Bankruptcy Concept History and Evolution

Bankruptcy Concept

History and Evolution of the Bankruptcy Law

General Concept

The Bankruptcy Code

The Bankruptcy Process

Advantages and Disadvantages, Alternatives

Myths about the Bankruptcy Law

Bankruptcy is now known as a federal court process aimed at helping individual consumers and businesses get rid of their debts or to set up a plan to repay them with the protection of the bankrupt courts (Jackson 2006). Rather than disabling the debtor from settling his obligations, the process gives him the chance to meet or fulfill them. It first releases him from personal liability from all or some of his debts by preventing his creditors from collecting the debts (Jackson). Bankruptcy is now a protection and a means to help the debtor make himself over. This concept took many years to evolve to what it is now. In its earliest form, bankruptcy was a strict measure to remedy debtor fraud, which was then considered a crime (ABC Amega 2006). Rules and practices in those days were stern and creditors treated debtors harshly (ABC Amega).

History and Evolution of the Bankruptcy Law

The concept of debtor default dates back to the time of the Code of Babylon's King Hammurabi in 1795 BC (ABC Amega 2006). The Code included early laws and rules for settling debts. In cases when the debtor could not repay, the creditor could confiscate his child, wife, slave or the debtor himself into bondage until the obligation was met. In ancient Greece and Rome around 31 BC, indebtedness remained a crime. It was only during the reign of Augustus that a distinction was made between the debtor as a person and his debts. The laws of the time allowed the debtor to choose between giving his property up or himself as repayment (Amega). The history of bankruptcy law consists of three phases (Duhaime 2007). The first phase involved basic debt collection. The Roman Law of the Twelve Tables in 450 BC provided for a method of dealing with debtors who could not repay their debts. Table III provided for a process, which first allowed the debtor to settle his obligation in 30 days or have someone pay for it for him. If the debtor failed, the creditor could bind the debtor with a weight of 15 or more pounds. The creditor could choose to feed him or not with a pound of meal each day. On the third "market" day, the creditor could divide the body of the debtor with other creditors among themselves. Under Roman law, the debtor who could not meet his obligation did not have to be cut into pieces but his creditor could have him imprisoned for life. The creditor also had the option to sell the insolvent debtor, along with his family, to permanent foreign slavery. The concept of imprisonment was adopted by some parts of India and with an added feature. The creditor could take the debtor's wife and, if he did, the act would cancel the debt. Under Charlemagne, the debtor had to surrender his possessions in order to escape or prevent imprisonment. Imprisonment remained an option for the creditor but torture was outlawed (Duhaime).

The second phase dealt with insolvent debtors and help for debtor-traders only (Duhaime 2007). Henry VII of England in 1542 issued a statute against those who willingly or unwillingly failed to remit their debts. The Lord Chancellor ordered the seizure of the insolvent debtor's property. The statute was later change to provide help to protect the bankrupt debtor who was a trader only. The law of that time considered traders to incur only accidental losses and that the inability to repay would not be their fault. Other persons would not have the same capability and had no right to incur large debts and not repay them. The third phase affords financial help to the beleaguered debtor for whatever reason he has become insolvent (Duhaime).

The law passed under the reign of Henry VII focused on the recovery of the creditor's investment and that most insolvency was involuntary at the time (ABC Amega 2006). Bankruptcy was then considered "offenders" who were criminally punished with imprisonment. Debtors were said to fill prisons to an overflow. Under the rule of Queen Elizabeth I in 1570, only creditors could file for bankruptcy proceedings and only traders or merchants qualified. The rest were still sent to prison for the "crime." It was during the reign of Queen Anne in 1750 that a statute was issued for a more humane treatment of honest debtors. Debtors who cooperated in the bankruptcy proceedings could merit a discharge of his debt and even a monetary allowance from the estate for his positive participation. In the event of a lack of cooperation, a fraudulent debtor's penalty even increased from imprisonment to death. The 1732 Statute of George II was the bankruptcy law in effect in England at about the same time the United States Constitution was ratified. At first, the Statute was clearly and strongly biased towards the creditor. But by the middle of the 18th century, a more enlightened attitude crept in. Bankruptcy remained a crime up to the 19th century. Petitions from debtors did not exist. Bankruptcy was regulated by the colonies in the new land. Under the Pennsylvania Bankruptcy Act of 1785, flogging of the convicted bankrupt debtor was allowed while he was nailed by the ear to the pillory. The ear was then cut off (ABC Amega).

