Involuntary Bankruptcy: Is It A Clear And Present Danger?

Involuntary bankruptcy keeps many of my  asset protection clients awake at night.

Involuntary bankruptcy is the one thing that debtors cannot plan for nor control, and it is the most powerful creditor weapon against an otherwise effective asset protection plan. Why? Because debtor’s protections in a Florida bankruptcy court are much weaker than they are in state court. For example, a Florida debtor can protect unlimited money in a Florida homestead, and full protection is afforded immediately upon purchase and occupancy. Under the new bankruptcy law, however, the purchase of a Florida homestead within two years prior to bankruptcy is reversible as a fraudulent conversion and protection is capped at $137,000 for 40 months after purchase.

So how real is the threat of involuntary bankruptcy against wealthy Florida debtors? Is involuntary bankruptcy a “clear and present danger,” or does this threat sound worse than it really is.

I have never been involved in an involuntary bankruptcy proceeding because no such petition has ever been filed against any of my asset protection clients. Other attorneys I’ve spoken with report similar experience. I decided to investigate this question by asking people in the bankruptcy system who have a superior perspective. This past week I discussed involuntary bankruptcy with a law clerk for a bankruptcy court judge in Florida’s middle district and a Chapter 7 bankruptcy trustee. Both people were cooperative and interested in the question. The law clerk has been serving as a bankruptcy law clerk for the same bankruptcy judge for almost six years. The trustee has been a full-time Chapter 7 trustee in our district for 18 years. Here is what they had to say about involuntary bankruptcy.

The bankruptcy law clerk said that involuntary petitions are “very rare.” He can recall “just a handful” during his six year tenure. Involuntary petitions which are filed, he said, are filed mostly against insolvent companies rather than people. The only ones this law clerk can recall specifically being filed against an individual debtor were filed against the main principals of companies themselves subject to an involuntary bankruptcy. The clerk cannot recall any involuntary bankruptcy petition being filed against an individual debtor for the purpose, or with the effect, of switching the debtors homestead and other exemptions to the less favorable bankruptcy law matrix.

The Chapter 7 trustee reported a similar experience with involuntary bankruptcy stating that these petitions are “very rare” against companies or individuals. The trustee can recall one or two involuntary bankruptcies in his 18 years on the trustee panel. None have been filed since 2005 when the new bankruptcy law went into effect, and none were designed to attack the debtor’s exemption planning.

I asked the law clerk why involuntary bankruptcy petitions were so unusual given that they can be a powerful weapon against some debtors. The law clerk explained that involuntary bankruptcy petitions are “very complicated.” Most bankruptcy attorneys lack the knowledge and experience to file an involuntary petition, and the creditor has to find a very sophisticated bankruptcy firm. As a result, involuntary petitions are”risky and expensive.” A bankruptcy court can deny a creditor’s petition for any number or reasons. If the creditor attorney makes even a small mistake the court probably will sanction the creditor/client.

What does this mean for asset protection planning? It means that the prospect of a creditor filing an involuntary petition to, for example, deprive a wealthy debtor of homestead protection, is an issue that should be mentioned, but it is not something that should control asset protection planning. Asset protection is never perfect or guaranteed; nothing is guaranteed in a courtroom. Most people can minimize the already unlikely prospect of involuntary bankruptcy by having at least twelve unsecured creditors (credit cards). An involuntary bankruptcy petition against a debtor with twelve or more unsecured creditors requires the joinder of three creditors.

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