The Very Rocky History of U.S. Bankruptcy Law

You think the present Congress can’t get anything done? It took more than a hundred years for Congress to pass the first permanent bankruptcy law.

Lots of people know that bankruptcy was important enough to our founders to be included in the U.S. Constitution. But that’s just the very beginning of the story:

• The Bankruptcy Clause, giving power to Congress to “pass uniform laws on the subject of bankruptcies” was added with very little debate, late in the Constitutional Convention’s proceedings. There had been no provision for nationwide bankruptcy in the earlier doomed-to-fail Articles of Confederation.

• The only vote against the Bankruptcy Clause was by Connecticut, which already had a detailed bankruptcy law and wanted to keep it instead of ceding that authority to the federal government. One of their delegates also was concerned that a federal bankruptcy law would include the death penalty for debtors for certain bankruptcy offenses, as English law still did at the time.

• But just because Congress was empowered by the Constitution to pass bankruptcy legislation, for nearly half our history it did so in an extraordinary irregular and knee-jerk fashion. Three different times during the 19th century a federal bankruptcy law was passed, each time immediately after a devastating financial “Panic,” only to be repealed after just a few years. During the majority of the time that no federal law was in effect, the states developed a patchwork of bankruptcy and debtor-creditor laws, which became less and less effective as commerce became ever more interstate.

• Then finally Congress passed the Bankruptcy Act of 1898, which lasted 80 years.  Although primarily inspired by commercial creditor interests, it included the following debtor-friendly provisions: most debts became dischargeable, creditors no longer had to be paid a certain minimum percentage of their debts, and no longer could withhold their consent to the debtor’s discharge.

• The Bankruptcy Act of 1898 survived many attempts at repeal, in contrast to its predecessors. It was amended numerous times, in a major way in 1938 in response to the Great Depression. That 1938 amendment added the “chapter XIII “wage earners’ plans, the predecessor to the current Chapter 13s.

• The 1978 Bankruptcy Reform Act, which brought into existence the Bankruptcy Code, was the result of a decade of study and debate. It is the only major enactment of bankruptcy law in U.S. history which was not enacted in reaction to a severe economic downturn. It has been tweaked every few years since then, most significantly in 2005.