Article I, Section 8 of the U.S. Constitution allows Congress to pay uniform laws on bankruptcy (ABC Amega 2006, Jackson 2006). President James Madison closely linked the regulation of bankruptcy to that of commerce. The federal government of the time found it necessary to deter debtors from escaping to another State to avoid being forced to meet their obligation. Early federal bankruptcy laws in the United Stated in 1800 were momentary responses to poor economic conditions of the period. The first was in response to land speculation and the 1793 depression. Bankruptcy proceedings remained an option by creditors against debtors who were merchants or traders only. The 1800 Act was repealed for failing to curb debtor fraud. The States continued to regulate relations between debtor and creditor although they could not discharge pr-existing debts and not the debts due to citizens of another State. Because of these limitations and the Panic of 1837, the second federal bankruptcy law was enacted. It was a milestone in that problematic debtor could directly file bankruptcy and receive a discharge. The law also extended the relief to all debtors. It changed bankruptcy from a creditor protection and remedy against debtor fraud into a voluntary system of protection for debtors. As could be expected, this liberal measure allowed the commission of fraud and abuse. Thousands of debtors were released, minimal dividends were paid to creditors and administrative fees ran high. Quickly, the law became unpopular until it was repealed in 1843. Congress passed the next bankruptcy act in 1867, following the Panic of 1857 and as the Civil War raged. All debtor classes were eligible and it allowed voluntary petitioning. It became controversial for allowing very lenient and generous exemptions. Under this new law, a debtor could retain his homestead properties and thousands of dollars in personal property. It lasted longer than preceding laws but it was repealed in 1878 because of widespread fraud and displeasure. An amendment in 1874 introduced the composition agreement. This agreement allowed the debtor to propose to pay a certain percentage to pay his debt fully over time while keeping his property. The Bankruptcy Act of 1898 was passed and was in effect for 80 years. It was the start of permanent federal bankruptcy laws. It continued to redefine bankruptcy in terms of debtor entitlement. It banned farmers and wage earners as well as creditor approval as condition for discharge. Problems like the lack of time limit between bankruptcies encouraged abusive debtors to incur debts without the intention to repay, declare bankruptcy and discharge their debts repetitiously without limit. Instead of repealing the law, Congress only introduced amendments. The most radical and comprehensive was the 1938 amendment, also called 1938 Chandler Act, which provided for the reorganization of businesses. In 1970, Congress established the Commission on the Bankruptcy Laws of the United States to review the then existing laws. On its recommendation the Bankruptcy Reform Act of 1978 replaced the 1898 Act with the Bankruptcy Code.-Title II. The Act substantially altered bankrupt practices. It contained provisions for strong business reorganization and stronger personal bankruptcy. In the 1980s, the Bankruptcy Reform Act of 1978 led to many legal controversies, amendments and judicial clarifications. The Bankruptcy Amendment Act of 1980 dealt with tas-related issues while the Bankruptcy Amendment Act of 1984 restrained companies' right to terminate work contracts. Many bankruptcies were filed and recorded in the 80s and early 90s. "Prepackaged" techniques facilitated the courts' work efficiently, but these also raised professional fees and wasted corporate assets. President Bill Clinton signed the Bankruptcy Reform Act of 1994 into law. It became the most comprehensive legislation on bankruptcy since the 1978 Act. It provided for fast proceedings, encouraged debtors to reschedule their obligations rather than liquidate and helped creditors recover their claims against bankrupt estates. The 1994 Act also created the National Bankruptcy Commission, charged with investigating further modifications of the bankruptcy law. Latter laws, however, disregarded many of the Commission's recommendations. In April 2005, President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Many experts consider this the most extensive rework of the U.S. bankruptcy law since 1978. The most important changes introduced in this Act concern individual bankruptcy cases, small business bankruptcies and cross-border insolvency cases (ABC Amega, Jackson).

II General Concept

Bankruptcy is governed by the Bankruptcy Code, which became effective in 1978 (Empowerment Zone 2007). It was amended in 1994 and then in 2005. The 2005 amendments formed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 or BAPCPA. This Act ignited major changes for consumer bankruptcies and set into motion a few restrictive provisions for business bankruptcies. All bankruptcy cases must be filed with the federal Bankruptcy Court. It is monitored by a federal Bankruptcy Judge, who is appointed by the Circuit Court of Appeals. The Bankruptcy Judge may hear only bankruptcy cases. This is a specialized area of the law, which has its own set of courts and rules. These bankruptcy courts seem to maintain a kind of secret aura (Empowerment Zone).

