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What is the difference between voluntary and involuntary bankruptcy?

Updated on
March 16, 2024

What is Voluntary Bankruptcy?

Voluntary bankruptcy is when you choose to file for bankruptcy yourself. There are two main types of personal bankruptcy under the U.S. Bankruptcy Code that a debtor can file voluntarily:

  • Chapter 7 Bankruptcy: This is also known as liquidation bankruptcy. It involves liquidating your assets to pay back your creditors. Any assets that are not exempt under the law are sold by the bankruptcy trustee and the proceeds are used to repay creditors according to priorities of the bankruptcy code. Remaining unpaid debts are discharged, with some exceptions like student loans and alimony.
  • Chapter 13 Bankruptcy: This is also known as wage earner bankruptcy. It involves setting up a 3-5 year repayment plan to pay back creditors over time. You get to keep your assets but must live on a court-approved budget and make monthly payments to creditors. After completing the repayment plan, remaining unpaid debts are discharged. To qualify for Chapter 13 you must have a regular income.

The primary advantage of filing for voluntary bankruptcy is that you initiate the process yourself and have more control, versus creditors forcing you into an involuntary bankruptcy against your will.

What is Involuntary Bankruptcy?

Involuntary bankruptcy is when creditors force a debtor into bankruptcy through the legal process. Creditors can file an involuntary bankruptcy petition against a debtor if certain criteria are met.

The most common type of involuntary bankruptcy filing is under Chapter 7 of the bankruptcy code. This involves liquidating the debtor's assets to pay creditors.

For creditors to file for involuntary bankruptcy against a debtor, the following criteria must be met:

  • The debtor must have at least 12 eligible creditors.
  • At least 3 unsecured creditors must join in filing the involuntary petition.
  • The debts owed to the petitioning creditors must total at least $16,750.
  • The debtor must not be paying debts as they come due.

Once an involuntary petition is filed, the debtor has the right to contest it. Reasons for contesting can include:

  • The creditors do not meet the minimum criteria for filing.
  • The amount owed to creditors is less than the $16,750 minimum.
  • The debtor can work out alternative repayment plans with creditors.

If the debtor does not contest, or the petition meets the requirements, the court can order relief and put the debtor into involuntary bankruptcy.

Criteria for Involuntary Bankruptcy

For creditors to file an involuntary bankruptcy petition against you, they must meet certain criteria set by the bankruptcy code:

  • Minimum Number of Creditors - The petition must be filed by at least 3 creditors for business/individual debtors, or 1 creditor if it's a partnership.
  • Minimum Unsecured Debt Owed - The unsecured debts owed to the creditors filing the petition must total at least $16,750 for individual debtors, or $17,000 for business debtors. This does not include debts that are secured by collateral.
  • Generally Not Paying Debts - The creditors must establish that the debtor is generally not paying their debts when they are due. This means failing to make timely payments on multiple debts over a period of time prior to the bankruptcy filing.

The creditors must meet all 3 of these criteria for the court to put you into an involuntary Chapter 7 bankruptcy. If they do not meet the requirements, you can contest the involuntary petition.

Contesting an Involuntary Petition

If you believe the creditors filing the involuntary bankruptcy petition against you don't meet the legal criteria, you have the right to fight it. There are several ways you can contest an involuntary bankruptcy petition:

Argue the creditors don't meet the criteria

To file an involuntary bankruptcy, the creditors must meet certain requirements. For example, there must be 3 or more creditors owed a certain minimum amount that is past due. Review the specifics for your state and argue that the creditors don't meet these criteria. Provide evidence that not enough creditors are included or that the amount owed or time criteria are not met.

Claim the amount owed is less than required

Even if the number of creditors is sufficient, argue that the total amount of debt owed is less than the minimum amount required by law to force you into involuntary bankruptcy. Produce documentation like invoices, contracts, or correspondence showing the amount you actually owe the creditors is below the threshold.

Work out a repayment plan

You can also attempt to negotiate with the creditors to create a repayment plan outside of bankruptcy. If you can get the creditors to agree to structured payments over time, they may agree to dismiss the involuntary bankruptcy petition. But the plan must provide repayment terms that satisfy the creditors enough for them to drop the bankruptcy case voluntarily.

Contesting an involuntary bankruptcy filing can be complex, so consult with legal counsel experienced in bankruptcy law to assess the options in your specific situation. But it's important to understand you have rights to fight an involuntary bankruptcy push by creditors if you believe their petition does not meet the legal standards or if you can reach an agreement on repayment.

Chapter 7 Involuntary Bankruptcy

If the court decides to put you into Chapter 7 bankruptcy against your will, a trustee will be appointed to your case. The trustee's job is to liquidate your nonexempt assets and use the proceeds to pay back your creditors.

Any assets not exempt under bankruptcy law can be seized and sold by the trustee. This may include things like second homes, rental properties, luxury vehicles, valuable collections, etc. The trustee will try to get the highest price possible to pay off your debts.

After liquidating all non-exempt assets, most remaining unsecured debts will be legally discharged. However, certain debts like student loans, alimony, child support, and taxes cannot be wiped away in bankruptcy.

While the discharge provides some financial relief, having an involuntary Chapter 7 bankruptcy on your credit report will make it very difficult to get approved for new credit or loans. It will show up for 10 years and severely damage your credit score during that time.

