Involuntary Bankruptcy Considerations for Partnerships and Joint Ventures By D. Hiatt Collins hcollins@gsrm.com

When business partnerships fall on financial hard times, the relationship between the partners may sour and cause disagreement over the course the business should take. These disagreements can include whether the partnership should file for bankruptcy or attempt to ride out the difficulties. In cases of disagreement, the Bankruptcy Code allows a fraction of the general partners to file what is known as an “involuntary bankruptcy” petition on behalf of the partnership.
An involuntary bankruptcy may only be filed by certain parties and in certain types of cases:

• Involuntary bankruptcy may only be filed for a Chapter 7 liquidation or Chapter 11 reorganization.
• Involuntary bankruptcy may not be filed against a farmer or family farmer, or against a corporation that is not-for-profit.
• If a partnership includes limited partners, they do not have the authority to file involuntary bankruptcy on behalf of the partnership. Only one or more general partners may file the involuntary bankruptcy.

Involuntary bankruptcy may be filed by as few as one of the general partners of a partnership, or as many as all of the general partners minus one. One or more of the general partners may file an involuntary bankruptcy notwithstanding any agreement between the partners not to do so or any state or local law. Any general partners who oppose the filing of the involuntary bankruptcy may file an answer to contest the involuntary petition.

If a group of partners attempts to file a voluntary bankruptcy petition on behalf of the partnership but is unable to secure the support of all the general partners, a court will often treat the attempted voluntary bankruptcy as aninvoluntary bankruptcy. If all of the general partners agree to file on behalf of the partnership, that bankruptcy is by definition a voluntary bankruptcy, and cannot be termed involuntary.

Additionally, a joint venture is treated as a partnership in the context of involuntary bankruptcy. The entities that make up the joint venture may file on behalf of the venture, so long as those entities are equivalent in rights and duties to general partners, and not limited partners.

The Bankruptcy Code section authorizing involuntary bankruptcy contains an important safety factor: a court can only allow an involuntary bankruptcy to proceed if the debtor is generally not paying its debts as they come due, unless those debts are subject to a bona fide dispute. This prevents parties from forcing a partnership or joint venture into bankruptcy in order to extract immediate payment of debts if the partnership or joint venture is not actually in financial distress dire enough to require bankruptcy, and would be capable of paying those debts in the future.

A court looks at the following two factors to determine if a debtor is not paying its debts as they come due, and is therefore subject to involuntary bankruptcy:

1. Which debts the debtor was not paying at the time the involuntary petition was filed, and which debts the debtor was paying immediately before the involuntary bankruptcy was filed; and
2. How large the unpaid debts are, what the role of those debts was in prompting the filing of bankruptcy, and how the debtor has conducted itself.

If the debtor is determined not to be paying debts, a court may still prevent an involuntary bankruptcy to proceed if those debts are in dispute. A court will look at the following three factors to determine whether a debt is subject to a bona fide dispute:

1. The debtor disputes the existence of the debt, not just the amount of the debt;
2. The debt can be examined and understood without substantial litigation of legal issues or facts; and
3. On balance, the debtor’s interest in avoiding being forced into bankruptcy outweighs the risk to the creditor that the debtor’s assets may be diminished by its continued operation.

As a final note, parties contemplating filing an involuntary bankruptcy petition on behalf of a partnership should be aware that a court may dismiss the involuntary bankruptcy case and require the parties that filed it to pay the debtor partnership’s costs and attorneys’ fees if the court considers the bankruptcy to have been filed for improper or frivolous reasons. Further, if the court finds that the involuntary petition has been filed out of spite, malice, or a desire to embarrass the debtor, or filed when particularly ill-advised, the court may determine that the petition was filed in bad faith and require that the filing parties pay regular damages and punitive damages, if warranted.