5 -- Bankruptcy:
Introduction, History
© Charles Tabb 2010
Front-Page News
Scandal
$600 Billion
Charles Ponzi
Famous Bankrupts
Filings quadrupled
Filings Return post-BAPCPA
Which chapters?
Chapter filings
Chapter 7
Chapter 13
Chapter 11
Other
Business or consumer?
type of filing
Consumer
Business
Credit Card Debt and Bankruptcy
Revolving Consumer Credit and Non-Business Bankruptcy
filings, Two-Year Time Lag, 1982-2006
Revolving Consumer Credit, Two Years Earlier
Non-Business Bankruptcy Filings (per 1,000)
20
06
20
04
20
02
20
00
19
98
19
96
0
19
94
0
19
92
2
19
90
500,000
19
88
4
19
86
1,000,000
19
84
6
19
82
1,500,000
Defoe’s “Four Sorts”
• 1st -- The Honest Debtor
– Fails by necessity, losses, sickness, decay of
trade
• Goal of the law:
– That a necessary favour be shown, in pity
and compassion
Sort # 2
• 2nd – the Knavish, Designing, or Idle,
Extravagant Debtor
– Fails either because he has run out his
estate in Excesses, or on purpose to cheat
and abuse his Creditors
• Goal of the Law:
– That a due rigor and restraint be laid upon the
2nd, that Villany and Knavery might not be
encourag’d
Sort # 3
• 3rd: the moderate Creditor
– Seeks but his own, will omit no lawful
Means to gain it, yet will hear reasonable
and just Arguments and Proposals
• Goal of the Law:
– That a due care be taken of the third, that
mens Estates may, as far as can be, secur’d
to them
Sort # 4
• 4th: the Rigorous Severe Creditor
– Values not whether debtor honest or Knave
– Will have his debt, whether it be had or not
– Without mercy or compassion; full of ill language,
passion, and revenge
• Goal of the Law:
– Due limits set upon the last
– No man may have an unlimited Power over his FellowSubjects, to the Ruin of both Life and Estate
History of Bankruptcy:
ancient and primitive societies
• in Mesopotamia around 4000 B.C.,
debtors who defaulted on loans of items
like food became indentured servants to
creditors.
“Fasting on”
• Creditors in ancient India and Nepal "fasted
on" debtors. The creditor would fast on the
debtor's doorway until the debt was paid,
bringing humiliation to the debtor. If creditor
died, the community would take debtor out
and beat him to death
Ancient Egypt
• Ancient Egyptians performed elaborate burial
rituals to ensure passage to the afterlife, and
debtors customarily pledged the body of their
nearest deceased relative. In cases of default,
the creditor could remove the body and close
the tomb to prevent future burials
North African tribes
• Around 1000 B.C., in some North African
tribes, failure to pay a creditor was viewed as
a sign of dishonesty that affected the entire
tribe. The group could then push out the
debtor, putting an end to his familial
relationships as well as to his protection by
the tribe.
Ancient East India
• Creditor given full sanction in disposing
of debtor, his wife, and children
• Debts could be satisfied by creditor
violating the chastity of the debtor’s wife
Draco -- Athens
• ~ 623 B.C. – debtors pledged bodies for
debts
• Default
– Initially capital offense
– “softened” by allowing creditor to foreclose
on debtor, i.e., take debtor and family into
slavery
Solon
• 594 BC revised Draco’s laws
• Forbade debtors from pledging their
body as security
• Abolished slavery for debt
• BUT –bankrupt forfeited Greek
citizenship
Rome: Twelve Tables
• Debtors in Rome around A.D. 450 pledged
themselves to creditors. Those who didn't pay
up could be taken into slavery, and the
language of the law suggests the debtor could
be carved up into pieces.
– Scholars debate whether this dismemberment
was literal or figurative.
Bible: slavery
• Now the wife of one of the sons of the
prophets cried to Elisha, “Your servant my
husband is dead, and you know that your
servant feared the lord, but the creditor has
come to take my two children to be his
slaves.”
