The Creditor who Threatens to File an Involuntary Bankruptcy Petition
Problem: The client call went like this: “I’m a little late paying my trade creditor, but its barely 120 days. The problem is I just received an email with a filled-out involuntary bankruptcy petition. This debt collector is threatening to throw my company into an involuntary bankruptcy unless I pay up immediately. Can they really do this?”
Short Answer: Unfortunately, the answer could be “Yes”. But exceptions exist to protect the debtor from this unscrupulous tactic of a bully creditor.
Story: While 2020 and Covid-19 seem to push every conceivable business limit, threatening an involuntary bankruptcy is simply over-the-top. This week, one of our clients who is in a very good financial condition, received an unexpected email from a rogue debt collector with an attached involuntary petition form filled out and, allegedly, ready to file. Understandably, panic set in for our client. Can this be possible? The petition listed three creditors, but only two of them were in the client’s system as actually having outstanding payables of less than $21,000. The third named company was fake. Does that sound like some sort of fraudulent claim? How should the client respond and how can outside counsel help?
Analysis: Even though the threat of an involuntary petition may be used by creditors as a way of gaining leverage with a potential debtor, if the petition fails the creditors may face serious consequences such as sanctions or the imposition of awards for damages by a court. In one 1986 case, the court sanctioned the filing creditor $67,394.99 (valued at $156,730.86 in 2020) for filing without good faith as the creditor failed to honestly negotiate with the debtor and investigate the amount of total debtor’s creditors. Filing creditors must show the debtor has 12 or more creditors; then, the involuntary bankruptcy petition requires three petitioning creditors. Section 303(b) of the Bankruptcy Code prevents two types of claims from being the basis of an involuntary petition: those that are "contingent as to liability" and those that are "the subject of a bona fide dispute." Both exceptions aim to prevent creditors from using the threat of an involuntary petition to bully an alleged debtor into settling a speculative or validly disputed debt. This rule’s underlying purpose prevents creditors from using: (1) "the fear [of] involuntary bankruptcy…as a means of harassing an honest debtor"; and (2) "the threat of an involuntary petition…to compel the debtor to make preferential payments ." Unfounded threats which lead to unfounded filings are heavily punished by bankruptcy courts as involuntary bankruptcies have foreseeable harm to honest debtors.
Our Action: We immediately went to work with our client to analyze the petition and identified several key flaws, including a seemingly fake creditor, key missing details, and the potential for bona fide disputes with the named creditors. We contacted the debt collector (not an easy task with shady debt collectors) to ask a few questions. We learned that some of the “claims” were for 2014 invoices – all of which had been paid, and all well past the four-year statutes of limitation. When pressed for supporting documents, the “claims” quickly unraveled—despite some choice words from the collector. In the midst of this stressful moment, we sought to gain as much information as possible for our client to enable it to make the best financial decision.
Conclusion: The choice now becomes: (i) Do we just pay the two claims, with the fear that this debt collector would be left with the belief that his tactic was successful and he would try it again with us, or with others in this industry, or (ii) Do we file a claim for sanctions against this guy to shine some sunlight on his bad faith intentions? Our client elected to pay off the smallest of the two creditors, in full, leaving the rogue collector with only one real client. Our client also made two partial payments to that remaining creditor, who just wanted to continue a true business-to-business relationship. Both of these vendors were unaware of what the collector had been up to. But we did have the good fortune of sharing a laugh, when our client told us: “I saw my life flash before my eyes”! The moral of the story is to stay firm when faced with panic situations and have a plan in place for “emergency” situations.
Doré Rothberg McKay attorneys are business lawyers with legal knowledge most companies will need to succeed. Whether your business is just starting or ready to be sold, we have the experience to advise you.
We value being part of our clients’ emergency plans and will always stand ready to jump in to quickly solve these problems