Involuntary Bankruptcy – A Useful Tool for Lessors and Creditors

“Bankruptcy.” To many creditors, this term is understood to mean a lost cause, a write-off and the end of the collection process. To other creditors, including those that appropriately use the filing of an involuntary bankruptcy petition, bankruptcy can mean the beginning of a successful strategy. Many of the benefits leasing creditors and others derived from the filing of an involuntary bankruptcy petition against a delinquent customer under the former Bankruptcy Code are preserved in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), with some favorable additions. Used intelligently, and in the right situation, the filing of an involuntary bankruptcy petition can still be a useful tool.

One of the luxuries we have when discussing BAPCPA and filing involuntary petitions is that we don’t have to meticulously lay out the law under the former Bankruptcy Code, as anyone filing an involuntary petition after reading this article will certainly be operating under BAPCPA, which is now the law. Under the current Bankruptcy Code, an involuntary petition may only be filed by a minimum of three (3) creditors with debts totaling at least $12,300 in the aggregate. If the alleged debtor challenges the petition, the petitioning creditors will need to show that the debtor is unable to meets its obligations as they come due and that the creditors claims are not contingent as to liability or the subject of a bona fide dispute as to liability or amount. If the debtor has fewer than twelve (12) creditors, then a single creditor holding a claim of at least $12,300 can file an involuntary petition. Successfully prosecuting an involuntary petition generally means the fees and costs associated therewith are an expense to be borne by the debtor’s estate, provided it has sufficient assets to do so. This right is preserved in Section 503(b)(3)(A). Congress recognized that creditors should not bear the financial burden of declaring an already delinquent customer bankrupt. However, make sure to first seek the advice of experienced counsel before filing an involuntary petition, as the is court is empowered to grant judgment in favor of the debtor for its costs or attorneys’ fees if the involuntary petition is filed in bad faith and ultimately dismissed. Thus, before filing an involuntary petition against an account debtor, it is vitally important to make sure the creditor(s) joining in the petition meet the requirements of Section 303(b).

So when is it appropriate to use an involuntary bankruptcy petition? For starters, almost every company that leases equipment or sells on credit has either encountered or heard the story of the account debtor transfers its assets the week before the creditor executes on judgment, and many times the transfer is made to a related entity. In this situation, it may be critical to preserve the rights of creditors by filing an involuntary petition in bankruptcy. In this scenario, there are a couple important tools that can be utilized by the bankruptcy estate. Whether the action is prosecuted by the trustee in a chapter 7, the debtor-in-possession, trustee or committee of unsecured creditors in a chapter 11, grounds may exist for avoiding the sale under Sections 548 or 547 of the Code, relating to fraudulent transfers and preferences, respectively.

Under Section 548, fraudulent transfers, the trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within two (2) years before the filing of the petition, where the transfer was made for less than equivalent value while the debtor was or became insolvent or where the transfer was made with the actual intent to hinder, delay or defraud. Under the old Code, creditors enjoyed a look back period of one (1) year, but BAPCPA extended this period for an additional year. Even with the expanded reach back period, it is still important to file the involuntary petition to stop the running of the clock. This is often the case when a debtor quietly forms a new company for the sole purpose of acquiring the debtor’s assets for less than equivalent value, leaving creditors to chase a now-empty shell corporation with minimal or no assets. Through the prosecution of a fraudulent transfer claim the transferred assets can be recovered for the benefit of creditors.

Similarly, sometimes assets are transferred to another creditor or insider in exchange for the forgiveness of debt. While you are in process of collecting a debt you find out that the debtor just paid a substantial sum to another creditor, leaving the debtor with insufficient funds to pay your claim. Section 547 of the Code, relating to preferences, enables the trustee to avoid these transactions and recover assets for equal distribution to all creditors, not just the most aggressive or most favored creditor. In both scenarios, what otherwise would spell zero recovery may turn into partial or complete recovery. In collections the old adage “something is better than nothing” certainly rings true.

Sometimes, even though liability on your claim is established, it is more evident that the debtor will make it extremely expensive or inconvenient to collect. Perhaps this is because the debtor has enough resources to engage in delay tactics while it attempts to save its business or while it attempts to hide assets. To combat these tactics the filing of an involuntary petition may be the best route. In these situations, it may be better to force the debtor to disclosure its assets and manage its debts in bankruptcy at its expense, rather than yours. Whether a trustee makes a distribution in chapter 7 or the debtor successfully converts to chapter 11 and proposes a plan of reorganization, the debtor will bear the bulk of the expenses and creditors will have greater control in the direction of the case and the distribution of assets.

Particularly with regard to equipment leases, it is beneficial to get the clock started in bankruptcy. Under section 365(d)(1), if the trustee doesn’t assume the lease within 60 days after the order for relief, the lease is rejected from the bankruptcy estate. In addition, if the trustee or debtor decides that they want to keep the lease, the lease must be assumed an all defaults must be cured. Also, if the customer is not paying, having them under the Court microscope could be a good thing. Section 365(d)(10), the debtor is required to make payments starting with the 60 th day after the Order for Relief (adjudication of bankruptcy). If the debtor isn’t paying, having the power of the court behind your demands (after 60 days) should help. Again, be sure to seek the advice of counsel as Section 303(i)(2), preserves the right of the debtor to seek damages, including possibly punitive damages, for involuntary petitions filed in bad faith. If liability on your claim is not established or admitted, or you don’t have the requisite number of creditors joining in the petition, filing an involuntary petition may not be the best strategy and can get you into trouble.

Unsecured creditors may also have an incentive to file an involuntary petition in the face of an overly aggressive secured lender. Perhaps the debtor’s business has value as a going concern, which would be lost if the secured creditor liquidated its collateral. The filing of an involuntary petition may give a trustee a chance to briefly operate the debtor’s assets and sell them at fair market or going concern value, as opposed to liquidation. In other scenarios, the secured lender may have problems with its paper, particularly its UCC filings. Trying to navigate the world of state law remedies may prove time consuming and expensive, especially in cross-state (or transnational) transactions. Here, creditors are well served by focusing all of the issues in one forum and examining the security interests and collateral of the lender in front of the trustee and bankruptcy judge.

Finally, involuntary bankruptcy petitions can be useful in those situations where you simply don’t know what happened. One of your best customers suddenly goes belly up without notice. Typically, creditors suspect foul play, which may not always be the case. Rather than just letting the company dissolve and disappear, creditors often find an involuntary bankruptcy petition a useful tool in conducting an “autopsy” of the debtor’s business. While creditors may or may not ultimately see a distribution from the bankruptcy, it can be insightful to have an organized and open examination of the debtor’s business and financial demise. In these situations the collection benefits are not immediate, but can be extremely useful in future collection policy.

This article appeared in the Equipment Leasing Newsletter

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