History of Bankruptcy

As we discussed on our introduction to bankruptcy webpage, bankruptcy dictated by the Supreme Court in 1934 was created to give a borrower a brand new beginning.  The case that made this decision was Local Loan v. Hunt 1934.  The Supreme Court stated, “relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes” page 292 U.S. 244.  Even though Local Loan v. Hunt enraptures the spirit of the law on why America allows bankruptcy this is not where the concept of bankruptcy was established. 

When the founders of America were developing the Constitution they attempted to address the issue of bankruptcy in Section 8 Article I by establishing a set of uniform laws that everyone would follow. 

As an interesting side note we want to discuss a brief history of the development of Bankruptcy.  The idea of bankruptcy or forgiving a debt can be traced back to the Romans and to biblical times.  While the Romans and Greeks did not forgive debt they had methods of borrowers paying back the debt.  A borrower who owed a debt may have had to sell themselves, family, and slaves into slavery.  Some provinces limited the time and harshness a creditor may own and treat debtor (less than ten years) while other provinces did not.  Nevertheless, it has become commonly accepted that the word bankruptcy was derived from Latin.  Bankruptcy is a combination of two Latin words bancus and ruptus.  Bancus is roughly defined to mean table and ruptus is roughly defined as broken.  The history written by the Romans tells of tales when the original bankers would set up a table with money in public locations of Rome to attract customers and carry out business.  If this Roman’s business was found to be unsafe in any manner the people would force him out of business.  They then would break his bench and leave it for everyone to see.  This would signify to all the other Romans they should not do business with this particular Roman.

During the time of Rome and polytheism a new idea of monotheism started to develop.  A book called the torah or the Old Testament was written for this religion and later was updated by what is known now as the Bible.  The Old Testament addressed the idea of forgiving a debt several times.  One example is in the book of Leviticus 25: 10-13 and it basically states that Moses speaks of a Holy Year, once every fifty years, in which all debts are forgiven and all Israelites who sold themselves into slavery would be freed.  Another example is in the book of Deuteronomy 15:1-2 and is basically stated that creditors would forgive all outstanding debts once every seven years. 

A more substantial form of bankruptcy in which the American concept was influenced by the British laws established in the 1540s by Henry the VIII.  The British’s laws around bankruptcy were influenced by the Romans.  Henry’s intention was not to protect the borrower.  He was using bankruptcy as a method which reinforced the creditor’s rights and helped to imprison a debtor who owed the creditor money.  This prison came to be known as debtor’s prison. 

Throughout the 1800s Congress passed several bankruptcy laws trying to make modifications that would benefit the people only to decide to repeal all of the laws they passed.  As with progress these laws were only a foundation of ideas, but through trial and error they started to evolve.  At the end of the 1800s (1898) Congress approved the Bankruptcy Act.  This act was the most beneficial bankruptcy law that had been passed up until this point in time.  The courts understood the era America had entered.  It was the Industrial Age; a time of fast paced work and exponential growth of businesses. Due to factories needing capital America saw a large expansion in the number of banks in our country.  These banks gave the factories the money they needed to improve and/or purchase equipment.  As with massive expansion and a fast paced economy there were companies that were unable to survive in this type of environment.  These companies made bad investments and went out of business.  Congress had the insight in 1898 to understand what America was experiencing.  They knew all companies would not be able to survive, therefore, in order for the successful companies to take more risk they needed to develop safety net in case a business failed.  This is how The Bankruptcy Act of 1898 was developed.  It released a borrower of all their debts.  Additionally, the Act allowed for broader exemptions on a borrower’s assets more so than any other of the acts in the past.  It also established rules that are still in existence today.   For example, it granted the right to assign a court official to carry out laws and hear bankruptcy cases in their assigned local district.  America has 90 bankruptcy court districts today that carry out bankruptcy laws.  The Bankruptcy Act of 1898 also instituted the idea of “chapters” to file for bankruptcy.  A borrower would have to file for bankruptcy under these “chapters” based upon specific criteria created by the Supreme Court.  

The next progression in bankruptcy was seen in the mid and late 1930s.  In 1934, as we discussed above, the Supreme Court heard and ruled their translation on the laws of bankruptcy in Local Loan v. Hunt.  Then in 1938 Congress passed the Chandler Act which was introduced by Congressman Chandler to be a general amendment to the National Bankruptcy Law.  The Chandler Act established Chapters X and XI in addition to providing more power to the district authorities, “bankruptcy referees”.  These court appointed officials were provided autonomy to help carry out these reorganizations.  The next major change in the bankruptcy courts was in 1946.  Instead of paying court officials on a compensation basis per case the court officials received a fixed salary for a full-time position.  This helped keep the court officials independence for each case.  In 1973 the Supreme Court renamed the court official from Referee to Bankruptcy Judge.  The major revisions to bankruptcy laws were not until the Bankruptcy Reform Act of 1978.

The Bankruptcy Act of 1978 performed an overhaul on the bankruptcy process.  It established the bankruptcy laws and interpretations that we use today.  We will discuss the Chapters on individual webpages but changes that the 1978 Act established were as followed:

  • Chapter X, XI, and XII with an updated Chapter 11.  This chapter is used today for businesses having to reorganize their companies. 
  • The 1978 Act strengthened an individual’s right when filing for bankruptcy by giving additional advantages to the laws associated with Chapter 13. 
  • Federal judicial districts received their own U.S. Bankruptcy Courts which provided them with their own clerks and employees.
  • Chapter 7 which is liquidation under section 704 appointed a Trustee to sell all the assets for the corporation and any claims (liens) that the corporation owed paid out based upon priorty. The priority were as followed
    • Secured Creditors
    • Administration Expenses (i.e. legal fees)
    • Unsecured Creditors (received pro rata distribution)
    • Shareholders
  • The 1978 Bankruptcy act enacted an automatic stay as soon as the corporation or individual filed for bankruptcy.  An automatic stay immediately stops all creditors from pursuing payment and harassing the individual who filed for bankruptcy.

Finally, in the 1980’s two rulings were made to Bankrupcty laws.  The Supreme Court 1982 questioned the constitutionality of the grant of bankruptcy jurisdiction to independent courts with judges who served limited terms.  Then in 1984 ruled that Bankruptcy Courts will be a part of the United States District Courts, but United State Courts of Appeals will select the Bankruptcy Judges who will oversee the courts in each district.

As a reader an individual can see the complexities that have been associated with a debtor who is unable to pay their debts.  Since the Roman era till today civilized societys have been trying to establish the best option on how to address persons and corporations who are unable to pay their debt.  From slavery to bad credit.  As with our Constitution the bankruptcy laws are living and breathing laws that are always changing and trying to develop into outcomes that are beneficial for the debtor and the creditor.  As you can see there has to be a give and take with bankruptcy.  However, we as a society have to deal with the bankruptcy laws we have at hand today and incorporate them into our situations.  Therefore, when dealing with laws with so many intricacies it is best to obtain the help of a professional.

  • Share/Save/Bookmark