Bankruptcy is defined as “a legally declared inability or impairment of ability of an individual or organization to pay its creditors”. Though a less-than-pleasant experience, it is often an unavoidable step that enables the debtor to make a fresh start and the creditor to recoup at least part of the debt. Bankruptcy has got a lot of coverage in recent times, especially with the worst recession since the Great Depression of 1929 assailing world economy. However, the history of bankruptcy dates back at least 500 years to medieval England.
Before we embark on a journey through time to trace bankruptcy’s roots, its important to know the origin of the word. The word “bankrupt” originates from the ancient Latin bancus (a bench or table), and ruptus (broken). Ancient bankers used to conduct their business at a bench in public places like marketplaces and fairs. When a banker failed, his bench (bancus) was broken (ruptus) to advertise to the public that he was no longer in a condition to do business. Even today, the word “bankrupt” means the inability of an individual or company to do business.
The first bankruptcy law was enacted in England in 1542 during the reign of Henry VIII, and was heavily biased against the debtor where he could be jailed and all his assets seized. With time, the law was relaxed to allow debtors out of prison, many of whom promptly fled to the debtors colonies in Georgia and Texas. Even as imprisonment became rarer in the 1800s, collusive bankruptcy (agreed upon by creditor and debtor) became legal in 1825. Voluntary bankruptcy was authorized in England in 1849.
When the United States Constitution was adopted in 1789, bankruptcy was specifically mentioned as being subject to federal law. The first US bankruptcy law was passed in 1800 and provided only for involuntary proceedings. Voluntary bankruptcy was legalized in 1841 and its scope expanded by subsequent legislation in 1898 and 1938. The Bankruptcy Reform Act of 1978, commonly known as the Bankruptcy Code, made major changes to bankruptcy law.
There was considerable confusion on the overlapping and conflicting jurisdictions of the new court structure, and an “Emergency Rule” had to adopt by the courts. This rule remained in effect until enactment of the 1984 legislation on July 10, 1984 when the Bankruptcy Amendments and Federal Judgeship Act was implemented. Consequently, new bankruptcy courts were allowed to exercise the entire subject matter jurisdiction of the district courts, subject to certain limitations.
In 1986, the Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act made considerable changes relating to family farmers and established a permanent trustee system. In recent years, the Bankruptcy Reform Act of 1994 has enacted changes that affect the mortgage banking industry. At present, there exist six types of bankruptcy under the Bankruptcy Code, located at Title 11 of the United States Code:
1. Chapter 7 – straight bankruptcy for basic liquidation.
2. Chapter 9 – municipal bankruptcy to resolve municipal debts.
3. Chapter 11 – corporate bankruptcy for restructuring.
4. Chapter 12 – family farmers and fishermen bankruptcy.
5. Chapter 13 – wage earner bankruptcy for regular income earners.
6. Chapter 15 – international bankruptcy to allow foreign debtors to clear debts.
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