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Bad faith in involuntary bankruptcy

You’ve heard about how bad faith on the part of a debtor can impact their bankruptcy filing. When they are motivated by anything other than unmanageable debt and the desire to start over, the court can dismiss their case. However, there are also cases where creditors can act in bad faith, particularly when they force a debtor into involuntary bankruptcy.

Bankruptcy laws allow a creditor to file an involuntary Chapter 7 or Chapter 11 petition against a debtor. The goal is to protect their claim when they believe that you are spending away your assets or appearing to favor some creditor claims over others. If you have 12 or more creditors, three or more may petition if:

  • Each petitioner has a valid claim that is not in dispute or in question regarding its liability
  • The aggregate total of their claims are at least $15,775 more than the value of any liens on your property

Section 303(i)(2) warns creditors against filing an involuntary petition in bad faith: if the court is forced to dismiss such an action, it may award damages to the debtor and impose punitive damages on the creditor.

Why would a creditor file in bad faith?

As case law suggests, self-interest is the primary motivator in a bad-faith involuntary petition. For example:

  • The creditor wants to gain leverage for settlement: they are using the bankruptcy courts as a substitute debt collector
  • The creditor wants to force you into negotiations over a matter important to their business
  • The creditor wants to take over your company or shut it down
  • The creditor is hostile to you and wants to harass you

In the 2015 case Forever Green Athletic Fields, Inc., the U. S. Court of Appeals for the Third Circuit addressed the question of whether bad faith by a creditor can cause a case to be dismissed even if the debtor is not paying their bills and the other criteria for filing an involuntary petition are satisfied.

The creditors argued that their motives were irrelevant because all other criteria for the filing were satisfied. The court found that meeting the criteria was only the first step: the action still had to be undertaken in good faith, otherwise the U.S. bankruptcy process was no longer equitable.

In Forever Green Athletic Fields, Inc. the appeals court upheld the bankruptcy court’s finding of bad faith because a creditor appeared to have filed the involuntary petition in order to prevent the debtor from filing an arbitration claim against it.

If you are the subject of an involuntary Chapter 7 or 11 filing, contact a New York bankruptcy attorney. They can explain how a bad faith filing is defined under the Bankruptcy Code and how to proceed if you are targeted by one.

Jayson Lutzky is a Bronx, New York personal bankruptcy lawyer. He has over 35 years of experience practicing law and offers free in-person initial consultations. You may reach his office at 718-329-9500 to set up an appointment. Mr. Lutzky can help determine if bankruptcy is right for you in a consultation.

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