Short History of Consumer Bankruptcy

Individual bankruptcy filing is rooted in the Constitution of the United States.  The U.S. Constitution provides that:

“The Congress shall have the Power to Establish an uniform Rule of Naturalization and uniform Laws on the subject of Bankruptcies throughout the United States”

The first bankruptcy laws in the United States were created by the Bankruptcy Act of 1800. It mostly applied to “Traders” which was another term for general merchants. You can imagine the risks of importing and exporting goods in the early 1800s.  This Bankruptcy Act provided little relief for individual non-merchants and greatly favored the creditors.

A new Bankruptcy Act was approved by Congress in 1841. The Bankruptcy Act of 1841 “opened the door” to voluntary bankruptcy petitions for individuals that were not traders.  It also began to look towards “rehabilitation” of the bankruptcy filer.  This new way of thinking about debt and bankruptcy led to additional changes is 1867.  Changes to the law in 1867 allowed for an individual to file for bankruptcy and propose compensation to his creditors, which if accepted, would be binding terms on all creditors.  The Bankruptcy Act of 1867 was repealed in 1878. Creditors were unhappy with the small returns they received, and debtors were unhappy because they rarely received a full discharge of their debts.

Bankruptcy as we currently know it was created by the Bankruptcy Act of 1898. It created Federal Courts of Bankruptcy, created a Bankruptcy Referee (a precursor to the Bankruptcy Judge). This Act also provided more opportunities for the Debtor to receive a discharge.  This Act has been amended several times since its creation. The Chandler Amendments passed in 1938 during the Great Depression led to our current day Chapter 13 bankruptcy process of reorganization.  It was amended again in 1978, 1984, 1986, and most recently in 2005.

The Bankruptcy Reform Act of 1978 created specific bankruptcy judges and trustees. It remains, with some subsequent amendments, the law we use today. It created Chapter 7, 11, 12 (which was amended in 1986 to include Family Farmers), 13, and 15 bankruptcy filings that an individual or entity can choose.

Currently, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, sets out the process generally known as consumer bankruptcy.  Under this Act the bankruptcy Court is trying to balance the harm to creditors with the need to provide “honest but unfortunate debtors” an opportunity for a fresh start.

This act allows consumers to file either Chapter 7 bankruptcy or Chapter 13 bankruptcy.  A Chapter 7 bankruptcy is the most common type of bankruptcy and allows a debtor to eliminate his personal liability on most debts. A Chapter 13 bankruptcy is a Reorganization of Debts. It is used to stop foreclosures and to allow a debtor to catch up his past due balances on secured debt. It can also be used to create a repayment plan when a debtor does not qualify for a Chapter 7 bankruptcy.

For more information about the history of bankruptcy check out Robert Jacobvitz post on the National Conference of Consumer Bankruptcy Judges. You can also read more indepth history in Debt’s Dominon by David A Skeel, Jr.