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A Brief History
The current concept of bankruptcy has come a long way from its earliest origins. Today, it is universally seen as a protection for, and means of rehabilitating debtors. Yet, in its earliest origins and well into the 19th century, bankruptcy was strictly considered a creditor’s remedy to what was considered a crime -- debtor fraud. In fact, until the 20th century, rules and practices strongly favored the creditor and were very harsh toward the debtor. Outlined in this article is a chronology of the major events in history and jurisprudence leading up to the state of bankruptcy law in the United States today.
1795 BC -- The origins of the concept of debtor default can be dated back to the Code of Hammurabi, written by Babylon’s King Hammurabi between 1795-1750 BC. The Code is one of the earliest attempts at setting rules for settling debts. It provided that creditors could take the debtor’s child, slave, wife, or even the debtor himself into bondage until the debt was satisfied.
31 BC -- Unpaid debt continued to be considered a crime in ancient Greece and Rome, although by the time of Augustus (ruling from 31 BC – 14 AD) a distinction was made between the person of the debtor and his debts -- allowing a debtor to choose to give his property, rather than his body (or his child’s), to his creditors in repayment.
1000-1450 AD -- The term bankruptcy has two etymological roots in the Medieval period. In Latin, banca rotta, which meant “broken board”, referred to the custom in Medieval Italy of angry creditors breaking up the work benches of defaulting merchants. French banqueroute, signified debtors running away “on the route or road” from creditors with their ill-gotten gains.
1542 -– The first official laws concerning bankruptcy were passed in England during the reign of Henry VIII. With debtors’ prisons overflowing, these laws provided creditors some options other than imprisoning those who defaulted. The focus continued to be on recovering the investments of the creditors and practically all bankruptcies were involuntary. Bankrupts were considered “offenders” and subject to criminal punishment including incarceration.
1570 –- A more comprehensive law was passed during the reign of Queen Elizabeth I. Only creditors were allowed to commence bankruptcy proceedings, and only merchants could be considered. Thus, individual (consumer) debtors were still subject to imprisonment. There was no provision for the discharge of debt, so collection activities could proceed after the bankruptcy case was finalized.
1705 –- The Statute of Anne was the first set of laws establishing more humanitarian treatment of honest, but unfortunate debtors. It introduced the discharge of debts for debtors who cooperated in the bankruptcy proceeding, and provided such debtors a monetary allowance from the estate. However, it increased the penalty for fraudulent bankrupts from imprisonment to death.
1732 -- The 1732 Statute of George II was the English bankruptcy law in effect at the time of the ratification of the United States Constitution (1789). Although the law remained strongly pro-creditor throughout this period, by the middle of the 18th century, a more enlightened attitude toward credit, commerce and bankruptcy began to take hold.
1785 –- Bankruptcy continued to be considered a crime well into the 19th century. Voluntary debtor petitions did not exist. In the New World, bankruptcy law was regulated by the colonies. The Pennsylvania Bankruptcy Act of 1785 allowed the flogging of convicted bankrupts while nailed by the ear to the pillory. The criminal's ear was then hacked off.
1789 -– The authority of the U.S. federal government (i.e. Congress) to regulate bankruptcy is explicit in the Constitution. Article 1, section 8 states that Congress may pass “uniform laws on the subject of bankruptcies.” James Madison described federal bankruptcy legislation as “intimately connected with the regulation of commerce,” and necessary to prevent debtors from fleeing to another state to evade local enforcement of their obligations.
1800 -– In the United States, early federal bankruptcy laws were temporary responses to bad economic conditions. The first federal bankruptcy law, enacted in 1800, was in response to land speculation and the depression in 1793. It essentially copied the English statute; however, the death penalty was replaced by a maximum of ten years imprisonment. Bankruptcy continued to be a liquidation initiated only by creditors against traders (merchants). The 1800 Act was repealed in 1803 because it facilitated debtor fraud. Apparently friends or family members were filing “friendly” bankruptcy petitions against debtors, fictitiously claiming debts, sharing in the distributions, and voting to approve debtor discharges.
1841 –- The states continued to regulate relations between debtors and creditors after the repeal of the 1800 Bankruptcy Act. However, state relief was limited in that (1) states could not constitutionally discharge preexisting debts; and (2) states could not discharge the debts due a citizen of another state. Due to these limitations, and the Panic of 1837 (a reaction to the most severe American depression to date), the second federal bankruptcy law was enacted in 1841.
