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Understanding involuntary bankruptcy

One of the principal concerns of dealing with a person or corporation that is in financial difficulty is the possible mismanagement of the debtor business. Assets may be sold for less than fair market value or simply hidden from creditors. The debtor may decide to pay some creditors and not others. The bankruptcy code has a provision that creditors can use to protect themselves: involuntary bankruptcy.

Unlike an ordinary Chapter 7 or Chapter 11 proceeding, an involuntary bankruptcy is commenced by creditors of the debtor. The code specifies that three or more entities, each of which holds a non-contingent claim against the debtor, may file a petition asking the court to declare the debtor bankrupt and place its assets under court control. Other creditors who hold claims that are not contingent and not secured may join the petition.

Any party in interest can move the court for an order appointing an interim trustee to take charge of the debtor's property. A debtor can reclaim possession of its property by posting a bond in an amount required by the court. If the debtor does not oppose the petition in a timely manner, the court may issue an order for relief allowing the debtor's property to be liquidated to pay creditors' claims. If the petition is controverted by the debtor, the court will order a hearing to determine if the debtor is in fact bankrupt. In an involuntary bankruptcy, bankruptcy is defined as the inability or refusal of the debtor to pay its debts as they accrue or the seizure of the debtor's property by a party, such as a receiver, who has been appointed to take custody of the debtor's property for purposes of enforcing a lien. The potential for mischief in an involuntary proceeding is high, and the law provides severe penalties for anyone who uses it in bad faith.

An involuntary bankruptcy proceeding can have severe consequences for the debtor or for creditors if the petition is dismissed. Anyone who is considering filing such an action against one of its customers, or anyone who is facing the possibility of being served with an involuntary petition, may want to get more information about the procedures and potential outcomes.

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