Voluntary Bankruptcy

Definition

Voluntary bankruptcy is a type of bankruptcy proceeding initiated by an individual or business who recognizes their inability to repay outstanding debts. By voluntarily filing, the debtor seeks protection and relief from creditors under the federal bankruptcy laws. This is in contrast to involuntary bankruptcy, where creditors initiate the bankruptcy proceedings to recover unpaid debts.

Phonetic

The phonetic pronunciation of “Voluntary Bankruptcy” is: vɑːˈlʌnˌteri bæŋkˈrʌptsi.

Key Takeaways

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1. Voluntary Bankruptcy Initiation: Unlike involuntary bankruptcy, voluntary bankruptcy is initiated by the debtor themselves. It usually happens when they realize their debts are beyond their current financial ability to pay. They will then file a petition to the bankruptcy court, which will inspect their financial situation and determine the best course of action.
2. Ease of Financial Pressure: One of the main advantages of filing for voluntary bankruptcy is that it helps to alleviate significant financial pressure. When the bankruptcy proceedings begin, there is an automatic temporary stay against all collection actions. This stay is in place until the case is resolved or unless the stay is lifted by the court. Hence, it can provide a debtor immediate relief from harassing creditors.
3. Impact on Credit Score: While voluntary bankruptcy will ease financial pressure by discharging certain debts, it is also critical to remember that it will significantly impact a debtor’s credit score for several years. It could make it harder to secure loans or credit in the future, affecting their buying power. Therefore, it’s important to consider all options and implications before filing for voluntary bankruptcy.

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Importance

Voluntary bankruptcy is significant in the business/finance field because it allows businesses or individuals, who are unable to repay their debts, to consciously choose to file for bankruptcy. This process offers a potential relief from overwhelming debt, albeit with significant consequences. Its importance is also tied to how it impacts creditors and the overall marketplace. It renders creditors having to stop all attempts to collect debts under an automatic stay. Also, by businesses declaring bankruptcy, economies can keep industries moving by eliminating the zombie companies and allowing for more innovation and competition. However, it also implies severe implications such as assets liquidation, damaging credit reports, and potential future lending challenges for the filing entity. Understanding voluntary bankruptcy is fundamental in making informed and strategic financial decisions.

Explanation

Voluntary bankruptcy, as the term suggests, is an action initiated by an individual or a business entity to legally declare their inability to pay off their debts. Its primary purpose is to provide a systemic way for the indebted party to manage and, if possible, to resolve their insolvency issues while receiving protection from further debt collection activities by the creditors.The process works by the debtor filing a petition in a bankruptcy court. This may further involve the liquidation of their assets – if it is a Chapter 7 filing – or initiating a debt reorganization plan – if it’s under Chapter 11 or Chapter 13. The goal here isn’t to evade debts but rather to navigate through financial distress in an orderly manner. Emphasizing the prevention of an uncontrollable debt spiral, it effectively helps alleviate the burden on the debtor, and at the same time, it provides a potential path for creditors to recover some of the owed amounts.

Examples

1. Enron: One of the most prominent cases of voluntary bankruptcy occurred in 2001 with the energy company, Enron. Overwhelmed by tremendous debt and a series of financial scandals, Enron filed for Chapter 11 bankruptcy. This allowed the company to clear most of its debt, reorganize its business processes, and liquidate assets under court supervision in an attempt to become solvent again.2. GM (General Motors): In 2009, the automotive giant, General Motors, filed for Chapter 11 bankruptcy due to the financial crisis and declining car sales. The company faced a significant financial decline which led to it voluntarily filing for bankruptcy protection. GM used this opportunity to restructure its operations, shutting down many of its older plants and focusing more on innovative and fuel-efficient vehicles.3. American Airlines: It’s not uncommon for airlines to file for voluntary bankruptcy due to tough competition and volatile fuel prices. American Airlines filed for Chapter 11 bankruptcy in 2011, despite not being insolvent. The company chose voluntary bankruptcy to reduce its labor costs and negotiate a better contract with their employees. After the bankruptcy proceeding, the company came out stronger and more competitive.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Debtor
• Creditors
• Bankruptcy trustee
• Chapter 7 Bankruptcy
• Chapter 11 Bankruptcy

Sources for More Information

• Investopedia
• The Balance
• Nolo
• LegalZoom