Bankruptcy cases begin with the filing of a petition with the clerk of the Bankruptcy Court (Empowerment Zone 2007). The petition has two pages and identifies the debtor and the pertinent chapter of the Bankruptcy Code to apply. At the time of filing, an estate is created and all the debtor's assets are considered property of that estate. Everything before the filing is described as "pre-petition," and everything after it is described as "post-petition."

Who May File

Most anyone may file for bankruptcy (Empowerment Zone 2007). But if the court believes that the person who seeks it is abusing the law, it may deny the relief sought. Bankruptcy is a serious matter, which requires serious consideration. It has long-term serious consequence. The debtor should determine his personal and family needs, evaluate his assets against obligations, and consider alternatives to bankruptcy (Empowerment Zone).

Participation in Proceedings

In general, participants in bankruptcy proceedings are the debtor, the bankruptcy judge, the creditors, and the trustee (Empowerment Zone 2007). The debtor is the person seeking relief in the bankruptcy petition. He is also called petitioner. The bankruptcy judge is the judge who presides over the hearings. The creditors are persons, business entities or government agencies, which have monetary claims on the debtor. And the trustee is a court-appointed person who represents the interests of all unsecured creditors. He is accountable for the surrendered property of the debtor and for collecting and liquidating it. He also investigates the debtor's financial affairs, examines all of his proofs of claim, provides information to any interested party and files reports, certain tax returns and other records the court may require (Empowerment Zone).

Functions of the Bankruptcy Law

The Bankruptcy Law serves two main purposes (Consumer Education Center 2007). It provides a creditor with some payment if the debtor can afford to pay. Secondly, it gives the debtor a new start by canceling many of his debts according to a court-determined schedule of discharges (Consumer Education Center).

Kinds of Bankruptcy

Of those available to individuals, these are a liquidation type, a rehabilitation type for individuals or businesses, a rehabilitation type for individuals with regular sources of income, and a rehabilitation type for family farmers and fishermen (Consumer Education Center 2007). There is a rehabilitation type primarily for business debtors or individuals with huge debts and assets. The liquidation and the rehabilitation type for individuals with regular sources of income are the most important types for consumers. Both types offer or make possible payments to the creditor, a discharge for the debtor and supervision by a trustee. The liquidation type involves surrendering some of the debtor's property, at least theoretically, in exchange for the discharge of many debts. The trustee sells his non-exempt property to pay the creditor. Under the rehabilitation type for individuals with regular sources of income, the debtor can keep his property but has to commit to a three-year-to-five-year repayment plan. As a result, he secures a discharge of most of the debts not paid in the plan. Under both types, creditor have to stop collection after the case is filed. The debtor is protected by "automatic stay," a relief, which is often temporary (Consumer Education Center).

Difference Between the Liquidation Type and the Rehabilitation Type for Individuals with Regular Sources of Income

The liquidation type is, as the term says, for liquidation (Consumer Education Center 2007). The debtor gives up some of his property at the time he files the bankruptcy case. The trustee uses the sale to pay the creditor. The debtor has no assets over and above what the law allows him to keep. He, thus, does not give up any property. Approximately 90 days after the case is filed, the debtor has most of his debts discharged. Some are cancelled, but some must be paid after the case. Examples of those, which are left are child support payments, some taxes, student loans, collaterals for loans. Only those in the list at the time of bankruptcy are cancelled or discharged. The debtor is allowed to keep the money he earns after filing the case. He may also keep most of the property he acquires after the filing (Consumer Education Center).

The rehabilitation type for individuals with a regular source of income is quite different (Consumer Education Center 2007). Under this type, the debtor pays some of his debts over time from his current income and according to a court-approved plan. He keeps all of his property, exempt or not, but he makes regular payments on his debts out of his income after filing the bankruptcy case. The plan payment must be the same total or at least as much as the creditor will have received if the debtor has just liquidated. His payments are given to a trustee who, in turn, makes the payment or distributes it to creditors, if there is more than one. The payments are made according to a regular installment plan, as proposed by the debtor. He is usually assisted by a lawyer. The repayment plan usually lasts until the debt is fully paid or up to three or five years. The debtor is discharged from his debt at the completion of the plan (Consumer Education Center).

