90 Second Lesson: I’ve Been Asked to Sign an Involuntary Bankruptcy Petition. Should I?

Question:

The credit manager of an Akron-based company asks: “One of our commercial accounts is pretty far behind in paying on our invoices. Another vendor approached me and asked me to join in signing an involuntary bankruptcy petition. Is there any legal risk in doing this?”

Answer:

The Advantages and Disadvantages of an Involuntary Petition

In a word, yes. If an involuntary bankruptcy petition is dismissed without the debtor’s consent for any reason other than abstention of the court, Bankruptcy Code § 303(i) provides that the debtor may have judgment against the petitioning creditors for its costs, including reasonable attorneys’ fees. 

Moreover, if the court determines that the petitioners, or any one of them, filed the petition in bad faith, the debtor may also have a claim for any actual damages caused by the filing and for punitive damages. Actual damages could include harm to the reputation of the debtor’s business, lost profits, and loss of earning capacity; damages that can often be quite costly. Additionally, creditors generally cannot set off these damages against any debts that the debtor owes to the creditor. 

Courts award these fees to discourage creditors from using the involuntary bankruptcy process improperly—thus prospective petitioning creditors should ensure that their filing has merit and should avoid filing to gain any improper advantage or to harass the debtor. Because involuntary bankruptcy proceedings often seriously disrupt the debtor’s business, courts do not hesitate to impose costs, fees, and damage awards on a creditor that files improperly. Essentially, a creditor should make sure that its involuntary petition serves some legitimate purpose before filing. 

Consider Liability and Risk Before Filing an Involuntary Petition

In most cases, the filing of an involuntary bankruptcy petition, while a powerful collection tool, also involves the assumption of a calculated risk by the petitioning creditors. For this reason, and with due regard for the fact that time is often of the essence in involuntary bankruptcy cases, prospective petitioning creditors should appreciate that the decision to go forward does expose them to potential liability that would not be a factor if recourse were limited to their state law alternatives. Therefore, before filing or agreeing to sign an involuntary bankruptcy petition, a creditor should carefully balance the risk of a possibly improper filing against the benefits of the involuntary bankruptcy process.

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[Editors’ Note: This 90 Second Lesson is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to [email protected] and we will try to answer it. This 90 Second Lesson is based, in substantial part, in material reprinted from Commercial Bankruptcy Litigation 2d and Strategic Alternatives for and Against Distressed Businesses, with permission of Thomson Reuters. For more information about these publications, please visit www.legalsolutions.com.

To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can watch at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Bad Debtor Owes Me Money!
2. Opportunity Amidst Crisis- Buying Distressed Assets, Claims, and Securities for Fun & Profit

This is an updated version of an article originally published on April 30, 2020.]

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