My clients often ask me in fits of frustration: how did bankruptcy get to be like this? And I then have the chance to tell them about the storied history of bankruptcy! Usually, they ask this question out of rage at the sheer number of documents they’re asked to produce, but I take it as an opportunity to share the joys of tax law (that is not sarcasm, I love what I do).
But I figured we can all benefit from learning something about the history of bankruptcy. So, I wanted to share with you all some of the greatest developments. What follows is a brief history laid out by the major laws that we’ve created surrounding bankruptcy.
Without further ado: the great and storied history of bankruptcy in America!
Bankruptcy Act of 1800:
a temporary solution to a temporary issue
In the years of America, land speculation had led quite a few people deep into debt. The federal government enacted this law to help out the growing number of debtors in the union. Mostly, this law was in line with contemporary English practices. The law required that 2/3 of the debtor’s creditors had to agree to the discharge for the debtor to achieve one. Us modern bankruptcy lawyers are still thanking our lucky stars that particular law was only on the books for three years!
This law also only provided for the involuntary bankruptcy of traders and merchants. This meant that only a certain profession and class of citizen would go through bankruptcy and that they could not elect to declare bankruptcy. It was only when the required proportion of creditors decided they wanted a specific debtor to go through bankruptcy that a debtor would begin the process.
Other than that, the act was actually fairly similar to modern bankruptcy. A judge would appoint a third party commissioner (much like a trustee) to work with creditors to settle debts with the debtor’s remaining property.
The law was incredibly short lived and very few, personal bankruptcy laws existed until 1841!
Bankruptcy Act of 1841:
the real establishment of bankruptcy in America
A lot of the major developments in the history of bankruptcy happened right around this act. Quite a few things changed to make bankruptcy more like how we practice it today:
- No more imprisoning debtors!
- Make bankruptcy voluntary
- All professions and classes can file for bankruptcy
This law was much more long-lived than the previous and made bankruptcy a bit more mainstream.
Bankruptcy Act of 1867:
Corporations enter the game
The big innovation here was that the courts began to allow corporations to go into bankruptcy, not just individuals! Debtors were allowed to choose in their bankruptcies from both state and federal exemption laws. This law was not all pro-debtor however. To get a discharge, creditors all had to consent to the forgiveness of debt or the debtor had to pay at least 50% of a dividend.
Bankruptcy Act of 1898:
Someone call the ref!
In the history of bankruptcy, you’ll see that we as Americans have long been debating the role and identity of a particular player. This player we now call the trustee. This law coined them “referees”.
The bankruptcy referee was appointed by a judge to work for a two-year term. The referee was also paid based on the funds brought into the estate. This is actually not so different from the trustee today.
Chandler Act of 1938:
spring cleaning in the history of bankruptcy
Now we get to everyone’s favorite task. You’ve created all these bureaucratic processes and now… you’ve got to organize them!
I see this act in the history of bankruptcy as the most influential to our understanding of bankruptcy today. It created the “chapter” system we use today and separated individual from corporation bankruptcies. Here’s how the chapter system broke down when it was first enacted:
- Chapter X: corporate
- Chapter XI: real property arrangement
- Chapter XIII: wage earner plans
Bankruptcy Reform Act of 1978:
real, modern bankruptcy
This is really when modern bankruptcy began. This act established bankruptcy courts in each district of America and appointed specific judges to deal with bankruptcies.
This act also reworked the original chapter designations a bit. Chapter 11 replaced the previous three, and a new Chapter 13 offered what they called a super discharge. This new chapter 13 made filing and reorganization easier for both corporations and individual debtors.
Family Farmer Bankruptcy Act of 1986:
creating the trustee
The main aim of this act was to establish Chapter 12 bankruptcy. This allowed for a specific path that family run farms could discharge debts. It is quite rare.
The lasting effect of this act was on the role of the trustee. A few years prior, in 1979, the modern role of the trustee began as a pilot program. This act made the position and role of the trustee in bankruptcy permanent.
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:
ironing out the details
This act had quite the long list of lasting effects on the history of bankruptcy. Here are just a few:
- Established the means test to determine eligibility
- Mandated credit counseling for debtors in bankruptcy
- Mandated financial management training for individuals filing Chapter 7 and 13
- Eliminated the Chapter 13 “super discharge”
- Allowed waiver of bankruptcy filing fee
- Allowed debtors to directly appeal to a higher court