Eligibility

The law allows a debtor to choose the type of bankruptcy to file for (Consumer Education Center 2007). But he needs to qualify for that type. Bankruptcy cases filed for the liquidation type are now more limited. An individual debtor with primarily consumer debts who wants to file for the liquidation type must be prepared to have his finances investigated to determine his capability to repay. A set formula, called a "means test," is used for the investigation. It is meant to force debtors with some capability to repay to do so rather than have their debts discharged. This test compares his excess monthly income with the amount of unsecured debt. This will show how much he is capable of paying his creditor but under the rehabilitative type for individuals with regular sources of income. The computations are only hypothetical and do not reflect the actual capacity of the debtor to meet his obligation. If he appears capable of repaying the minimum of his debts, but in reality, cannot, he may be allowed to file for the liquidation type. However, the means test is a complex procedure. If the test shows that the debtor is capable, he will be ineligible to file for the liquidation type. If he wants to file a bankruptcy, he must do so under the rehabilitation type for individuals with regular sources of income the qualifications for the rehabilitative type are a regular income and no indebtedness over and above $922,975 in secured debt and $307,675 in unsecured debt. These amounts tend to increase. Examples of secured debts are home mortgage and auto loans. Examples of unsecured debts are usually credit card debts (Consumer Education Center).

The Value of Bankruptcy

It imposes an injunction against collection activities of creditors (Consumer Education Center 2007). Creditors are obligated to stop pursuing and troubling the debtor. This is termed "automatic stay.(Consumer Education Center)." The policy behind it is that the debtor is entitled to some "breathing" space while his assets are evaluated or while reorganization is going on (Johnsen 2003). A creditor who violates the automatic stay by continuing to pressure the debtor may be subjected to monetary sanction or some other penalty (Johnsen).

Discharge

Discharging a debt means that the debtor no longer has the obligation to pay it (Consumer Education Center 2007). It prohibits the creditor from exerting any more efforts to force the debtor to pay back. But a discharge does not cancel the indebtedness of the debtor's family member or friend who is indebted to the creditor. Moreover, the debtor's property, which is used as collateral for a loan, can be repossessed by the creditor. This also means that not all debts can be discharged even when the debtor satisfactorily complies with all the requirements and his duties in his bankruptcy case. Only debts owed and scheduled at the time of the case was filed can be discharged. Those incurred afterwards are not covered. Other examples are certain taxes, unscheduled debts, alimony, maintenance or support debts, pre-petition fines and restitution, debts for injury or death, student loans and condo or coop fees. The creditor must ask the court to exempt these debts. If he does not, they will be discharged.

Costs for Filing for Bankruptcy

As of October, 2005, the filing fee for liquidation or rehabilitative type has been $274 (Consumer Education Center 2007). Some courts impose additional administrative fees. The filing fee may be paid in installments. It may also be waived if the debtor's income is convincingly low to the court. A debtor may need a lawyer to help him file for bankruptcy. Lawyers charge a fixed amount for the service, which differs according to the type of bankruptcy (Consumer Education Center).

III the Bankruptcy Code

Title 11 is on the Bankruptcy Code. Chapters 1, 3 and 5 discuss the general provisions, which are applicable to all bankruptcy proceedings (Empowerment Zone 2007). Remaining chapters each discuss a different type of bankruptcy proceeding. A debtor can invoke only one of these chapters at any given time. He cannot invoke Chapter 7 and Chapter 11 simultaneously, for example. Chapter I defines the numerous terms throughout the Code, the rules for construction, the general powers of the Code and the qualifications of debtors for each type of bankruptcy available. Chapter 3 is about case administration, such as the appointment of trustees and the regulation of the bankruptcy estate. Chapter 5 is on the regulation of claims, distribution, discharge, and the trustee's avoiding powers. Chapter 7 discusses a court-supervised procedure. Under this procedure, the trustee collects the non-exempt property of a debtor, sells it, and distributes the sale to creditors according to the priority of interests, established by the Code's provisions. Chapter 7 is about the type available to individual, married couples, corporations and partnerships. When the liquidation process is complete, a debtor's remaining debts are discharged. Chapter 9 is about the adjustment of debts of a municipality. Chapter 11 is about reorganization. Chapter 12 is about adjustment of the debts of a family farmer with regular annual income. And Chapter 13 is on adjustments of the debts of an individual with regular income and the rehabilitation of the debtor to allow his future earnings to repay creditors. Chapter 11 is on businesses desiring to continue operations while repaying its creditors, according to a court-approved plan or reorganization. Such a business is usually allowed to retain its assets and to continue operating. The debtor proposes a repayment plan for the approval of the court and the majority of creditors. When approved, the debtor and the creditors are bound to the terms of the repayment plan. Plans like this may include repayment from future earnings, sales of assets and/or recapitalization and merger. Chapter 9 is on the reorganization of municipalities like businesses. Chapter 13 is about debtors who keep property and repay debtors usually within 3 to 5 years according to the terms of the plan. Repayment ranges from 10 to 100% according to the expected income and resources of the debtor. Chapter 12 also provides for similar contents as those of Chapter 13, focusing on farmer-debtors who want to continue farming operations in the course of the repayment plan. Chapter 15 is about special and ancillary proceeding wherein the United States court helps a foreign court, which exercises primary bankruptcy jurisdiction over a foreign debtor (Empowerment Zone).