– II Kings 4:1
Bible: Release
• At the end of every seven years, you shall
grant a release. And this is the manner of the
release: every creditor shall release what he
has lent to his neighbor.
– Deut. 15:1
Incentive effects?
• If there is among you a poor man, you shall
not harden your heart or shut your hand
against your poor brother, ... but you shall
lend him sufficient for his need. …
• Take heed lest there be a base thought in your
heart and you say, “The seventh year, the year
of release is near,” … and you give him nothing
– Deut. 15:7-9
Jubilee
• The fiftieth year shall be a jubilee for you.
• In the Year of Jubilee, everyone is to return to his
own property
• If one of your countrymen becomes poor among
you and sells himself to you, do not make him
work as a slave. He is to be treated as a hired
worker …; he is to work for you until the Year of
the Jubilee. Then he and his children are to be
released.
– Lev. 25:11, 13, 39-41
Middle Ages
• Imprisonment for debt introduced 1285
in England
• Lasted until 19th century
Expansion of commerce
• Interests of evolving nation-states implicated
• Desperate to encourage commerce and lending
– So needed to protect creditors
• Examples
– Italy: insolvent debtor tortured to reveal his property
– Holland (Charles V 1531, 1540): absconding debtors
summarily hanged
– Spain: insolvent debtor imprisoned until made
“cessio” (composition) to pay creditors
1st English Bankruptcy Law 1543
• King Henry VIII
• “an act against such persons as do make
bankrupts”
• Debtors treated as quasi-criminals
• For benefit of creditors only
– Only creditors could file case
– No discharge of debts
– Collective proceeding – equitable treatment of all
creditors when multiple defaults
Only applied to merchant debtors
• English bankruptcy law only applied to
merchant debtors
– True until 19th century
• Only group for whom credit was justifiable
• Non-merchant debtors were dealt with under
separate “insolvency” laws
– No debt discharge
– Might be able to get release from prison
Queen Elizabeth I: 1571
• 1st comprehensive bankruptcy law
• Template of basic principles of law that
lasted until formation of U.S.
17th century – raising the stakes
• Kept having trouble collecting from debtors –
hide property, lie, etc.
• 1604 – uncooperative debtor could be
pilloried in public square and have his ear cut
off
• 1623: bankruptcy commissioner given power
to break into debtor’s house and seize
property
Statute of Anne 1706
• The final straw – enacted in response to
notorious frauds of Thomas Pitkyn
• Carrot for debtors who cooperated:
– DISCHARGE of debts
• Stick for uncooperative debtors:
– DEATH penalty (“felon without benefit of clergy”)
Articles of Confederation
• No federal bankruptcy power
• Regulation of bankruptcy left to
individual states
• As colonies many of the states had fairly
comprehensive bankruptcy laws
U.S. Constitution
• Article 1, § 8, clause 4: Congress
given power to “pass uniform laws
on the subject of bankruptcies”
Madison - Federalist
• Reason for Bankruptcy clause as federal
power?
