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Understanding involuntary bankruptcy

The great majority of bankruptcy petitions filed in Bradley County and in Tennessee at large are filed by debtors seeking to have all or a portion of their debt load erased by the bankruptcy court. The rare exception is a petition filed against a person or an entity by three or more creditors asking to have the defendant declared bankrupt and to have the court take charge of the debtor's assets. Such petitions are called involuntary bankruptcies, and they are used by creditors to freeze the assets of an entity who may be mismanaging or wasting its assets.

Involuntary bankruptcies are governed by Sec. 303 of the Bankruptcy Code. All involuntary proceedings must be commenced under either Chapter 7 seeking dissolution of the entity or under Chapter 11 seeking to impose a plan of reorganization. An involuntary bankruptcy must be commenced by at least three creditors, each of which holds a claim against the debtor. Such claims must not be contingent or the subject of a "bona fide" dispute. The combined value of the claims must exceed $10,000.

Unlike ordinary filings under Chapters 7 and 11, the debtor may continue to do business, and Sec. 363 - the automatic stay - does not apply. After service of the petition, the debtor can file an answer that disputes the allegation of bankruptcy. A trial will be held to determine the validity of the creditors' claims. The petitions must prove one of two facts in order to prevail. One, the debtor is "generally not paying" its debts as such debts become due, except for debts that are the subject of a "bona fide dispute," Two, within 120 days of the filing of the petition, a third party acting as a custodian takes control of the debtor's property.

In summary, if the petitioners prevail, the trustee will take possession of the debtor's property if the petition was filed under Chapter 7 or file a plan of reorganization if the petition was filed under Chapter 11. If the petitioners fail to meet their burden of proof, the court will dismiss the petition. In the event that the petition is dismissed, the court may order the petitioners to pay the debtor's attorneys' fees. If the court determines that the petition was filed in bad faith, it can order the petitioners to pay punitive damages.

Involuntary bankruptcies can be significantly more complex than a straight bankruptcy proceeding, and anyone who is contemplating commencing such a case may wish to consult an experienced bankruptcy attorney before proceeding.

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