Bankruptcy is defined as “a legally declared inability or impaired ability of an individual or organization to pay its creditors.” While it is a less than pleasant experience, it is often an unavoidable step that allows the debtor to start over and the creditor to recover at least part of the debt. Bankruptcy has gotten a lot of coverage of late, especially with the worst recession since the Great Depression of 1929 ravaging the world economy. However, the history of bankruptcy goes back at least 500 years to medieval England.
Before beginning a journey through time to trace the roots of bankruptcy, it is important to know the origin of the word. The word “broken” comes from the Old Latin bancus (bench or table) and ruptus (broken). Ancient bankers used to conduct their business at a bank in public places such as markets and fairs. When a banker went bankrupt, his bank (bancus) broke up (ruptus) to announce to the public that he was no longer in a position to do business. Even today, the word “bankrupt” means the inability of an individual or company to do business.
The first bankruptcy law was enacted in England in 1542 during the reign of Henry VIII, and was heavily biased against the debtor where he could be imprisoned and all his assets confiscated. Over time, the law was relaxed to allow debtors to be released from prison, many of whom quickly fled to debtor colonies in Georgia and Texas. Although imprisonment became rarer in the 19th century, collusive bankruptcy (agreed to by creditor and debtor) became legal in 1825. Voluntary bankruptcy was authorized in England in 1849.
When the United States Constitution was adopted in 1789, bankruptcy was specifically listed as being subject to federal law. The first US bankruptcy law was passed in 1800 and provided only for involuntary proceedings. Voluntary bankruptcy became legal in 1841 and its scope was expanded by subsequent legislation in 1898 and 1938. The Bankruptcy Reform Act of 1978, commonly known as the Bankruptcy Code, introduced important changes to bankruptcy law.
There was considerable confusion about the overlapping and conflicting jurisdictions of the new judicial structure, and the courts had to adopt an “Emergency Rule”. This rule remained in effect until the enactment of the 1984 legislation on July 10, 1984, when the Federal Judgment and Bankruptcy Amendments Act was implemented. Consequently, the new bankruptcy courts were allowed to exercise all the subject matter jurisdiction of the district courts, subject to certain limitations.
In 1986, the United States Judges, Trustees Bankruptcy Act and the Family Farmers Bankruptcy Act introduced significant changes regarding family farmers and established a system of permanent trustees. In recent years, the Bankruptcy Reform Act of 1994 has enacted changes that affect the mortgage banking industry. Currently, there are six types of bankruptcy under the Bankruptcy Code, located at Title 11 of the United States Code:
1. Chapter 7 – direct bankruptcy for basic liquidation.
2. Chapter 9 – municipal bankruptcy to resolve municipal debts.
3. Chapter 11 – corporate bankruptcy due to restructuring.
4. Chapter 12 – Bankruptcy of family farmers and fishermen.
5. Chapter 13: bankruptcy of wage earners for regular wage earners.
6. Chapter 15: international bankruptcy to allow foreign debtors to discharge their debts.