Having a hard time collecting money
from one of your customers? Don’t
want to subject yourself to a long, complicated and sometimes expensive lawsuit?
Depending on the situation, you may have
an interesting, little-known option: Force
your customer into involuntary bankruptcy
and collect when the assets of your customer
are liquidated.
“This is a very aggressive maneuver and an
alternative to the garden-variety breach-of-contract collection action,” says Leonard
M. Shulman, managing partner, Shulman
Hodges & Bastian LLP. “Frankly, it is also
less expensive. The legal fees involved in
preparing and prosecuting an involuntary
bankruptcy petition are a fraction of what a
breach-of-contract action and post-judgment
collection activity can cost.”
Smart Business talked to Shulman about
using involuntary bankruptcy as a collection
strategy.
How can an involuntary bankruptcy petition
result in getting money that is owed to you?
An involuntary bankruptcy is placing a
company or an individual into a potential
Chapter 7 [bankruptcy]. The involuntary petition is filed by one creditor if the ‘alleged
debtor’ has 12 or fewer total creditors or by
three creditors if the debtor has more than 12
creditors.
In order to petition the court in such a manner, the money owed by the alleged debtor
must not be disputed (subject to a bona fide
dispute by the debtor), unliquidated (amount
owed is unknown or subject to a future
event) or contingent (much like a guaranteed
debt that is not yet owed).
When the petition is filed, the company or
individual in question becomes an ‘alleged
debtor’ and has 30 days to respond by asserting either (1) that the involuntary petitioners
are not true creditors or (2) that the alleged
debtor is generally paying debts as they
become due.
The alleged debtor does have one other
strategic option: namely, agree that it should
be in bankruptcy. Instead of a Chapter 7 liquidation, the alleged debtor can consent to an
order for relief and elect to attempt a Chapter
11 reorganization. Chapter 11 of the U.S.
Bankruptcy Code provides a breathing spell for the debtor, during which negotiations can
take place to try to resolve creditor difficulties. The debtor can terminate burdensome
contracts and leases, recover assets and
rescale its operations in order to return to
profitability and pay its debts over time.
Why should a company use the involuntary
bankruptcy strategy?
It is an extremely powerful tool that is often
overlooked because it is not well known.
Let’s say a company does not pay what is
owed to you. Assuming you find out that it
has more than 12 creditors, you have a
choice. You can file a collection lawsuit in
state court and try to collect upon that judgment, or you can locate two other creditors
who have not been paid and the three of you
could place your common debtor into involuntary bankruptcy. If the debtor does not
have a defense, its assets will be liquidated
and your debt may be paid, along with the
debts of other creditors. Note that the debt
will be paid to the extent that there are unencumbered assets with which to pay creditors.
However, this strategy does not come without risks. If your claim is subject to a real dispute by your debtor — which ultimately shows the court that the involuntary petition
was wrongful — you can be assessed significant sanctions. So creditors have to be
extremely certain that their claims and the
claims of any other petitioners are valid —
not disputed, unliquidated or contingent.
How difficult might it be to locate other creditors?
The process of finding other creditors is
easy in this day of the Internet. You could do
an online credit search, a search through the
Better Business Bureau or use a variety of
other means, including the use of third-party
services or investigators to locate other outstanding creditors.
What role do bankruptcy trustees play in the
involuntary bankruptcy process?
If the alleged debtor does not have a
defense to the involuntary bankruptcy petition and the alleged debtor does not voluntarily opt for a Chapter 11, then a trustee is
appointed to liquidate all its assets. If value of
the assets in liquidation is less than what is
owed to all creditors, the creditors will share
pro rata in whatever money the trustee generates when the trustee liquidates the assets.
The trustee has other powers to recover
assets transferred prior to bankruptcy, a discussion of which is beyond the scope of this
interview.
How common is this strategy? Isn’t it fairly
unusual?
It is becoming more acceptable as it is
becoming more known. Creditors are getting
very frustrated with the garden-variety
breach-of-contract process, which includes
waiting up to a year for a judgment, trying to
collect on the judgment, and perhaps getting
delayed or stonewalled by the debtor.
Involuntary bankruptcy is a very quick
process. The alleged debtor has to respond to
the petition filing within 30 days, and within
60 to 90 days, it can be adjudicated a debtor,
ultimately to be liquidated by a court-appointed trustee.
LEONARD M. SHULMAN is a managing partner with Shulman Hodges & Bastian LLP. Reach him at [email protected] or (949)
340-3400.
