Bankruptcy

I

Introduction

Bankruptcy, legal proceeding in which a debtor declares his or her inability to pay consumer or business debts as they become due. Debtors may seek a discharge from continuing personal liability for unsecured debts or they may attempt to reorganize financially by seeking an extended period of time in which to pay all or a proportion of their indebtedness.

II

Early Procedures

Debtors who were unable to meet their financial obligations were harshly treated under the legal systems of most countries until relatively recent times. During one period in ancient Rome, creditors were entitled literally to divide a debtor's body or to enslave debtors and their families. Under the laws of England in the reign (1603-25) of King James I, debtors who were unable satisfactorily to explain their inability to pay were placed in the public pillory. Debtors might be put to death if their failure to pay their creditors was due to fraudulent practices. Savage reprisals of this kind were eventually halted, but for many years British courts ruled that debtors who failed to pay a judgment against them were guilty of a breach of the peace and therefore subject to imprisonment.

With the development of more sophisticated trade and commercial practices, steps were taken to ameliorate the condition of defaulting debtors. Beginning in the late 1800s, bankruptcy legislation in the United States evolved to permit persons who were unable to pay their unsecured debts to be discharged from that responsibility if they were willing to liquidate property in order to repay certain creditors. Both the federal bankruptcy statute and each state's laws allowed a debtor to retain some exempt property in order to permit the debtor's family to maintain a minimum standard of living. The states' exemption laws varied widely in the amount of property they allowed a debtor to retain, but the general purpose was to enable debtors to obtain “a fresh start.”

III

Current Practices

The Constitution of the United States empowers Congress “to establish ... uniform laws on the subject of bankruptcies throughout the United States” (Article I, Section 8). This grant of power to Congress has been interpreted to preclude the states from writing their own individual bankruptcy laws. The most recent update to federal bankruptcy legislation is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the first major overhaul of federal bankruptcy law since the Bankruptcy Reform Act of 1978, which was amended in 1984 and 1986. President George W. Bush signed the new law in April 2005.

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The Bankruptcy Abuse Prevention and Consumer Protection Act makes it more difficult for individual debtors to file for bankruptcy under Chapter 7 of the bankruptcy code. Chapter 7 enables individual debtors to liquidate or lower some debts in exchange for forfeiting some assets. Debtors must now meet more stringent criteria for filing under Chapter 7. The criteria are determined by the median income in the state in which the debtor resides. Those who fail to qualify for Chapter 7 must file for bankruptcy under Chapter 13, which requires repayment of debts at a set amount per month over a period of three to five years.

The 2005 legislation was supported by the credit card and retail industries but was opposed by several leading consumer groups and bankruptcy lawyers. Supporters of the new law argued that it would hold people accountable for their debts and prevent abuse by gamblers and compulsive shoppers. Opponents argued that the law penalized people facing unusual circumstances, citing studies showing that most bankruptcy filings under Chapter 7 result from medical emergencies, divorces, or the sudden loss of a job. Critics also said that the law imposed obligations on bankruptcy attorneys that would result in higher legal fees for those declaring bankruptcy. The new law’s requirement that anyone seeking to declare bankruptcy must first take a credit counseling course, the critics said, was potentially onerous for low-income people.

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