Voluntary bankruptcy is a type of bankruptcy where an insolvent debtor brings the petition to a court to declare bankruptcy because they are unable to pay off their debts. Both individuals and businesses are able to use this approach.
A simple definition of voluntary bankruptcy: it’s when a debtor chooses to go to court over bankruptcy rather than being forced to do so. Voluntary bankruptcy is designed to create an orderly and equitable settlement of the debtor’s obligations.
Key Takeaways
- Voluntary bankruptcy is a bankruptcy proceeding initiated by the debtor who cannot satisfy their debts.
- It differs from involuntary bankruptcy, which originates from creditors.
- Involuntary and technical bankruptcy are other forms of bankruptcy. In involuntary bankruptcy, a creditor can force a debtor into court to get paid.
- Voluntary bankruptcy is the most common type of bankruptcy.
How Voluntary Bankruptcy Works
Voluntary bankruptcy is a bankruptcy proceeding that is initiated by a debtor who knows that they cannot satisfy the debt requirements of their creditors.
Voluntary bankruptcy typically begins when no other solution can be found for a debtor’s dire financial situation. Filing for voluntary bankruptcy differs from filing for involuntary bankruptcy, which occurs when one or more creditors petition a court to judge the debtor as insolvent (unable to pay).
Voluntary Bankruptcy and Other Forms of Bankruptcy
In addition to voluntary bankruptcy, other forms of bankruptcy include involuntary bankruptcy and technical bankruptcy.
Bankruptcy filings vary among states, which can lead to higher or lower filing fees, depending on the location of the filing.
Creditors may request involuntary bankruptcy for debtors when they can only get paid through bankruptcy proceedings, requiring a legal basis to enforce payment. A debtor must have reached a certain level of debt for a creditor to request an involuntary bankruptcy, which varies based on whether the debtor is an individual or corporation.
In a technical bankruptcy, an individual or company has defaulted on their financial obligations, yet this has not been declared in court.
Voluntary Bankruptcy and Corporations
When a corporation goes bankrupt, either voluntarily or involuntarily, a specific series of events occurs for all stakeholders to receive due payments. This starts with distributing assets to secured creditors, who hold collateral on a loan to the business.
If they cannot get a market price for the collateral (which has likely depreciated over time), secured creditors can recoup some of the balance from the company’s remaining liquid assets.
Secured creditors are followed by unsecured creditors—those who have loaned funds to the company, such as bondholders, employees owed unpaid wages, and the government if taxes are owed. Preferred and common shareholders, in that order, receive any outstanding assets, if any remain.
Various types of bankruptcy that a corporation can declare include Chapter 7 bankruptcy (liquidation of assets), Chapter 11 (corporate reorganizations), and Chapter 13 (debt repayment with lowered debt covenants or payment terms).
Of all the types of bankruptcy, voluntary bankruptcy is the most common.
Related Terms: involuntary bankruptcy, technical bankruptcy, secured creditors, unsecured creditors.
References
- United States Courts. “Bankruptcy”.
