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A People’s History of Bankruptcy in the United States

Bankruptcy in the United States: A Timeline of Eroding Rights

bankruptcy in the united states

Bankruptcy in the United States is an internationally unique legal remedy for those suffering from burdensome debt. Very few other countries allow individuals in debt to discharge and eliminate their personal, consumer debt. Of the other nations who do maintain some sort of “insolvency” law, as it tends to be called, the majority provide a form of bankruptcy that benefits creditors exclusively. It is a means of forced asset liquidation which creditors can force an individual or company in debt into in order to force a sale of property that may repay the debt.

The US started out that way, too. In fact, we still have “involuntary bankruptcy” of the sort. But we have also developed something genuinely helpful to those in debt rather than simply helpful to folks’ vampiric creditors.

Unfortunately, that unique individual benefit has been under attack through various re-writings and amendments forced upon the US Bankruptcy Code (the Federal statute underlying the bankruptcy process in the United States).

The US Constitution and Bankruptcy

Bankruptcy is provided for in the US Constitution in the most vague possible way: Article I, Sec. 8 simply states that Congress is authorized to establish uniform bankruptcy laws throughout the country.

Note that it doesn’t state that Congress must establish any such thing. Or that bankruptcy must benefit individual Americans. Or that the Federal “uniform” Bankruptcy Code must be interpreted in the same way in different Federal judicial jurisdictions (which it most certainly is not!).

The Bankruptcy Act of 1800

The first “uniform bankruptcy law” enacted by our new Congress was the Bankruptcy Act of 1800. This Act was purposed solely to benefit creditors by way of an involuntary bankruptcy process forced upon “merchant debtors” in which assets were liquidated for the benefit of the debtor’s creditors. It was also (not much later) repealed in 1803, leaving the US with no bankruptcy law at all until …

The Bankruptcy Act of 1841

This Act allowed not only for voluntary bankruptcy filings but also for filings by individual (i.e., human) debtors for the first time. This is the beneficial novelty of the American bankruptcy process that remains with us today. That was the Good. The Bad is that it also introduced a mechanism for the recovery of “fraudulent transfers” for the first time.

This was a process whereby property transferred allegedly in fraud (to hide or shield it from creditors) could be recovered for the benefit of those creditors. Sounds fair enough, right?

Today, this process, alive and well in our contemporary Bankruptcy Code, is one of the most abused mechanics of the Code, allowing Chapter 7 Trustees in particular to frighten debtors into forking over settlements and funds and property to which the Trustees are not legally entitled by threatening to sue debtors’ grandmothers and friends. (Click here more on Chapter 7 Trustees and fraudulent transfer “avoidance.”)

Unfortunately, for the creditors of 1841, however, this Act was also repealed in 1843. But the key concepts above remained in the air for subsequent iterations.

The Bankruptcy Act of 1867

This Act was notable for foreshadowing Chapter 13 individual reorganization (debt payment) plans by allowing debtors to negotiate payment of  debt for less than full amounts owe—but required creditor consent. As amended in 1874, the Act allowed debtors to distribute assets to creditors as a means of repayment.

This mechanism would follow the concept of bankruptcy in the US to the contemporary Code, which, again, provides an ugly basis for abuse by Chapter 7 Trustees in the seizure and liquidation of debtors’ property.

Again, however, the Act was repealed in 1878.

The Bankruptcy Act of 1898

Here’s an Act that finally last a while … 80 years or so. It created the position of “referee,” a precursor to both today’s Chapter 7 and Chapter 13 Trustees and today’s bankruptcy judges. The referee’s function was to “assist in expeditiously transacting the bankruptcy business.” In other words, to perform the administrative functions of the process.

This Act did create a position called a “trustee,” also. However, this person’s function was radically different than today’s Trustees who are, in the Chapter 7 context, empowered to seize and liquidate “non-exempt” assets of a filing debtor and avoid preferential payments and fraudulent transfers, and, in the Chapter 13 context, to receive a debtor’s monthly plan payments and distribute those funds to creditors. The original Trustee of 1898 filed suits in different courts to effect the completion of the bankruptcy process, as litigation in these early bankruptcies was heard in state courts, not in a specialized Federal bankruptcy court as they are today.

