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by Vault Law Editors | March 10, 2009


Ye olde common law

Bankruptcy law, or at least some variation thereof, existed as far back as the Roman Empire, although modern U.S. bankruptcy law springs from British bankruptcy statutes dating back to the sixteenth century. Bankruptcy was originally more of a sword than a shield, initiated by creditors and often leading to imprisonment for the delinquent debtor. A fresh start it wasn't.

The original thirteen -- the United States colonies -- adopted similar versions of these laws during pre-Revolutionary times, with some debtor-friendly modifications, such as the allowance of debtors to retain certain exempt assets (although imprisonment often remained an option). True to form, these laws varied within from colony to colony, and by "the time of the Constitutional Convention, debt-enforcement laws were a patchwork of local rules and procedures."i

Start of a federal system& and growing pains

The framers of the U.S. Constitution attempted to render uniform this "patchwork," deputizing Congress in Section 8, Article I "to establish . . . uniform Laws on the subject of bankruptcies throughout the United States." Great in theory, slow-in-coming in practice. In 1800, 1841 and 1867 Congress passed federal bankruptcy laws; in 1803, 1843 and 1878, it promptly changed its mind, repealing each respective act.ii During these brief windows --1801 through 1803, 1841 through 1843, and 1867 through 1878 -- the United States actually had uniform bankruptcy laws, mostly focusing on liquidation processes. During the other 82 years of the century, a debtor seeking relief turned to the hodgepodge of state insolvency proceedings, including assignments and receiverships, dating back to those colonial laws.

But slowly, slowly, the law was evolving, both within each state and with each federal bankruptcy act. The creditors' sword was becoming the debtors' shield; classes of exempted assets were expanded, and most significant, a debtor could see its debts discharged, albeit only with creditor approval. Best of all for debtors, imprisonment (except in cases of fraud or other grievous situations) eventually went the way of shackles and the guillotine, first in several turn of the century state laws, then in the federal 1841 Act. Opposition to the then-revolutionary debtor protections led to the quick repeal of the 1841 Act in 1843, and later the 1867 Act in 1878.iii Nonetheless, the foundations of today's bankruptcy practice were already hammered into place.

One that stuck: the Bankruptcy Act of 1898

Finally, in 1898, Congress passed a bankruptcy law that stuck -- the Bankruptcy Act of 1898, which sat on the books for eighty years. The 1898 Act acknowledged the fast-growing "credit economy"iv of the Industrial Age, placing the focus of bankruptcy far more on the debtor than ever before; it provided for a full-fledged discharge of debts and more and broader exemptions of assets than previous acts. The 1898 Act also established the "bankruptcy referee," an officer of the district courts, as the predecessor to the modern-day bankruptcy judge. Most of the roots of the current bankruptcy system are found in the 1898 Act. Most important, although the 1898 Act, like its predecessors, focused on liquidation, it also introduced several chapters for the rehabilitation of distressed businesses.

This trend towards reorganization continued through the next century, and the Chandler Act of 1938 created Chapters X and XI bankruptcies, which allowed public and privately-held companies, respectively, to reorganize themselves instead of liquidating their assets. The 1938 Act also significantly strengthened the authority of the bankruptcy referee, vesting him with quasi-judicial powers allowing it to help effectuate these reorganizations. Suddenly, bankruptcy was becoming a viable tool of survival instead of a method of death.

The birth of modern bankruptcy

And then came the revolution. And as with so many other revolutions, it emerged from a relatively minor event.

In the late 1960's, Congress proposed legislation to strengthen the effectiveness of an individual's discharge from its debts in liquidation proceedings. This narrow amendment eventually grew to a major shake-up in the bankruptcy bureaucracy: the Bankruptcy Reform Act of 1978.

The 1978 Act significantly strengthened the powers and enhanced the jurisdiction of bankruptcy judges (a Supreme Court rule had changed bankruptcy referees' title to "bankruptcy judge" five years earlier). The Act also supplanted Chapters X and XI with Chapter 11 corporate reorganizations and replaced the old consumer bankruptcy Chapter XIII with Chapter 13, with both new sections making it significantly easier for businesses and consumers to reorganize under the Code.

The 1978 Act changed everything. Previously, corporate bankruptcy was a "ghetto" avoided by most white shoe firms. It was usually no more than a glorified auction process for small fry, neither fish nor fowl, typically devoid of sophisticated corporate transactions or exciting courtroom action. Most major corporations did not opt for bankruptcy; in the 1970's for instance, the only two well-known corporate bankruptcies were of the Penn Central Transportation Corporation, in 1970, and W.T. Grant Company, in 1975. Bankruptcy was just not where the action was.

The 1978 Act legitimized the practice, creating new opportunities for sophisticated corporate debtors to use the Code as a reorganization tool, and allowing bankruptcy practitioners to argue cutting-edge issues before federal judges with broader powers than ever. Before the 1978 Act most major firms had no bankruptcy department; afterwards, nearly every major firm developed thriving bankruptcy and restructuring groups, observes Gregory Willard of Bryan Cave LLP.But first, there was chaos. In 1982, with the new bankruptcy system still in its infancy, the Supreme Court struck down the 1978 Act in the Marathonv case. The Court held that Congress overstepped its bounds, impermissibly granting bankruptcy courts, created under Article II of the Constitution, powers restricted to full-fledged "Article III" courts. And then, adding insult to injury, Congress missed its court-imposed deadline to amend the act, throwing the bankruptcy system into complete havoc.

Fortunately, Congress got its act together and passed the Bankruptcy Amendments and Federal Judgeship Act of 1984. The 1984 Act addressed Marathon by reconstituting bankruptcy courts as units of the district court, with proceedings officially "referred" to bankruptcy courts under district courts' standing orders.

Attorneys who entered the bankruptcy practice in the early 1980s remember this time as a brave -- and chaotic -- new world, between the 1978 Act, Marathon, and the 1984 amendments. All attorneys, whether veterans or just out of law school, stood on a "level playing field, learning a brand-new law," remembers Florida attorney Brian Behar, echoing many veteran attorneys' memories of the time. And in the process, modern bankruptcy practice was taking shape.

Developments since the 1978 act

Since 1984 the Code has been amended several times. In 1986 an amendment nationalized the Office of the United States Trustee, a unit of the Department of Justice, which enforces the Code and oversees many of the administrative functions of bankruptcies, such as appointing Chapter 7 trustees. The Bankruptcy Reform Act of 1994 also significantly amended both the corporate and consumer provisions of the Code

More recently, in 2002, Congress tried once again to amend the Bankruptcy Reform Act, with the most significant proposed change being limits in the ability of individual debtors to discharge credit card debt. These amendments died in Congress as a result of the most controversial proposed addition, a minor detail in the Code but a nuclear bomb in the political landscape: Restrictions on the ability of anti-abortion activists to discharge debts arising from judgments in lawsuits arising from their anti-abortion advocacy, reflecting the role of politics and social policy in shaping the Code.

i. The Oxford Companion to American Law, 54 (2002).

ii. The Oxford Companion to American Law, 54 (2002).

iii.The Oxford Companion to American Law, 55 (2002).

iv. The Oxford Companion to American Law, 55 (2002).

v. Northern Pipeline Construction Co. v. Marathon Pipeline Co., 458 U.S. 50s, 102 S. Ct. 2858, 73 L.Ed. 2d 598 (1982).

vi. Bankruptcy Court Decisions Weekly News & Comment, Volume 40, Issue 11, December 10, 2002, page 1.

vii.Daniel Altman, Chapter 11? Or Time To Close The Books? NY Times, December 15, 2002, Money & Business Section.


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