The Truly Amazing History of Bankruptcy Law

Debtors’ prisons? There’s that and a lot more to the very colorful history of bankruptcy law.

 

American bankruptcy law naturally grew out of the law of England during our colonial history. Pre-Revolutionary War bankruptcy laws were extremely different from current law.

• The first bankruptcy law in England was enacted more than 450 years ago during the reign of Henry VIII. Debtors were called “offenders” under this first law, in effect seen as perpetrators of a property crime against their creditors. The purpose of this law, and as expanded during the following hundred and fifty years, was not to give relief to debtors. Rather it was to provide to creditors a more effective way to collect against their debtors.
• Given this purpose, it is not surprising that this first law did not give debtors a discharge—a legal write-off—of their debts. In a bankruptcy the assets of the “offender” were seized, sold, and the proceeds distributed to creditors. And then the creditors could still continue pursuing the “offender” for any remaining balance owed.
• A bankruptcy proceeding could only be started by creditors, not by debtors.  Creditors accused a debtor of an “act of bankruptcy,” such as physically hiding from creditors, or hiding assets by transferring them to someone else.  The current extremely seldom used “involuntary bankruptcy” is a remnant of this.
• Strangely, only merchants could file bankruptcy. Why? Credit was seen as immoral, with only merchants being allowed to use credit, for whom it was seen as a necessary evil. As the only ones who had access to credit, only merchants had the capacity to become bankrupt.
• For the following century and a half through the late 1600s, Parliament made the law even stronger for creditors, allowing bankruptcy “commissioners” to break into the homes of “offenders” to seize their assets, put them into pillories (structures with holes for head and hands used for public shaming), and even cut off their ears.
• Finally in the early 1700s the discharge of debts was permitted for cooperative debtors, but only if the creditors consented!
• Yet the law still provided for the death penalty for fraudulent debtors (although it was very seldom used).
• Cooperative debtors received an allowance from their own assets, the very early beginnings of the current Chapter 13 “adjustment of debts.”

So this was the English bankruptcy law that was largely in effect at the time that the U.S. Constitution was adopted. That gives some perspective on what the framers may have had in mind with the Bankruptcy Clause of the U. S. Constitution. That Clause gave Congress power to “pass uniform laws on the subject of bankruptcies.” Fortunately the language is so open-ended that it gave bankruptcy laws the opportunity to evolve during the last two hundred fifty years into one infinitely both more compassionate and beneficial for the economy.

But this evolution during our national history was extremely rocky, until surprisingly recently. That is the topic of the next blog.