IV. The Bankruptcy Process

This consists of:

gathering detailed financial information, such as detailed descriptions of the debtor-filer's financial affairs for the previous year, a list of his debts and assets and a statement of monthly home and expenses (Empowerment Zone 2007, Johnsen 2003) filing the appropriate forms and paying the fees to the court clerk providing notice to creditors, as arranged by the court, 20 days from filing court appearance for compulsory meetings with creditors. The court sets the 20-40 days after the filing the debtor's property is turned over to the trustee, per court orders, for distribution to creditors.

A securing debt discharge approximately 90 days after filing attendance at court hearings (Empowerment Zone, Johsen).

Although a citizen has the right to represent himself or herself in bankruptcy courts, the procedure is complicated and taxing and thus requires expert attention to detail. Furthermore, the governing laws are complex, technical and always subject to change. Every situation is different from another and the consequences of filing are uncertain. These difficulties and uncertainties can be overcome by hiring a lawyer to assist and advise. He can analyze the debtor's particular circumstance and preferences. A lawyer will also be more knowledgeable in preparing the necessary documents and help the debtor make better decisions (Empowerment Zone, Johnsen).

Involuntary Petition

In certain circumstances, an involuntary petition may be filed by a group of creditors against a debtor (Empowerment Zone 2007). This is done by three creditors to whom the debtor owes unsecured, liquidated, non-contingent debt. The creditors must claim that the debtor is unable to pay his debts, which have become due. If the debtor has fewer than 12 creditors, a single creditor can file the involuntary petition. The debtor retains the right to dispute the petition that he has been regularly paying his debt or that the creditors are ineligible to participate in the petition. The debtor may also consent that the petition should proceed. Upon the filing, an injunction - "automatic stay" - becomes effective. It prevents the creditors from proceeding with any action against the debtor. They can no longer collect, foreclose, perfect a lien, set-off lawsuits or terminate contracts.

The Organization of Bankruptcy Courts

Each federal district court has a bankruptcy unit within (Jackson 2006). This unit hears and decides petitions from debtors who seek discharges and relief from bankruptcy. Some States have a number of federal districts. At present, there are 90 bankruptcy courts throughout the United States. Bankruptcy judges are appointed to 14-year terms by the Court of Appeal. They preside over bankruptcy proceedings with their vast decision-making capability and authority. Congress decides the number of bankruptcy judges. At present, there are 326 (Jackson).

Bankruptcy petitions are first heard by the U.S. District Court (Jackson 2006). Then it moves to the appropriate Circuit Court of Appeals and on ultimately to the U.S. Supreme court if a certiorari is granted. Although the judge has the ultimate decision-making power and authority over bankruptcy cases, the process is mostly administrative in nature. The bankruptcy trustee carries out most of the process. In most cases, the trustee for both the liquidation and rehabilitative types of bankruptcy is appointed by the United States Trustee Program and then approved by the bankruptcy court. His duties are decided by the regional U.S. trustee offices (Jackson).

V. Advantages and Disadvantages of Filing for Bankruptcy

Advantages creditor may not embark in most legal proceedings against a debtor who has filed for bankruptcy or proceed with those already in process without the approval of the court (Empowerment Zone 2007).

A an orderly and systematic set of rules determines the distribution of the debtor's property or the minimum amount he may repay to the creditor.

A many of his pre-bankruptcy debts will be resolved in the proceeding and give him the much-needed "fresh start." In most cases, the creditor loses claim over the debtor's future income or assets. Wages, earnings and property acquired after bankruptcy are beyond a creditor's claim.