1 5 -- Bankruptcy: Introduction, History © Charles Tabb 2010
2 Front-Page News
3 Scandal
4 $600 Billion
5 Charles Ponzi
6 Famous Bankrupts
7 Filings quadrupled
8 Filings Return post-BAPCPA
9 Which chapters?
10 Business or consumer?
11 Credit Card Debt and Bankruptcy
12 Defoe’s “Four Sorts” 1 st -- 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
13 Sort # 2 2 nd – 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 2 nd, that Villany and Knavery might not be encourag’d
14 Sort # 3 3 rd : 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
15 Sort # 4 4 th : 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 Fellow- Subjects, to the Ruin of both Life and Estate
16 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.
17 “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
18 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
19 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.
20 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
21 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
22 Solon 594 BC revised Draco’s laws Forbade debtors from pledging their body as security Abolished slavery for debt BUT –bankrupt forfeited Greek citizenship
23 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.
24 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
25 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
26 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
27 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
28 Middle Ages Imprisonment for debt introduced 1285 in England Lasted until 19 th century
29 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
30 1 st 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
31 Only applied to merchant debtors English bankruptcy law only applied to merchant debtors – True until 19 th 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
32 Queen Elizabeth I: 1571 1 st comprehensive bankruptcy law Template of basic principles of law that lasted until formation of U.S.
33 17 th 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
34 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”)
35 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
36 U.S. Constitution Article 1, § 8, clause 4: Congress given power to “pass uniform laws on the subject of bankruptcies”
37 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”
38 Exercise of Bankruptcy Power For 1 st 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
39 1 st 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
40 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
41 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
42 2 nd US Law: 1841 Enacted in wake of Panic of 1837 Bankruptcy Act of 1841 was watershed Voluntary bankruptcy allowed for 1 st time – Debtor had right to file petition Eligibility not limited to merchant debtors – “all persons whatsoever owing debts” > Thus, for 1 st time in history, any debtor (merchant or not) could himself file bankruptcy and, if he cooperated, get a discharge of debts
43 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 ”
44 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
45 3 rd Act -- 1867 3 rd 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
46 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
47 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
48 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)
49 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
50 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
51 Bankruptcy reform in the 1970s 1970: Congress created 1 st Bankruptcy Review Commission 1 st 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
52 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
53 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
54 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
55 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
56 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”
57 Split the baby in 1978 law Gave bankruptcy judges unified jurisdiction But did not give them Article III status
58 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
59 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
60 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
61 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
62 BAFJA Enacted July 10, 1984 1 st : 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
63 BAFJA 2 nd : addressed Bildisco problem New § 1113 1 st aspect: reject collective bargaining agreements – Largely codifies Bildisco – CAN reject if show sufficient necessity, tried to bargain 2 nd aspect: unilateral modification – Reversed Bildisco – Now must have prior court approval, emergency only
64 BAFJA 3 rd : 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
65 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
66 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
67 1994 Act & Commission 2 nd 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
68 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)
69 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
70 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