As amended in 1910, it also made corporations eligible to file voluntary bankruptcy (as opposed to the prior “merchant debtors”). While this Act did enunciate narrow exceptions to discharge of debtors’ liabilities, the entry of the corporate debtor into the bankruptcy process lay the groundwork for the conceptualizing of “corporate personhood” by the US Supreme Court later on—and, eventually, may have paved the road for the influx of corporate bankruptcy professionals (lawyers) into the bankruptcy court judiciary, which, today, is evidenced in a serious “empathy gap” from the bench in certain jurisdictions for individuals seeking protection from their creditors in the bankruptcy process.

The Bankruptcy Reform Act of 1978

This Act overrode the prior Bankruptcy Act and is, as (significantly) Amended, the Bankruptcy Code that underlies today’s bankruptcy process.

The Act of 1978 provided for actual Federal Bankruptcy Courts in the various Federal judicial districts (here in Michigan, we have two—the Eastern and Western Districts—for example) and allowed for Bankruptcy Judges rather than Referees, assigning many of the routine administrative tasks of the referees to the Chapter 7 and Chapter 13 Trustees and the US Trustee, the division of the US Department of Justice that oversees, now, criminal bankruptcy fraud, attorney ethical obligations, and other matters of overarching interest.

The Bankruptcy Code provides for a more specifically outlined Chapter 13 bankruptcy process, allowing individuals to repay only what they can afford from their essential household budget over a period of 3-5 years. It created the position of and system of remuneration of Chapter 7 Trustees, who, now, are paid a small fee for each case processed that does not result in the seizure and sale of debtors’ assets—but a percentage of the amount distributed to creditors from any liquidated assets in other cases.

This self-interested system of Chapter 7 Trustee remuneration has, now, resulted in a sort of organized shakedown in many cases, as mentioned above. Chapter 7 Trustees are motivated to act in a manner beneficial to their pocketbooks as opposed to the benefit of either filing debtors or, occasionally, creditors.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”)

Although there were a few other Amendments of the 1978 Act along the way (addressing the question of whether Bankruptcy Courts were or were not “Title III” Courts under the US Constitution, etc.) and, although some of those Amendments did involve textual revisions to the detriment of debtors (the 1978 Code allowed for the discharge of student loan debt, for instance, but the 1982 Amendment made all Federally guaranteed student loans non-dischargeable, for instance), no prior amendment was more sweeping and more oriented toward the favor of creditors than the BAPCPA of 2005.

BAPCPA enacted a swathe of unfriendly amendments to the Code too numerous to identify individually, but the major crimes of the Amendment include:

  • Insertion of the “means test,” a mathematical formula which purports to root out “abusive” Chapter 7 filings by examining the prior 6 months’ worth of the debtors’ entire household’s income. It forces more individual debtors into Chapter 13 bankruptcy, in which something is repaid back to creditors rather than nothing—and then forces them to repay more to their creditors than they can actually afford in some cases by mandating that a minimum amount of money is repaid, regardless of household budget.
  • Total non-dischargeability of all student loans, Federally guarantee or private.
  • Expanded disclosure and reporting requirements for debtors, resulting in a more intrusive and invasive process.
  • Higher fees
  • Tedious “credit counseling” course completion requirements that utterly ignore the fact that most people don’t file bankruptcy because they are morons but because they lost a spouse, lost a marriage, lost a job, or suffered a medical setback—none of which are the result of poor budgeting skills!
  • And others.

The Act, drafted by financial industry lobbyists, was passed by a Republican majority Congress—but with significant help from Democratic legislators such as Joe Biden and Hillary Clinton.

People’s Bankruptcy in the United States: Wounded But Still Kicking

Despite the steady evolution from start-to-finish of US bankruptcy law as a vehicle for debtor assistance to a vehicle for creditor repayment and the protection of immortalcorporate personhood, it remains the only really effective option under US law for a consumer to find some relief from unmanageable debt. Bankruptcy began as a collections vehicle and, since 2005, more closely resembles that original configuration that any time since at least 1978, but it will still do—although at greater cost and burden than is reasonably required—what it is supposed to do: discharge your debt.

Bankruptcy is not a reward for irresponsible financial behavior, as its critics have claimed. It is a means of removing the most essential component of our functioning economy—YOU—from the role of “debtor.” It is designed to pull you and your disposable income, whatever it happens to be, out of debt so that you can spend your money on the goods and services necessary for our economy to expand. We are all better off you have money to spend buying a product that will keep the company producing that product profitable and its employees employed than you are throwing it away at a credit card’s terrible interest-rate.

If you are a Michigan resident and would like to explore your options for a Chapter 7 or Chapter 13 bankruptcy with an experienced Michigan bankruptcy attorney, please contact us at (866) 674-2317 or click the button below to schedule a free, initial consultation.

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