Earlier this week, four bondholders of Suntech Power Holdings Co. Ltd. filed an involuntary bankruptcy petition in the Southern District of New York to force Suntech into a Chapter 7 liquidation. The four bondholders, Trondeim Capital Partners, L.P., Michael Meixler, Longball Holdings, LLC and Jiangsu Liquidators, LLC collectively hold more than $1.5 million in Suntech bonds. Three of the four, Trondheim, Meixler and Longball have obtained judgments from a New York federal court allowing them to pursue repayment of their Suntech bonds plus interest. Suntech, a manufacturer of solar panels, is in the process of implementing a restructuring that included a bankruptcy proceedings of a subsidiary in China.

The filing highlights a recovery strategy that is infrequently used by creditors, and provides an opportunity to discuss the statutory requirements of an involuntary petition as well as the pros and cons of pursuing such a strategy. In certain situations, an involuntary bankruptcy could be a valuable tool for creditors to maximize recovery.

Bankruptcy Code section 303 governs involuntary cases, and provides that an involuntary petition has three main requirements: (i) if an entity has more than 11 creditors (which is normally the case in larger restructuring proceedings), the petition must be filed by three or more separate creditors; (ii) these creditors must have claims that are not contingent or subject to a bona fide dispute as to liability or amount; and (iii) the unsecured claims of the petitioners must exceed $14,425 in the aggregate. Once an involuntary petition has been filed, the debtor has 21 days to respond. During this period, generally known as the “gap period,” the debtor can maintain control of its business (although, if circumstances warrant, an interim trustee may be appointed). If the debtor responds, the court will determine the adequacy of the petition, as well as whether the debtor is generally paying its debts as they come due. If the court is satisfied that these requirements are met, it will enter an order for relief, signifying that the debtor is now subject to the bankruptcy proceeding.

In the Suntech case, it will be interesting to see if Suntech challenges the filing. If Suntech chooses to challenge, one issue that its response may raise is whether the petitioner bondholders constitute three separate entities for the purposes of section 303. Case law indicates that joint holders of an obligation (here, separate holders of the same bond issuance) are often counted as one creditor. However, this usually means that the debt in question only provides for a single right to payment. Given the fact that three of the petitioning bondholders have already had their debts reduced to individual judgments, that seems unlikely in this case.

The filing of an involuntary petition certainly can have its benefits, as Suntech’s bondholders must have determined in their case. An involuntary is most frequently used when the debtor is running its business into the ground or squandering or transferring assets in a questionable manner, such as to insiders or to third parties for inadequate value. In such instances, if the creditors can get the involuntary to stick, they reap the benefits of the potential appointment of a trustee, as well as the use of the Bankruptcy Code’s preference and fraudulent transfer provisions. With respect to preference and fraudulent transfer actions, creditors filing an involuntary also get the benefit of fixing the date from which any clawback action lookback period will be calculated.

These benefits must be carefully considered though, as there may be a large downside to a questionable filing. If the debtor is successful and the petition is dismissed by the court, the petitioning creditors can be liable for the debtor’s costs and attorney’s fees. Additionally, if the court finds that the petition was filed in bad faith, the creditors can be liable for damages, including punitive damages.

As with any route to recovery, filing an involuntary petition has its pros and cons. However, it is a viable option that creditors should be aware of, and it will be interesting to see how Suntech progresses, as well as the rationale of the petitioners.