• Madison in Federalist papers:
– “intimately connected with regulation of
commerce”
– “prevent so many frauds where the parties
or their property may lie or be removed into
different states”
Exercise of Bankruptcy Power
• For 1st century as country, only rarely had a
federal bankruptcy law in effect
• Rest of the time was left to individual states
• Two big problems with state regulation
– Could not discharge prior debts
– Could not discharge debts of citizens of another
state
1st US bankruptcy law
• Bankruptcy Act of 1800
• Passed in wake of Panic of 1797
• Almost a verbatim copy of extant English
law
– (about only changes were using $ instead of £,
and deleting references to the King)
• Repealed 1803
Attributes of 1800 law
• Only involuntary bankruptcy
– i.e., only creditors could file
– Debtors who wanted discharge tried to get
friendly creditors to make filing
• Merchant debtors only
• For debtor who cooperated with the
bankruptcy trustee
– Discharge of debts (subject to some exceptions)
– Discharged from debtors’ prison
Abolition of imprisonment for debt
• Federal level – abolished 1833
• States – generally abolished as norm in 1830
and 1840s
– Note that vestiges remain – especially for child
support
– Theory is to pressure debtor into paying
2nd US Law: 1841
• Enacted in wake of Panic of 1837
• Bankruptcy Act of 1841 was watershed
• Voluntary bankruptcy allowed for 1st time
– Debtor had right to file petition
• Eligibility not limited to merchant debtors
– “all persons whatsoever owing debts”
for 1st time in history, any debtor
(merchant or not) could himself file
bankruptcy and, if he cooperated, get a
discharge of debts
> Thus,
Radical Expansion of “Bankruptcy”
• The 1841 Act was such an extraordinary
expansion of the nature of bankruptcy
relief that serious doubts were raised as
to whether it was even constitutional,
that is, did it even fall within “the subject
of bankruptcies”
Repealed 1843
• Act of 1841 was a dismal failure (from the
perspective of creditors)
– Collected almost nothing
– Many debtors got discharge
• Repealed less than two years after enacted, in
1843
3rd Act -- 1867
• 3rd U.S. Bankruptcy Act passed in 1867
• In wake of Civil War
• Two main innovations
– Use of state exemption laws
• Continues to present day
– Composition agreement (1874)
• Forerunner of reorganization provisions
Repealed 1878
• Deemed a failure for just about
everybody
– Northern creditors didn’t collect much from
Southern debtors
– Only 1/3 of debtors got a discharge – so
many exceptions
Bankruptcy Act of 1898
• Passed in wake of Panic of 1893
• Began era of permanent federal bankruptcy
legislation
– No chance will ever go back to state regulation
– State bankruptcy laws are preempted
• 1898 Act was in effect for 80 years, until
enactment of current Bankruptcy Code in
1978
Nature of 1898 Act
• General structure and nature of relief of 1898
Act similar to what have today
• Broad eligibility
• Voluntary bankruptcy allowed
• State exemptions
• Discharge of debts allowed, subject to a few
exceptions (e.g., fraud, willful and malicious
injuury)
Reorganization laws enacted 1930s
• Great Depression 1930s
• Congress enacted a series of reorganization
laws
– Replaced “federal equity receiverships”
– 1934: railroads
– 1935: corporate reorganization
– 1934, 1935: farmers
– After some uncertainty, upheld by Supreme Court
Chandler Act 1938
• Substantial revision of 1898 Act
• Reorganization provisions
– Chapter X: corporate reorganizations
– Chapter XI: “arrangements”
– Chapter XII: real property
– Chapter XIII: wage earners
Bankruptcy reform in the 1970s
• 1970: Congress created 1st Bankruptcy Review
Commission
• 1st ever overhaul of bankruptcy law not in
response to a financial panic
• Issued report 1973
• Hearings 1975-1976
• Bankruptcy Reform Act signed into law Nov 6,
1978 by President Carter
Reorganizations
• One major change in 1978 Code was to
create a SINGLE reorganization chapter
• Chapter 11 replaced old chapters X and
XI
• Combined aspects of each chapter
Exemptions
• Another major debate in 1970s reform was
whether to keep use of state exemptions for
bankruptcy debtors, or allow debtors to use a
uniform federal exemption
– Problem was some states have very few exemptions
• Compromise: allow debtor to choose state or
federal -> unless state of debtor’s residence
“opted out” of federal exemptions
– Which 2/3 of states have done
Biggest issue:
status and jurisdiction of courts
• Under 1898 Act, bankruptcy judges (or
“referees”) did not have Article III status
• Their jurisdiction was limited
– Summary vs. plenary
– Only core bankruptcy matters could be heard by
bankruptcy judge
– Very inefficient
Solution?