Some key takeaways about Chapter 7 involuntary bankruptcy include:

  • Non-exempt assets get liquidated by a trustee to pay creditors
  • Most remaining unsecured debts are wiped away after assets are liquidated
  • Credit score is severely damaged for up to 10 years due to bankruptcy on record

Converting an Involuntary Chapter 7 to Chapter 13

If you find yourself in an involuntary Chapter 7 bankruptcy, you may be able to convert your case to a Chapter 13 bankruptcy instead. This would allow you to propose a repayment plan to the court rather than having your assets liquidated.

To convert to Chapter 13, you would need to meet certain income requirements showing that you have enough income to make payments under a proposed repayment plan. Your income must be stable and regular.

You would then need to propose a repayment plan to the court that spans 3-5 years. This repayment plan allows you to keep your assets, make affordable monthly payments to creditors, and then have any remaining dischargeable debts eliminated after completing all payments under the plan.

The monthly payment amount in your Chapter 13 repayment plan depends on how much disposable income you have available after accounting for reasonable living expenses. Your repayment plan must pay creditors at least as much as they would have received in a Chapter 7 liquidation.

The court must approve the proposed repayment plan, and you must successfully make all payments under the plan in order to get your discharge of remaining debts at the completion of the repayment term. Converting an involuntary Chapter 7 to a Chapter 13 through a court-approved repayment plan allows you to avoid liquidation and hold on to your assets.

The Meeting of Creditors

If you file for bankruptcy, whether voluntary or involuntary, you will be required to attend a meeting of creditors. This is a hearing overseen by the bankruptcy trustee assigned to your case.

The meeting allows your creditors to come and ask you questions about your finances and the details of your bankruptcy filing. Creditors can ask about your assets, monthly income, living expenses, debts, and anything related to the information in your bankruptcy paperwork.

It is important to be completely transparent and honest when answering the questions from creditors. You will also need to provide any documents required by the trustee such as pay stubs, bank statements, tax returns, and paperwork related to your debts and assets.

The meeting gives the bankruptcy trustee and your creditors a chance to understand your financial situation more clearly. It is not meant to be confrontational but to ensure the accuracy of your case before deciding on discharging debts or approving a repayment plan.

The meeting of creditors is a standard part of all bankruptcy cases. Be prepared to attend and participate fully by responding to all questions asked by the trustee and creditors. Having all required documentation available demonstrates you are taking the process seriously.

Making Payments After Bankruptcy is Filed

If you end up in a Chapter 13 bankruptcy, you will have to make payments according to the repayment plan for 3-5 years. The trustee will collect payments from you each month and distribute them to your creditors. The amount you need to pay is determined by how much disposable income you have available after living expenses.

If your case is a Chapter 7 bankruptcy, your wages could be garnished to pay back creditors after your assets are liquidated. The trustee can require your employer to deduct a certain amount from each paycheck to go towards debts owed. Wage garnishment will continue until your debts are paid off or until you complete the bankruptcy process after several months.

The amount that can be garnished depends on how much you earn and the federal and state limits on wage garnishment. Speak to your bankruptcy lawyer about the potential impact on your income during a Chapter 7 case.

Consult a Bankruptcy Attorney

The decision to file for bankruptcy, whether voluntary or involuntary, should not be taken lightly. The bankruptcy process can be complex and the consequences severe. It's highly recommended that you consult with a qualified bankruptcy attorney before moving forward.

An experienced bankruptcy lawyer can provide counsel tailored to your specific financial situation. They can advise you on whether bankruptcy is the right move and which chapter may be best suited. The attorney can also inform you about exemptions that allow you to keep certain assets and explain how bankruptcy will impact your future credit and finances.

It's important to locate an attorney who specializes in bankruptcy law and has represented numerous debtors in the past. Ask people in your local area for recommendations. Contact your state bar association to find attorneys experienced in bankruptcy cases. Read reviews and compare several potential lawyers before deciding who to work with.

Schedule a consultation to discuss your debts, assets, income, expenses and overall financial circumstances. Be prepared to answer questions and provide documentation so the attorney can offer the most informed counsel. Make sure you understand all options clearly before making any decisions.

With the help of a qualified bankruptcy lawyer, you can navigate the complex legal process in the most advantageous way possible. Having an experienced attorney review your specific situation reduces risks and ensures your rights are protected throughout the bankruptcy proceedings.

Learn More About the Process

To properly understand the bankruptcy process and how it may impact your specific situation, it's important to educate yourself using reputable sources. Here are some recommendations on where to find more information:

  • Visit the website for your local bankruptcy court. Most courts have detailed information about the bankruptcy process, the various chapters and types, forms and documents needed, FAQs, and more. Reading through the court's website will give you a solid overview of how bankruptcy works in your jurisdiction.
  • Check out government resources like the official United States Courts website's bankruptcy section. It provides clear summaries and guides to the bankruptcy process.
  • Look for educational articles, videos, and content from legal and financial experts. Nonprofit organizations like LegalZoom, NOLO, and reputable law firms often publish helpful bankruptcy information. Avoid random blogs or forums, which may have inaccurate information. Vet any sources to ensure they are reliable.
  • Read books and eBooks focused specifically on bankruptcy. There are many well-researched books that break down how bankruptcy works in an easy-to-understand way. Your local library likely has titles you can borrow.

Getting familiar with the bankruptcy process will empower you to make an informed decision about the best route for your situation. Rely on official government, legal, financial, and nonprofit resources for trustworthy information.

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