A brief history of Bankruptcy Law in America

In 2002, there were over 1,576,000 bankruptcy filings in the United States.1

For most people, the term bankruptcy is full of dreadful connotations.  It's not a pretty picture when you are in a situation where you cannot pay your debts and the law takes over for you.  On the other hand, it's not as bad as it once was — The chances of you spending the rest of your life in debtor's prison are small — if the current bankruptcy laws are properly applied, the bankruptcy process can consolidate your debts, and provide a feasible schedule for you to repay them.  It hasn't always been this way.

The term bankruptcy derives from the Italian phrase "banca rotta," literally broken bench2.  The term comes from medieval Italy where it was the practice to deal with a businessman who did not pay his debts by "breaking" his trading "bench," thus putting him out of business.  Up until the 20th century, the rules regarding bankruptcy were very harsh and strongly favored the creditor over the debtor.  The emphasis was on retrieving as much of the creditor's investment as possible and very little regard was given to the effects on the debtor, whose life was often irrevocably ruined.  

The first official bankruptcy laws in England were passed under the rule of King Henry VIII in 1542.  Under these early bankruptcy laws, the debtor was considered a criminal and was subject to penalties ranging from incarceration in a debtor's prison, up to the death penalty.  Originally, bankruptcy law in America was derived from English statutes, but over time they were modified to accommodate short term changes in the economy as well as various special interest groups.

The first federal bankruptcy law in the U.S. was enacted in 1800 specifically to address excesses in land speculation.  These laws were repealed in 1803, and a new set of bankruptcy laws was passed in 1841, this time in response to the economic panic of 1837.  This law was in turn repealed in 1843.  The American Civil War was the stimulus for the next bankruptcy law in 1867.  This law lasted until 1878 and was the first to include provisions specifically addressing corporations. Unlike English law, all of the American bankruptcy laws contained some provision for the discharge of unpaid debt.  This paved the way for modern bankruptcy laws which include protections for the debtor and emphasize the concept of rehabilitation of debtors after the bankruptcy proceedings.

The Bankruptcy Act of 1898 provided for a bankrupt company to be put into an "equity receivership," that specifically protected the company's assets from creditors.  The provisions in the law for "reorganization" allowed a company to survive a bankruptcy proceeding and emerge to do business again. The reorganization principles in these early bankruptcy laws were expanded and formalized during the 1930's in response to the massive economic upheavals of the Great Depression.  Specifically, the Bankruptcy Acts of 1933 and 1934 were incorporated and extended in the Chandler Act of 1938. The Chandler Act remained the primary bankruptcy statute until it was superceded by the Bankruptcy Reform Act of 1978.  

The Bankruptcy Reform Act of 1978 was a significant legislative watershed in bankruptcy law.  It strengthened and consolidated business reorganization procedures under Chapter 11, and replaced the older personal bankruptcy regulations with Chapter 13.  The Bankruptcy Reform Act of 1978 made it significantly easier for both businesses and individuals to file for bankruptcy and seek protection from their creditors. The 1978 law did not cover tax-related issues and this was addressed in the Bankruptcy Tax Act of 1980. The 1980 law also addressed issues such as tax loss carry-forwards and taxation rules where equity is exchanged for debt relief.

Many felt that the 1978 law went too far in providing protections for the debtor and in 1982, the U.S. Supreme Court ruled that the expanded jurisdiction of the bankruptcy court was unconstitutional. This ruling led to the Bankruptcy Amendment Act of 1984, and reduced the power of the bankruptcy judges.  The 1984 act also limited the rights of companies to terminate labor contracts when they entered bankruptcy. In 1986, Chapter 12 bankruptcies were created to cover family farms

During the 1980's and early 1990's, record numbers of bankruptcies were filed including many well known companies such as Texaco, Continental Airlines, Greyhound, Federated Department Stores and Pan Am. Some of the large multinational companies that filed for bankruptcy challenged the legal system in demanding that the insolvency laws of several countries be reconciled. The 1990's also brought innovation to bankruptcy law in the form of "pre-packaged" bankruptcies that streamlined the process and allowed the court system to handle the large volume of cases.  The early 1990's also saw a sharp increase in the use of bankruptcy professionals such as examiners and mediators authorized by the court to expedite matters and reduce the cost and delay in large bankruptcy cases. 

The Bankruptcy Reform Act of 1994 (Public Law 103-394) is the most significant change in American bankruptcy legislation since the 1978 Act.  The 1994 Act, signed into law by President Clinton on October 22, 1994, contains provisions affecting business and personal bankruptcy laws.  Some areas the 1994 Act addressed specifically expedite bankruptcy proceedings, encourage consumers to utilize Chapter 13, rather than Chapter 7, to consolidate and reschedule their debt, and assist creditors in recovering claims against bankrupt estates.  The 1994 act also created the National Bankruptcy Commission to continue looking into needed changes in bankruptcy law.  In November 1997, the Commission completed its first comprehensive review and delivered a detailed report on recommended reforms. 

Further changes in bankruptcy law may be expected as the law evolves to meet the changing needs of society.

 

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1 Stats courtesy of the American Bankruptcy Institute: http://www.abiworld.org/

2 Background information courtesy of: The 2001 Bankruptcy Yearbook & Almanac: http://www.bankruptcydata.com/Yearbook2.htm

Bank"rupt*cy (?), n.; pl. Bankruptcies().

1.

The state of being actually or legally bankrupt.

2.

The act or process of becoming a bankrupt.

3.

Complete loss; -- followed by of.

 

© Webster 1913.

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