A Relatively Short History of the Bankruptcy Laws in the United States

This article briefly summarizes the history of the bankruptcy laws in the United States.

Article I of the United States Constitution, sec. 8, cl. 4, gives Congress the power to “establish . . . uniform laws on the subject of bankruptcies throughout the United States.”

Bankruptcy Act of 1800

The first bankruptcy law in the United States was enacted in 1800, eleven years after ratification of the U.S. Constitution, but was repealed three years later. It was passed in response to financial crises in 1792 and 1797. The Bankruptcy Act of 1800 was very similar to English bankruptcy law. It was very pro creditor oriented. Only involuntary bankruptcy cases were allowed, and only merchants could be debtors. To obtain a discharge from debts, two thirds of creditors by number and value of claims had to consent to the discharge.

 Bankruptcy Act of 1841

The next bankruptcy law in the United States, in 1841, was even shorter lived. It was repealed in early 1843. Under the 1841 Act, debtors for the first time could initiate their own bankruptcy case, and any individual was eligible to be a debtor in bankruptcy. Bankruptcy jurisdiction was vested in the United States District Court “in the nature of summary proceedings in equity.” The debtor could claim newly created federal law exemptions but could not claim state law exemptions. Creditors could veto a debtor receiving a discharge by a majority in number and in value of claims. A preferential transfer by the debtor prior to bankruptcy was a ground to deny the discharge.

Bankruptcy Act of 1867

Next came the Bankruptcy Act of 1867 passed following a financial crisis in 1857. The 1867 Act provided for both voluntary and involuntary bankruptcy cases. Individuals and corporations were eligible to be debtors in bankruptcy. Bankruptcy jurisdiction was vested in the United States District Court. The district court appointed “registers in bankruptcy” to assist the district court. The “register” was the predecessor of the bankruptcy referee, which in turn was the predecessor to the bankruptcy judge. An “assignee,” the predecessor to the bankruptcy trustee, superintended the liquidation of assets for the benefit of creditors.

The 1867 Act introduced the concept of the composition agreement in American bankruptcy law. The composition agreement was the predecessor to the plan of reorganization under current bankruptcy law. For the composition agreement to bind creditors it required creditor consent by a majority in number and three fourths in value of claims.

In addition, for the first time under the 1867 Act the debtor could claim state law exemptions.

The 1867 Act was criticized for small dividends to creditors, high expenses for administering the bankruptcy case, delays, and only about one-third of debtors being granted a discharge due to the many exceptions to discharge. The 1867 Act lasted about eleven years until it was repealed in 1878.

Bankruptcy Act of 1898

 Twenty years after the repeal of the 1867 Act, Congress passed the Bankruptcy Act of 1898. It was a watershed in American bankruptcy law.

The 1898 Act included many provisions aimed at making the administration of the bankruptcy estate more efficient and the distribution of the debtor’s property to creditors more equitable.

Under the 1898 Act, federal district courts sat as “courts of bankruptcy.” District courts appointed “referees in bankruptcy” who performed much of the judicial and administrative work. Referees were compensated on a fee basis until 1946 when that changed to a salary basis. Creditors had the power to elect trustees and creditor committees. The trustee could avoid preferential and fraudulent transfers. Confirmation of a composition agreement in lieu of liquidation required creditor consent by a majority in number and a majority in value of claims, and approval of the court as being in the best interest of creditors. The Act of 1898 contained more generous discharge provisions for the debtor than under prior bankruptcy law, but permitted a debtor to claim exemptions only under State law, and provided for both voluntary and involuntary bankruptcy cases.

Chandler Act Amendments to the Bankruptcy Act of 1898

The Chandler Act was passed in 1938 during the Great Depression. It substantially revised the Act of 1898. Under the Chandler Act amendments, Chapters X and XI governed corporate plans arrangement, Chapter XII governed real property plans of arrangement, and Chapter XIII provided for individual wage earner plans. Chapters X and XII were the precursors to modern day Chapter 11. Chapter XIII was the precursor to modern day Chapter 13.

Among other things, the Act of 1898 as amended by the Chandler Act included the concepts of classification of claims under plans of arrangements, cram down, voluntary and involuntary bankruptcy cases, the appointment of trustees, modification of both secured and unsecured claims.

