Banca Rotta: A Brief History of Bankruptcy, Part 2

Banca Rotta: A Brief History of Bankruptcy Part Two

Click here for Part 1

The first Bankruptcy Law in the US was repealed in 1803 – it was designed as a temporary measure only. It would be forty years before another federal act was passed that allowed for debt relief.

Fortunately, imprisonment for debt was abolished in 1833. Unfortunately, the only relief a Debtor could get in the meantime came from an Order from a State Court staying collection of a debt. At this time a State Court could also eliminate any future debt owed (monthly contract payment, interest, etc.) but the US Supreme Court ruled that a State cannot discharge past debt and could not under any circumstances discharge the debt of a Creditor from another State.

Finally in 1841 another Bankruptcy Act was passed, again due to a financial crash, this time in 1837.  This Act was not limited to merchants but to all citizens. Filing for bankruptcy was now voluntary as well as involuntary (although involuntary bankruptcy was again limited to merchants). Although it was still an automatic liquidation of assets, a Debtor was allowed to keep some of his property. This Act was repealed in 1843; as with the earlier law, it was considered a temporary measure.

A letter at Abraham Lincoln’s Law Office Museum in Springfield, IL was on display. It was a letter from Lincoln to a client. It is about bankruptcy. He instructed his client to bring all his farm equipment and farm animals to the state capital on a certain morning for auction. He also reminded the client how much he still owed Honest Abe! They may change the displays every few months, but hopefully it is still there!

A third Bankruptcy Act was passed in 1867, against due to a financial panic – this time in 1857 – as well as the financial catastrophe of Civil War.  Northern creditors used the Act as a way to force Southern Debtors into a liquidation of assets.  Involuntary bankruptcies could now be filed against individuals. Corporations could file bankruptcy, as well. Creditors still had to approve the discharge, unless the liquidated estate paid 50% of the debt owed.

The 1867 law also allowed a Debtor to pay a percentage of the debts owed over a set period of time – the forerunner to the modern Chapter 13.

This Act was repealed in 1878.

The fourth and “permanent” Bankruptcy Act was passed in 1898. Although other Acts have been passed since, bankruptcy laws remained a part of the US Code ever since.

The Bankruptcy Act of 1898 was created due to another financial crisis in 1893 as well as the declining fortunes in the railroad industry.

The Creditor consent for discharge was eliminated and exemptions from asset liquidations could be based on an individual state’s laws. The Court, through appointed Trustees, could void preferential transfers (payments to insiders) and fraudulent transfers to bring those funds back into the bankruptcy estate. A Debtor could still offer to pay his creditors a percentage of the debt owed over time if the Creditors approved the proposed “Composition”, as it was called.

Through the years, the Act was changed or amended to say that some debts do not discharge and more “composition” laws were added for businesses and municipalities. Different kinds of bankruptcies were divided into Chapters.

It was replaced by a Bankruptcy Act of 1978. The 1978 Act added procedural and “mechanical” rules to the old bankruptcy code.

Due to the recommendations of the 1970 congressional Commission on the Bankruptcy Laws of the United States, the Act created bankruptcy courts, akin to Tax Courts, which served as adjuncts to the US District Courts for each federal judicial district.

Before that bankruptcy "referees" heard preliminary and other bankruptcy matters before federal district judges heard and ruled upon disputed matters.

The Act also created a formal US Trustee program through the Department of Justice. Earlier the Trustee voided illicit transfers. Now all cases were appointed a Trustee who kept the authority overlooking the liquidation and administration of a Debtor’s assets. Some states use “Administrators” with essentially similar powers.

Practically, the new code included a new kind of bankruptcy allowing corporations to pay back a percentage of its debt (the Chapter 11) as opposed to a complete liquidation.

Due to a Supreme Court ruling in 1982, the Bankruptcy Act of 1978 was forced to overhaul the administration of its duties. Failure to do so could result in the Bankruptcy Court’s utter elimination. It was the Judicial Branch’s equivalent of “git outta my yard, ya damn kids!”

I’ll discuss what happened in Part 3.

Copyright 2016 Michael Curry