A Brief History of Bankruptcy

A Brief History of Bankruptcy

Everything has an origin, but do you know the history of bankruptcy? The beginning of the concept of the adjustment of the debtor-creditor relationship arises in the Old Testament, where it suggests that debts should be forgiven after seven years. The word “bankruptcy” comes from the Roman era when most merchants operated in marketplaces and their individual shops were actually long, narrow stone benches. If the merchant wasn’t paying his suppliers, his bench at the marketplace would be broken to show the general public that he wasn’t paying his bills on time (the word “bankruptcy” means “broken bench”).

The American legal system is a descendant of the British legal system. In Britain, a concept developed in the 1600’s which became known as debtor’s prison. The idea was that a person’s family would be so embarrassed if they had a member in jail for not paying his debts that the family would be motivated to make good for the poor soul. That worked out well if you were lucky enough to be born into the 3% or 4% of the population that was wealthy. However, for the 96% or 97% of the general population, it didn’t make a lot of sense. Not only was the head of the household kept in jail, often for years, but the rest of the family was left to fend for itself. An alternative to debtor’s prisons were debtor colonies. Georgia and parts of Australia were originally founded as debtor colonies. While informative, sometimes the history of bankruptcy can reveal laws that were very crude in nature.

When the founding fathers at the Constitutional Convention drafted the Constitution and the Bill of Rights, they changed the history of bankruptcy, two of the provisions were that there would be no debtor’s prison in the United States, and that Congress would enact uniform bankruptcy laws. The purpose of this was twofold. First, it became apparent that debtor’s prison did not work. Second, the founding fathers realized that hard working people could get into financial difficulties when trying to establish themselves and make a living in new, unsettled areas of the country. At the time of the drafting of the Constitution, a greater part of the population was farmers. Often it was necessary to mortgage lands which had been in families for generations in order to economically survive a planting and growing season until it was harvest time. For any number of reasons, many of which had nothing to do with a farmer’s hard work, harvests failed. Events such as a fire, flood, blight, drought, or any number of other occurrences could cause property which had been in the family’s name for generations to be lost through no intentional bad act on the part of the land owner. For reasons such as those, Congress developed the philosophy that an honest debtor is entitled to a fresh start, not a head start, but a fresh start. Accordingly, this philosophy was incorporated into the Constitution through the two provisions mentioned above. These provisions ensure that, with relatively little variation, the adjustment of the debtor-creditor relationship is consistent on a nationwide basis.

As a young boy I used to watch cartoons early in the morning and on Saturdays, even these taught us the history of bankruptcy. My favorite cartoons were the ones that were drawn in the 1930s, 1940s and 1950s. In those cartoons, whenever someone went into bankruptcy Court, they would come out dressed only in a barrel. In reality, the cartoons were not so far from the truth. The first permanent bankruptcy law enacted by Congress was known as the Bankruptcy Act and it was drafted in 1897. There was not a wholesale revision of that law until 1978. By that time, the outmoded exemption provisions and punitive aspects of the bankruptcy laws were found to be no longer appropriate for a society and economy which no longer resembled that which existed in 1897. The new bankruptcy laws provided standard federal exemptions, or allowed states to enact their own exemption laws to reflect the particulars of state law. Exemptions were intended to allow debtors to keep a reasonable amount of personal property which would be shielded from administration by the bankruptcy Court, and out of the reach of creditors of all types. Florida, for example, is a State which chose to opt out of the federal exemptions, and adopt its own. Therefore, Florida has been able to allow its state Constitutional Homestead provisions to remain intact, and to ensure that a Florida Homestead cannot be lost to creditors, except in a few rare circumstances, at least as of this date (there is currently legislation pending in Congress which may restrict Florida’s ability to retain its unlimited Homestead exemption).

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By: Joel S. Treuhaft, Esquire