The Bankruptcy Reform Act of 1978

In 1970 Congress created the Commission on the Bankruptcy Laws of the United States to study the then existing bankruptcy law and report on recommended changes. The Commission’s report ultimately led to passages of the Bankruptcy Reform Act of 1978.

Under the 1978 Act, bankruptcy judges instead of referees in bankruptcy preside over bankruptcy cases. Bankruptcy judges no longer are involved in the administration of the estate. Bankruptcy courts are granted expanded jurisdiction. Features of Chapters X and XI are combined into a single Chapter 11. The principle of “the economy of the estate” is eliminated, which had limited the amount of compensation paid to bankruptcy attorneys and other bankruptcy professionals. Chapter XIII become Chapter 13, which for the first time includes a super discharge.

The 1978 Act, with some later amendments, is the bankruptcy law in effect to today in the United States. Eligible debtors may commence bankruptcy cases under Chapters 7, 11, 12, 13, or 15. Certain creditors may commence involuntary bankruptcy cases under some of the chapters. A trustee is always appointed in Chapter 7, 12 and 13 cases and may be appointed in Chapter 11 cases. Debtors may obtain a discharge of debts to attain a “fresh start” upon meeting certain requirements, with exceptions. Individual debtors can claim federal law exemptions, or alternatively State law exemptions if permitted by State law. Each class of creditors must accept a chapter 11 plan by a majority in number and at least two-thirds in amount of claims, subject cramdown provisions that allow confirmation of a plan over a dissenting class of creditors.

 Bankruptcy Amendments and Federal Judgeship Act of 1984 (BAFJA)

In 1982 the United States Supreme Court curtailed bankruptcy court jurisdiction in Northern Pipeline Construction Co. v. Marathon Pipe Line Co. by ruling that the 1978 Act unconstitutionally gave powers reserved to Article III judges to non-Article III judges. The Marathon decision led to the enactment of BAFJA. BAFJA made bankruptcy judges in each judicial district a unit of the United States district court for that judicial district, vested bankruptcy jurisdiction in the district court, created the concept of “core,” “noncore” and “related to” matters, and authorized district courts to refer the exercise of bankruptcy jurisdiction to bankruptcy courts. In all judicial districts, district courts have referred the exercise of bankruptcy jurisdiction to bankruptcy courts to the fullest extent permitted by law.

BAFJA also added a new section to the Bankruptcy Code relating to rejection of collective bargaining agreements.

Bankruptcy Judges, United States Trustees and Farmer Act of 1986.

In 1986 Congress enacted the Bankruptcy Judges, United States Trustees and Farmer Act of 1986. It created a new chapter 12 for “family farmers” and made the United States Trustee System permanent (except in Alabama and North Carolina).

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) made substantial amendments to the 1978 Act, particularly for consumer and international (cross border) bankruptcy cases. For individual debtors, it makes credit counseling a condition for relief; requires financial management training for Chapter 7 and 13 debtors to obtain discharge; creates the role of consumer privacy ombudsman; establishes a means test; introduces automatic dismissal of a bankruptcy case if required documents are not filed timely; curtails the Chapter 13 “super discharge,” prevent bifurcation of car loans in Chapter 13 for vehicles purchased within 910 days prior to commencement of the bankruptcy case; contains limitations a debtor filing multiple bankruptcy cases; and adds provisions on reaffirming debts.

BAPCPA amendments also allow direct appeals to the court of appeals in certain circumstances; add family fisherman to chapter 12, make Chapter 12 permanent, and create a new Chapter 15 for cross border insolvencies.

Judge Thomas Small aptly described consumer provisions of BAPCPA by comparing them to a Rubik’s Cube: “The amendments are confusing, overlapping, and sometimes self-contradictory. They introduce new and undefined terms that resemble, but are different from, established terms that are well understood. Furthermore, the new provisions address some situations that are unlikely to arise. Deciphering this puzzle is like trying to solve a Rubik’s Cube that arrived with a manufacturer’s defect. Fortunately, after many twists and turns, a few patches of solid color emerge.” In re Donald, 343 B.R. 524, 529 (Bankr. E.D.N.C. 2006).

BAPCPA has resulted in a tremendous amount of litigation to interpret its meaning.