We might think that insolvency is the cause of bankruptcy. As a matter of fact, after Congress deleted the insolvent requirement in the Bankrupty Reform Act of 1978, it no longer is. Insolvency refers to the inability to meet liability payments of a person or an entity. An insolvent person is usually understood as bankrupt. In fact, a bankruptcy means more than mere insolvency. A bankrupt voluntarily petitions to court to be legally judged as insolvent so as, especially true in today’s economic environment, to be relieved of many obligations.The word bankruptcy comes from the Italian bancarotta, which means “broken bench.” In medieval Venice, merchants would bring with them their own benches to markets or other public places so that they could rest during the day. If a merchant went bankrupt, meaning he could not pay his debts, his creditors would break his bench, leaving no place for him in the business community. Therefore, the image of a broken bench became the symbol of a person’s insolvency. At this point in history, society’s attitude towards bankruptcies proved to be negative. Bankrupts were considered to be defrauders, and in some cases, criminals. Under societal condemnation, many of these unlucky people had to flee from their areas of residence and employment for fear for further punishments.
Interestingly enough, over the course of societal evolution, bankruptcies have become more acceptable today than ever before. We have reached to the point where going bankrupt has become a sought-after tool for many individuals as well as corporations to obtain financial relief. Thousands of individuals who have gone over their credit limits and are no longer able to meet their obligations have filed bankrupt petitions seeking a discharge of their debts. Similarly, that is one of the reasons why corporations seek bankruptcy protection. However, many of them file for bankruptcy on the attempt to cancel executory contracts and contingent liabilities.
In the history of law, the first known bankruptcy law was passed in England in 1542. Unlike what had been done previously, this statute allowed creditors to seek remedies from debtors other than imprisonment. Modern bankruptcies are different from those in old times in the sense that filing for bankruptcy is voluntary on the part of the debtor – the term used in place of bankrupt to lessen the long-lasting stigma of this word. According to Dennis Bechara, an attorney and frequent contributor to The Freeman, when the Constitution of the United States was adopted, bankruptcy laws differ among states. In an effort to reconcile these burdensome differences, an insertion was made in Section 8 of Article I of the Constitution a clause granting Congress the power to establish “uniform laws on the subject of bankruptcies throughout the United States.” In 1898, five years after the Panic of 1893, the Bankruptcy Act of 1898 was enacted. This law addresses what is now called a Chapter 7 Bankruptcy. Basically, such a bankruptcy involves the liquidation of the debtor’s assets. When a petition is filed, a trustee will be appointed to take charge of the debtor’s businesses. The trustee will either operate the businesses in a short period of time or immediately liquidate the assets. It is also responsible for collecting assets such as accounts receivable and preferences. These amounts, after the trustee’s and other legal fees are paid, will be divided among creditors on a pro rata basis. As a rule of law, secured creditors are always given priority over unsecured ones.
The 1898 Act was amended in 1938 by the Chandler Act, which introduced re-organizational bankruptcy. In the current law system, this type of bankruptcy is known as Chapter 11. Under the protection of this chapter, a troubled corporation might be able to reorganize its structure and continue to operate with in hope of profitability to make at least partial payments to unsecured creditors. Usually, many of the firm’s financial liabilities will be amended in favor of itself so as to assist the reorganized business.
Many factors in the 1960s and 1970s induced Congress to enact the Bankruptcy Reform Act of 1978. This statute restructured the organization of bankruptcy courts. It also sought to liberalize the ability of consumers and corporations to file for bankruptcy relief. As a result, there was a lot of controversy over the effects of these amendments. A number of corporations began to take advantage of the act. For example, Johns-Manville Corporation filed a petition for reorganization under Chapter 11 on August 20, 1982. Its reason for filing for bankruptcy was there had already been 16,500 lawsuits against the company claiming damages from asbestos-related injuries. The company estimated a contingent liability of $2 billion involving 52,000 lawsuits. And by seeking bankruptcy protection, the company was able to get itself of a great deal of liabilities.
The latest amendments were made in 1984 to add some additional categories regarding non-dischargeable debts. It also limited businesses’ ability to reject collective bargaining agreements which means labor contracts between organized workers and their employers.
Overall, the Congress has not changed the essence of bankruptcy law since more than 100 years ago although there have been quite a few changes. The law has been oscillating between helping debtors and limiting their relief. Perhaps, it is going to take time for us to get true bankruptcy reforms.