What Is Voluntary Bankruptcy?

Voluntary bankruptcy is a legal filing wherein a person initiates bankruptcy when they can’t pay their outstanding debt. If a person or a business has exhausted all their options and still can’t repay what they owe, they can file for voluntary bankruptcy.

Definition and Examples of Voluntary Bankruptcy

Voluntary bankruptcy occurs when someone petitions the court to declare bankruptcy. This is different from involuntary bankruptcy, wherein a creditor or a group of creditors petition a court to declare bankruptcy on a debtor due to their inability to pay.

A person or a company can declare voluntary bankruptcy. Let’s take a look at an example. 

Say Chris was laid off last year. After losing his job, he fell behind on bills, including credit card payments, utility bills, and loans. Even with the help of credit counseling, he isn’t set to repay his debt any time soon. He’s looking for a fresh start and the sooner he gets a clean slate, the sooner he can work to rebuild his credit. With no income and no way to repay his debt soon, Chris voluntarily declares bankruptcy.

What happens next is explained in more detail below.

How Voluntary Bankruptcy Works

A person can declare voluntary bankruptcy in two different ways: Chapter 7 and Chapter 13 of the Bankruptcy Code. 

Chapter 7 bankruptcy discharges all or almost all of your debt by liquidating your assets to repay your outstanding debt. If you don’t have a lot of assets, Chapter 7 is a relatively quick process, taking a few months from start to finish. Chapter 13 bankruptcy, on the other hand, doesn’t completely discharge your debt, but it does restructure it. The restructuring process could take many years to complete. 

Let’s look back at Chris as an example. Chris will file for Chapter 7 bankruptcy since he doesn’t have many assets, like a home or car. He needs to provide a complete list of creditors and how much is owed to them, along with income (if any), assets, and a detailed list of expenses. Over the next few months, the court will hold meetings both with Chris and the creditors to see if he meets the qualifications. If bankruptcy court finds him eligible, he’ll be discharged, or released of his responsibility for outstanding debt.

The Process of Filing for Voluntary Bankruptcy

Before a person can file for bankruptcy, they’ll need to receive credit counseling within 180 days prior to submitting a petition. This gives the bankruptcy court a chance to review your finances and see if you’ve exhausted all your options before getting a fresh start.

Once a person files for bankruptcy—both with Chapter 7 and Chapter 13—they’ll need to prove to a court that they don’t have the means to pay their outstanding debt. To do so, they must provide:

• Proof of current income
• Proof of current expenses
• Outstanding assets, debt, and liabilities
• Recent tax returns 
• Certificate of credit counseling
• Statement of financial affairs

Once a voluntary bankruptcy is filed, most debt collection will stop due to an automatic stay until the bankruptcy process is complete. At this point, the bankruptcy court or designated trustee will appoint an impartial case trustee to administer the case. Under Chapter 7, the debtor can keep certain exempt assets, but the trustee then liquidates the remaining assets. In this case, the trustee will sell (or liquidate) the debtor’s property, if applicable, to pay off the qualifying debt. 

While Chapter 7 liquidates, Chapter 13 rearranges, as previously noted. With Chapter 13, people who own assets like a home or car won’t lose their belongings. But the process takes much longer to complete and there are debt restrictions. For instance, unsecured debts must be less than $394,725 and secured debts need to be less than $1,184,200. These limits are changed periodically to reflect adjustments in the consumer price index. 

A Chapter 13 filing requires a person (or, in the case of a small business, a sole proprietorship) to outline their own repayment plan. Even if a plan hasn’t been approved, debtors are required to start making payments to the trustee within a month of filing for a Chapter 13 voluntary bankruptcy. All creditors need to agree to the plan ahead of time. When payments are made, they either go through the individual or through payroll deductions to make sure payments are on time.

The process is complete when a discharge releases a debtor from personal liability for most of their debt. That means creditors can’t go after people who have had a successful bankruptcy discharge, although this varies based on each person’s individual bankruptcy discharge. 

Note that there are some cases where a discharge is denied. Because the scope of Chapter 13 bankruptcy is so complex, debtors should seek legal counsel before reaching that point of the process.