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In medieval Italy,
when a businessman did not pay his debts, it was the practice to destroy his
trading bench. From the Italian for broken bench, "banca rotta," comes the
term bankruptcy.
Before the
20th century, rules and practices concerning bankruptcy generally favored the
creditor and were very harsh toward the bankrupt. The focus was on recovering
the investments of the creditors and almost all bankruptcies at this time were
involuntary. In England, the first official laws concerning bankruptcy were
passed in 1542, under Henry VIII. A bankrupt individual was considered a
criminal and was subject to criminal punishment. Potential punishments ranged
from incarceration in debtors prison to the death penalty.
In the
United States, early federal bankruptcy laws were temporary responses to bad
economic conditions. The first official bankruptcy law was enacted in 1800 in
response to land speculation. It was repealed in 1803. Similarly, in 1841, in
response to the panic of 1837, the second bankruptcy law was passed. It was
repealed in 1843. The economic upheaval of the Civil War caused Congress to
pass another bankruptcy law in 1867. That law was repealed in 1878. All of
these laws contained some allowance for discharge of unpaid debts. The first
two laws, those of 1800 and 1841, allowed only minimal discharge of debt. The
1867 law was the first to include protection for corporations.
Modern
bankruptcy laws and practices in the United States emphasize rehabilitating
(reorganizing) debtors in distress. The Bankruptcy Act of 1898 was the first to
give companies in distress an option of being protected from creditors. The
company could be put in an "equity receivership." This reorganization
provision was made much more formal and extensive in the United States during
the 1930s. The economic upheaval of the Great Depression yielded much
bankruptcy legislation, in particular, the Bankruptcy Act of 1933 and the
Bankruptcy Act of 1934. This legislation culminated with the Chandler Act of
1938. This included substantial provisions for reorganization of businesses.
During the
period from World War II through the 1970s, bankruptcy was not a major topic in
the news. With the exception of railroads, there were not many notable business
failures in the U.S. During the 1970s, there were only two corporate
bankruptcies of prominence, Penn Central Transportation Corporation in 1970 and
W.T. Grant Company in 1975.
The
Bankruptcy Reform Act of 1978 was passed in 1978 and took effect on October 1,
1979. This act substantially revamped bankruptcy practices. A strong business
reorganization Chapter was created, Chapter 11. (This replaced the old Chapters
X, XI and XII that had been created by the 1898 Act and amended by the Chandler
Act.) Similarly, a more powerful personal bankruptcy, Chapter 13, replaced the
old Chapter XIII. In general, the Reform Act of 1978 made it easier for both
businesses and individuals to file a bankruptcy and to reorganize.
The 1978
Act, a major piece of legislation, started a number of legal controversies and
many amendments and judicial clarifications of the 1978 Act were made during the
1980s. One pivotal event was a 1982 Supreme Court ruling that the bankruptcy
court's enlarged jurisdiction, which was established by the 1978 Act, was
unconstitutional. In layman's terms, the Supreme Court ruling stated that
bankruptcy judges had been given too much power by Congress and their duties
overlapped with those of other branches of the government. The 1982 ruling led
to the Bankruptcy Amendment Act of 1984.
There were
a number of other notable developments in bankruptcy rules during the 1980s.
The 1978 Act did not cover tax related issues and this was addressed by the
Bankruptcy Tax Act of 1980. The Tax Act clarified such things as tax loss
carry-forwards and taxation rules when there is an exchange of equity for debt.
A 1983 Supreme Court ruling challenged the ease with which companies could
protect themselves from labor contracts while in bankruptcy. The Bankruptcy
Amendment Act of 1984 limited the right of companies to terminate labor
contracts. In 1986, Chapter 12 was created for family farms.
During the
1980s and early 1990s record numbers of bankruptcies, of all types, were filed.
Many well known companies filed for bankruptcy, primarily Chapter 11
reorganization. Included were LTV, Eastern Airlines, Texaco, Continental
Airlines, Allied Stores, Federated Department Stores, Greyhound, R.H. Macy and
Pan Am. Several of these large cases, such as Maxwell Communication and Olympia
& York, had the added complexity of involving the insolvency rules of several
different countries. These massive bankruptcies created challenges for the
court system, but the system appears to have handled the challenge well.
New
techniques, such as "prepackaged" and "pre-arranged" bankruptcies, allowed the
court system to handle the increased caseload of the late 1980s and early 1990s
fairly efficiently. However, there still remain substantial concerns about the
level of professional fees and apparent waste of corporate assets in a number of
bankruptcy cases. Recent initiatives to deal with these issues include the
"fast track" approach to small and medium sized Chapter 11 cases being used in
several districts.
On October
22, 1994, the Bankruptcy Reform Act of 1994 (Public Law 103-394, October 22,
1994), the most comprehensive piece of bankruptcy legislation since the 1978
Act, was signed into law by President Clinton. The 1994 Act contains many
provisions, for both business and consumer bankruptcy, including: provisions to
expedite bankruptcy proceedings; provisions to encourage individual debtors to
use Chapter 13 to reschedule their debts rather than use Chapter 7 to liquidate;
provisions to aid creditors in recovering claims against bankrupt estates;
creation of a National Bankruptcy Commission to investigate further changes in
bankruptcy law; etc. In November 1997, the National Bankruptcy Review
Commission completed an extensive and detailed report on bankruptcy reform.
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