The 1841 Act is considered a watershed event in bankruptcy history. It allowed, for the very first time, a financially troubled debtor to directly file bankruptcy and receive a discharge. And, again for the first time, relief was no longer limited to merchants, but included “all persons whatsoever ... owing debts.” In essence, this Act transformed bankruptcy from a creditor remedy against debtor fraud into a voluntary system where debtors could protect themselves from creditors. Leniency on debtors quickly turned into fraud and abuse. Many thousands of debtors were discharged, minimal dividends were paid to creditors, and administrative fees were high. The act rapidly became unpopular and was repealed in 1843.
1867 -– Congress passed its next bankruptcy act in the aftermath of the Panic of 1857 and the economic upheaval of the Civil War (1861-1865). Like the 1841 Act, it opened eligibility to all debtor classes and allowed voluntary petitioning. The most controversial of its regulations was the incorporation of extremely generous exemptions. Traditionally, bankruptcy debtors were only allowed to retain clothing, bedding and the tools of their trade. The new law allowed retention of homestead properties and several thousand dollars in personal property. The 1867 Act lasted longer than its predecessors, but was eventually repealed in 1878 amidst widespread fraud and dissatisfaction.
1874 -– The Bankruptcy Act of 1867 was amended in 1874 and eventually repealed in 1878. A major innovation of the 1874 amendment was the introduction of the composition agreement – a forerunner of modern reorganization provisions. The composition agreement allowed the debtor to propose payment of a certain percentage of his debtors over time in full discharge of those debts, while also keeping his property.
1898 -– The Bankruptcy Act of 1898, which remained in effect for 80 years, marked the beginning of the era of permanent federal bankruptcy legislation. It was passed following the Panic of 1893, resulting from the second worst depression in U.S. history. It continued the process of redefining bankruptcy as a debtor entitlement. Involuntary petitions against farmers and wage earners were banned. Creditor approval and other conditions for discharge were fully removed.
Problems with the law surfaced; for example, there was no time limit between bankruptcies. Thus, individuals could systematically incur debts they planned not to repay, declare bankruptcy and discharge debts an unlimited number of times. Rather than repealing the law, as in the past, Congress took the route of trying to address issues via several amendments. The most radical and comprehensive amendment –- the 1938 Chandler Act -– included substantial provisions for reorganization of businesses.
1978 -– In 1970, Congress created the Commission on the Bankruptcy Laws of the United States to study and report on existing law. The Commission filed its report in 1973 and five years later the Bankruptcy Reform Act of 1978 replaced the 1898 Act with the Bankruptcy Code – Title 11.
The 1978 Act is unique in that it is the first major enactment of U.S. bankruptcy legislation that is not a result of a severe economic depression. This Act substantially revamped bankruptcy practices. It created a strong business reorganization chapter (Chapter 11) and a more powerful personal bankruptcy chapter (Chapter 13).
1980s -– The Bankruptcy Reform Act of 1978 resulted in a number of legal controversies and many amendments and judicial clarifications during the 1980s. Tax-related issues were addressed by the Bankruptcy Tax Act of 1980. The Bankruptcy Amendment Act of 1984 limited the right of companies to terminate labor contracts. Chapter 12 for family farms was created in 1986.
1994 -– During the 1980s and early 1990s record numbers of bankruptcies were filed. New techniques, like “prepackaged” bankruptcies, allowed the court system to handle the increased caseload fairly efficiently. However, there remained significant concerns about the level of professional fees and apparent waste of corporate assets. In October, the Bankruptcy Reform Act of 1994 was signed into law by President Clinton. It was the most comprehensive piece of bankruptcy legislation since the 1978 Act and contained provisions to: expedite bankruptcy proceedings; encourage individuals to reschedule their debts under Chapter 13 rather than liquidating under Chapter 7; and aid creditors in recovering claims against bankrupt estates. It also created a National Bankruptcy Commission to investigate further changes in the bankruptcy law. Subsequent bankruptcy reform legislation ignored many of the Commission’s recommendations presented in its 1997 report.
2005 -– On April 20, 2005, President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (S.256). This legislation is considered by many experts to be the most far-reaching overhaul of U.S. bankruptcy law since 1978. The most prominent changes affect individual (consumer) bankruptcy cases. However, the law also contains provisions affecting Chapter 11 business bankruptcies, small business bankruptcies and cross-border insolvency cases.
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