be paid on contract; however, such a maneuver should be saved only for the most extreme cases. Therefore, involuntary chapter 7 bankruptcies are extremely uncommon for business debtors, and even more uncommon for individuals.