History of Bankruptcy

“If there was no credit, there would be no bankruptcy”

The more the economy depends on credit, the more important bankruptcy becomes.

Recent debt statistics (4th quarter 2012) for the U. S. economy:         

Total Consumer Debt (includes mortgages):	$11.31 trillion
Credit card debt:	$850.9 billion
Student loan debt:	$986.8 billion
Total Business Debt:	$12.70 trillion
Total Government Debt:	$14.60 trillion

An economy that utilizes debt to this extent must have a safety valve if it to avoid the extremes of collection through indentured service (forced labor), or debtors’ prisons, or civil unrest, or violent revolution.

Bankruptcy provides that safety valve for the United States.

The concept of discharging debts and rehabilitating the debtor is at least as old as the Old Testament. The earliest legal system that permitted debt relief is found in the Mosaic law. In the book of Deuteronomy, chapter 15, verses 1-2; and 9-11, a discharge of debt was granted every seventh year (every Sabbath year) to all debtors.

Surprisingly, bankruptcy was unknown in Greece with provided no legal relief for debtors  -  only forced servitude (slavery). It is thought that perhaps the actual term “bankruptcy” originated in Italy. The word bankruptcy is derived from Italian banca rotta, meaning “broken bench,” which may stem from the custom of breaking a banker’s or moneychanger’s bench or table to signify his insolvency.

In the U. S. Constitution, Article 1, Section 8, Clause 4, Congress was to “establish uniform laws on the subject of bankruptcies.” Bankruptcy law has always been the province of the federal government. Bankruptcy laws are passed by Congress and administered through the United States Federal District Courts. Bankruptcy laws have always been responsive to the needs of the economy and, in growing measure, to the needs of debtors. 

“Discharge of debt” and a “fresh start” have not always been the dominant purpose of the U. S. bankruptcy laws. The early bankruptcy acts were more concerned about the collection of a debtor’s assets and their distribution to creditors.  The first bankruptcy act - passed in 1800 and repealed in 1803, required that 2/3’s of creditors vote for a debtor’s discharge of his debt. Debtors were allowed to keep only wearing apparel and bedding as property “exempt” from their creditors.

PANIC OF 1837: Next, the Panic of 1837, which resulted in an extended recession, led to the Bankruptcy Act of 1841, which was effective only from 1842 to 1843. This Act granted an automatic discharge of debt unless a majority of creditors voted against discharge. “Exempt” property was broadened to include furniture and other necessities up to $300.

AFTERMATH OF CIVIL WAR: The economic crisis that resulted after the Civil War led to the next bankruptcy act in 1867. This bankruptcy act included and applied the “exemptions” of the various individual states. Originally, debtors received discharges automatically, but the act was amended after just one year to require a majority of creditors to vote for discharge. This act was repealed in 1878.

PANIC OF 1893: The Panic of 1893, a serious economic depression, led to the Act of 1898, which formed the basis of our modern bankruptcy code. This Act created the role of “bankruptcy trustees,” to replace creditors’ committees and assignees of debtors’ assets. Bankruptcy referees were appointed by district court judges to oversee cases. Bankruptcy law became a permanent fixture in the United States.

The Chandler Act of 1938 added many new provisions and changed the focus of bankruptcy to rehabilitation of both corporate and individual debtors through utilization of different “chapter” proceedings.

In 1970, the emphasis shifted to the “fresh start” of debtors when Congress amended the Bankruptcy Act to give bankruptcy courts practically exclusive jurisdiction over discharge enforcement. Most importantly, Congress established the imposition of the “automatic stay,” which enjoined and prohibited any and all collection action against a debtor upon the filing of a bankruptcy petition with the court.

The Bankruptcy Reform Act of 1978 was a major overhaul of the bankruptcy system. Bankruptcy referees were elevated to bankruptcy “judges.” Bankruptcy trustees, not bankruptcy judges, conducted the initial debtor examinations (meeting of creditors). The office of United States Trustee was established to oversee the private trustees and monitor Chapter 11 business reorganization cases.

Another major overhaul of the bankruptcy laws occurred just a few years ago  -  the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) sets out the current procedures and substance of bankruptcy practice. BAPCPA is discussed in the article “How Bankruptcy Works.”