History of Bankruptcy in the United States

Bankruptcy is a law that allows individuals and businesses to reorganize the terms of a debt when they are unable to repay on the previous terms of the loan contract. Bankruptcy began during the Revolutionary war. Before that it was considered a crime if you were unable to pay off your debts. This practice was inherited from European migrants and their colonizing states, where people sometimes would simply be hanged for having unpayable debts.

US founding fathers considered this as a brutal practice. In many states you could end up in a debtors prison cell if you had unpayable debt before the founding fathers made an end to this. Also, many Americans would still be imprisoned for debts with British colonial rulers. But the historical idea of the United States was to give everyone a fresh beginning, a new start. Going bankrupt had to become part of this. Everyone should be able to start again a new life, also financially. How would this be implemented?

There are many causes of bankruptcy, but freedom is not worth much if you have a lot of debt that stops you from moving forward in life.

While in modern days the United States no longer has brick and mortar debtors’ prisons for private debts, the term “debtor’s prison” still exists. A debtor’s prison refers to the practice of imprisoning people because of a fine or a fee imposed by a judge, so is written in Wikipedia.

U.S constitution

The designers of the constitution sought to solve this problem and wanted to give bankruptcy a place in the constitution. It can now be located in the U.S constitution in Article I, Section 8. The law provides Congress power to write laws related to bankruptcy within the United States.

However, it took ten years for congress to ratify the bankruptcy law. Several states have established regulations on bankruptcy due to the lack of a uniform framework countrywide. Previously, the law provided for imprisonment of debtors until 1833 when the federal law abolished debtor’s prisons. Some states took even until 1849 to abolish the debtor’s prisons.

Some states took until 1849 to abolish the debtor’s prisons.

First Federal Bankruptcy Law

The first bankruptcy law, the Bankruptcy Act was passed in 1800. This was similar to state laws that were present at the time. The law favored the creditors and only gave room for involuntary bankruptcies of merchant debtors. An individual could not file bankruptcies on their own.

Debtors found a loophole where they would request creditors to initiate a bankruptcy case. It brought a need to repeal the law after three years due to massive favoritism and corruption. This made the states to run bankruptcy laws without a federal law in place.

Second Federal Bankruptcy Law

Congress passed the second bankruptcy law known as the Bankruptcy Act in 1841. The law allowed debtors to file voluntary bankruptcies on their own and get a debt discharge. A creditor did not have to initiate a case leading to a change in the insolvency law. Besides, the law provided that anyone could become a debtor and not just a merchant.

The law gave the United States District Court powers to grant a discharge and also hear a case relating to bankruptcy. The law led to many debt discharges, while only a few creditors received payments leading to the repeal of the law in 1843.

Third Federal Bankruptcy Law

The congress passed another nation-wide bankruptcy law in 1898. This was the first comprehensive law that became permanent. Several amendments and replacements followed the 1898 enactment of the Bankruptcy Law. Since then, the law has not been repealed, or the federal government operating without a bankruptcy law. However, the law was reformed in 1978.

Reforms of 1978 to the Federal Bankruptcy Law

The 1898 bankruptcy law led to the Bankruptcy Reform Act in 1978. The reforms were comprehensive and led to massive changes in the bankruptcy system. It led to the creation of “Bankruptcy Code” and led to increased scope on the power of bankruptcy judges. The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act led to an alteration of the Bankruptcy Reform Act of 1978.

This came after four years of studying how the Bankruptcy system could be reformed to suit all parties. It also gave guidelines on which debtors qualify for Chapter 7 and the ones could file a Chapter 13 to get a relief. It also led to the introduction of debtors’ education and credit counseling. Due to the tug of war between creditors and debtors, changes have been made o the bankruptcy law.

Bankruptcy Law of 2005

President Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 in 2005. It took effect on 20th October 2005. The law made it difficult for individuals to have their debts discharged. It also introduced payment for pre-bankruptcy counseling. It also led to changes in Chapter 7 Bankruptcy and Chapter 13 Bankruptcy.

Filing for Bankruptcy

Bankruptcy is carried out by a business or an individual to get some freedom from their debts. It also provides creditors with an opportunity for at least some repayment. It is handled by the federal courts based on the U.S Bankruptcy Code. Depending on the type of bankruptcy filed, it will stay on your record, but it gives you a fresh start. Read more on How to File for Bankruptcy.

Vincent is a writer and researcher with an interest in finance, banking, startups, and remittance. He holds a Bachelors degree in Applied Statistics with computing. He founded Nexin Startups, an online platform offering startup advice to investors and entrepreneurs. Read more about us and our authors.