BANKRUPTCY LAW

Bankruptcy is a legally defined status, conferrable on the select few only by formal adjudication. Debtors can be bankrupt only when statutes exist that prescribe the qualifications for bankruptcy, which for most of American history was the case only sporadically. With infrequent exceptions before the twentieth century, insolvent debtors could not be declared bankrupt unless they followed certain commercial occupations, amassed debts in excess of a large minimum, and committed statutorily defined acts of bankruptcy. Once they qualified, however, they were eligible for the brass ring of bankruptcy—a discharge from liability for their debts. For creditors, bankruptcy resolves the competition to determine who among them will be paid in full, in part, or not at all by distributing the debtor's property among them in proportion to their debts, so that they share in the losses equally.

In the eighteenth century, debtors and creditors alike appreciated the value of the bankruptcy process. Every colony and state permitted imprisonment for debt. Colonies and states occasionally experimented with insolvency statutes that released small and middling debtors from jail and apportioned their assets among their creditors but did not discharge them from liability. Experiments with true bankruptcy discharges were few.

Not surprisingly, calls to abolish imprisonment for debt went hand in hand with proposals to enact bankruptcy legislation. From the first published argument for bankruptcy discharges in 1755, bankruptcy was promoted as a benefit for creditors as well as for debtors. It would allow creditors to intervene and preserve the debtor's assets for all creditors, while the availability of discharge would induce debtors not to waste their assets in futile efforts to avoid debtors' prison. Merchants in particular favored bankruptcy legislation because they knew that insolvency was the downside of entrepreneurial risk.

colonial and state laws

Except for brief experiments in Massachusetts and New Hampshire in 1714 and 1715, respectively, the first true bankruptcy statutes in the colonies were a product of the economic dislocations of the French and Indian War in the 1750s and 1760s, which demonstrated that economic failure need not imply moral failure and thereby swept aside the principal objection to discharging debts. Between 1755 and 1757 New York, Rhode Island, and Massachusetts enacted bankruptcy systems that distributed insolvent debtors' assets among their creditors and discharged them from further liability on their debts. Connecticut followed suit in 1763. Three of the statutes—Massachusetts, Rhode Island, and Connecticut—were voluntary, meaning that debtors could apply. Only New York passed an involuntary act, initiable only by creditors. Three—Rhode Island, Connecticut, and New York—applied to noncommercial as well as commercial debtors. Only the Massachusetts act was limited to commercial debtors. The experiments were short-lived or restrictive or both in their application. Each one expired or was repealed. Their mere existence, however, marked a change in popular attitudes toward insolvency.

That change became even more marked after the Revolution, when the decline of prices, the scarcity of cash, depreciation, competition from British manufactures, obstacles to establishing export markets, and efforts by British creditors to collect prewar debts all contributed to postwar depression and a wave of business failures. As failure became the potential common fate of all merchants, merchants lobbied for bankruptcy laws. A Pennsylvania bankruptcy statute enacted in 1785 announced its commercial purpose in the preamble, that a bankruptcy law was "necessary and proper as well as conformable to the usage of commercial nations," thus assuming as fact an identity as a commercial nation that was hotly disputed in the debates over national bankruptcy legislation in the next decade. The law was nominally involuntary and limited to commercial debtors. New York experimented fleetingly in 1784 and again in 1786 with a voluntary bankruptcy law that applied to both commercial and noncommercial debtors.

the constitution and federal law

Against this background, delegates to the Constitutional Convention in 1787 agreed on Article I, section 8 of the Constitution, which empowered Congress "to establish … uniform Laws on the subject of Bankruptcies throughout the United States." James Wilson, one of the proponents of the clause, argued at the Pennsylvania ratifying convention that a federal bankruptcy law would be more in keeping with the interstate nature of commerce and the credit relations on which commerce rested. James Madison agreed, writing in The Federalist no. 42 that the "power of establishing uniform laws of bankruptcy, is so intimately connected with the regulation of commerce … that the expediency of it seems not likely to be drawn into question."

After this seemingly uncontroversial beginning, the question of national bankruptcy relief languished. Proposals for "uniform Laws on the subject of Bankruptcies" arose and died in each Congress from the very first one through the 1790s. As Congress took up bankruptcy bills in the those years, no one disputed that commercial creditors and debtors alike wanted a federal bankruptcy system that would sort out claims, distribute assets, and provide a discharge. Agrarian interests, however, rightly feared that a bankruptcy law would expose farmers and planters to the seizure of their land. They argued that the new nation was an agrarian society in which commerce was too undeveloped to require bankruptcy. Further sharpening the debate, Federalists saw a federal bankruptcy system as essential to expanding the authority of the national government, of a piece with proposals to enlarge the judiciary and extend a national network of turnpikes. Bankruptcy thus became part of the ideological divide between commerce and agriculture, and between nationalism and federalism.

What finally tipped the balance was the collapse of large-scale land speculation schemes in 1797, when for the first time numerous prominent men found themselves imprisoned for their debts or fugitives from their creditors. Their presence in the pool of insolvent debtors gave new urgency to the debate over bankruptcy. That debate culminated in the Bankruptcy Act of 1800, the first national bankruptcy law, which passed in February only by the deciding vote of the Speaker of the House. The Act was not a law for the common debtor. It applied only to merchants, bankers, brokers, factors, underwriters, and marine insurers who owed at a minimum the substantial sum of one thousand dollars.

Debtors imprisoned in New York joyously celebrated news of the law with a series of toasts to "this Godlike act." Others were not as enthusiastic. Congress repealed the statute in December 1803 after barely three-and-a-half years, a victim of the new Jeffersonian ascendancy. Thereafter, ambiguous U.S. Supreme Court decisions and the expectation that Congress would preempt the field discouraged most states from even attempting to establish bankruptcy systems. Congress did not enact a permanent bankruptcy law until 1898.

bibliography

Coleman, Peter J. Debtors and Creditors in America: Insolvency, Imprisonment for Debt, and Bankruptcy, 1607–1900. Madison: The State Historical Society of Wisconsin, 1974.

Mann, Bruce H. Republic of Debtors: Bankruptcy in the Age of American Independence. Cambridge, Mass.: Harvard University Press, 2002.

Bruce H. Mann