• Unified jurisdiction
– Bankruptcy judge could hear and decide all
matters arising under, arising in, or related
to a bankruptcy case
– Would eliminate all issues of “which court”
and allow one judge to handle everything
Problem
• If bankruptcy judge to exercise jurisdiction
over every aspect of a bankruptcy case, might
need to enjoy Article III status
• Exercising “judicial power of the United
States”
• there was strong opposition (led by CJ Burger)
to creating over 200 new Article III judges
– Especially for lowly regarded “bankruptcy referee”
Split the baby in 1978 law
• Gave bankruptcy judges unified
jurisdiction
• But did not give them Article III
status
Marathon Pipe Line
• 1982 U.S. Supreme Court held that it was
unconstitutional for a non-Article III
bankruptcy judge to hear a breach of contract
action involving bankruptcy debtor
– was obviously exercising “judicial power”
– Not enough that Article III district courts and
Courts of Appeals could review decisions on
appeal
Emergency Rule
•
•
•
•
Limbo for 2 years
Marathon decided June 28, 1982
New law (BAFJA) not enacted until July 1984
During that 2-year period, bankruptcy system
operated under “Emergency Rule”
– A model local rule adopted nationally
– System was that Article III district courts had
jurisdiction, and then referred that jurisdiction to
bankruptcy judges as adjuncts
Bildisco
• Feb 1984 U.S. Supreme Court held that a
chapter 11 debtor could reject its
collective bargaining agreement
• And that it did not commit an unfair
labor practice by unilaterally modifying
that agreement prior to rejection
• Organized labor went ballistic
The attack on “can-pay” consumers
• Meanwhile – the consumer credit industry had
launched a full-scale attack on the supposed
generosity and liberality of the new law for
individual consumer debtors
• Alleged that a large % of consumers who were
getting an immediate discharge of debts in
chapter 7 without paying creditors a dime in fact
could repay a significant % of their debts
– Funded studies (e.g., Purdue) that supported thesis
BAFJA
• Enacted July 10, 1984
• 1st: addressed Marathon problem
– Not give bankruptcy judges Art. III status
• Adjuncts of district court
– Split jurisdiction
• “hear and determine” core matters
• “hear” non-core related matters
BAFJA
• 2nd: addressed Bildisco problem
• New § 1113
• 1st aspect: reject collective bargaining
agreements
– Largely codifies Bildisco
– CAN reject if show sufficient necessity, tried to bargain
• 2nd aspect: unilateral modification
– Reversed Bildisco
– Now must have prior court approval, emergency only
BAFJA
• 3rd: compromise on can-pay debtors
• Enacted “substantial abuse” test to dismiss a
chapter 7 filing by an individual consumer
debtor
• Did NOT provide, though, that projected
ability to repay debts necessarily = substantial
abuse
• Did not allow involuntary chapter 13
Family Farmers
• 1986 – temporary enactment of “chapter 12”
for “family farmers”
– In response to farm crisis
– Remember “Farm Aid”?
Chapter 12 made permanent 2005
But very few chapter 12 cases actually filed
The 21-year Itch
• Consumer credit industry was NEVER happy
with the “half a loaf” they got in 1984 in the
“substantial abuse” test
• Lobbied incessantly for 21 years to get a more
draconian anti-debtor law passed
• Paid big
to get law they wanted
1994 Act & Commission
• 2nd National Bankruptcy Review Commission
created by 1994 Act
• Issued report 1997
• Report rejected idea of fundamental reform of
consumer bankruptcy
• Made many other useful recommendations
Anti-Consumer Debtor War
• Consumer credit industry ignored rebuff by
Commission and focused on Congress
• Bill after bill that stuck it to consumer debtors
passed from 1998 on, but got waylaid one way
or another
– Once Pres. Clinton pocket vetoed the bill
– Sept. 11 attack diverted Congress (a markup
hearing was scheduled for Sept. 12)
BAPCPA
• April 20, 2005, Pres. Bush signed the
Bankruptcy Abuse Prevention and (here is the
funny part) Consumer Protection Act
• Over 500 pages long, made myriad changes in
the bankruptcy law
– Many very useful
BAPCPA
• Most significant: reformed consumer
bankruptcy
– New “abuse” test
• apply “means test” to kick supposed can-pay
individual debtors out of chapter 7
– No involuntary chapter 13 – but may be
only option for debtor whose case is
dismissed under 7