A brief history of bankruptcy

Justice Livingston once said that it might be questioned whether a law by Congress that subjects every person in the United States to bankruptcy, regardless of occupation, would align with the spirit of the powers given to them concerning this issue.

This limited view has never been accepted by either Congress or the Supreme Court. In 1800, the first bankruptcy law was passed and it included bankers, brokers, factors and underwriters instead of just traders—which departed from English practice.

According to Justice Story, the English statutes only narrowly apply and are simply a policy that does not have anything to do with the nature of such laws. He believes that bankruptcy legislation mentioned in the Constitution refers to a law providing for people who cannot pay their debts.

The Supreme Court has agreed with this interpretation. In the case of Hanover National Bank v. Moyses, it was decided that the 1898 Bankruptcy Act was fair and allowed anyone to file for bankruptcy, not just businessmen.

The Court has unofficially allowed the bankruptcy laws to expand and cover almost all classes of people and corporations, including municipal organizations and workers..

The Bankruptcy Act has been edited to provide a wage-earners extension plan for those people who mainly receive their income from salaries or commissions. The Supreme Court has ruled that this plan may be used by anyone, even if they have been discharged from bankruptcy in the last six years.

Granting More Freedom to the Trustee and expanding their Rights

As coverage for bankruptcy laws has increased, the help given to debtors experiencing financial difficulties has expanded as well.

From the English act of 1800, which primarily benefited creditors, to the American act of 1841 exploring voluntary petitions– slowly but surely rehabilitation for debtors became an increasing worry for Congress.

You are no longer required to adjudicate bankruptcy to exercise jurisdiction. In 1867, the debtor was permitted by a majority of his creditors and confirmation from a bankruptcy court to either before or after adjudication, proposing terms of composition that would become binding.

The constitutionality of this measure, as well as later acts providing for the reorganization of corporations unable to pay their debts or mature, and relief proceedings for individual farmer debtors were held.

Not only does Congress have the power to adjust creditors’ rights. According to the Supreme court, a debtor’s property rights may be modified by postponing the redemption period after the purchaser has bought it.

In addition, the Court increased the bankruptcy court’s power over the property of creditors by allowing affirmative relief on a counterclaim to be filed against anyone who files a claim against an estate in bankruptcy.

The majority of Court decisions and statutes aim to create equity and fairness in the way a bankrupt’s assets are distributed. One example of this is United States v. Speers, which was codified by an amendment to the Bankruptcy Act. This act strengthened the position of trustees about federal tax liens that were unrecorded at the time bankruptcy was filed.

In other circumstances where the Supreme Court has needed to handle the priority of various creditors’ claims, they have held that costs relating to tort law for the receiver are an “actual and necessary” part of the administration. They have also ruled that benefits received from a nonparticipating annuity plan are not seen as wages, so they do not take priority. In addition, when taxes levied against a bankrupt business are allowed, any penalties incurred because the trustee did not pay these taxes while still operating should also be accounted for.

The Court’s current standpoint on these and other evolving situations is best expressed by Justice Sutherland in the Continental Bank v. Rock Island Ry. opinion, who wrote on behalf of a unanimous court: “these acts, though widespread, have not exceeded Congressional power; they are simply expansions into an area whose limits have not yet been fully determined.”

How the Constitution Limits Bankruptcy Powers

While Congress has the power to declare bankruptcy, it cannot overstep the Fifth and Tenth Amendments. The Bankruptcy Act provides that those who are required to testify or provide information in a case may be granted immunity from the use of that information.

Though a creditor’s right to their property cannot be unreasonably taken away by Congress, this is only the case until the Supreme Court finds that a bankruptcy court has summary jurisdiction. At that point, any voidable preferences given to the creditor can be taken back by the trustee through counterclaiming.

A corporation that has been dissolved by a state court may not file a petition for reorganization under the Bankruptcy Act, as Congress cannot supersede the power of a state to determine how such corporations shall be formed, supervised, and dissolved.

Even though Congress has the power to affect existing contracts, they usually don’t. And if laws related to bankruptcy are changed, those changes only apply to contracts entered into after the law is passed—not retroactively.

While a federal bankruptcy court cannot control the financial affairs of state political subdivisions, Congress may give such courts the ability to compositely settle debts owed by tax agencies or instrumentalities if the state has consented to the proceeding and if interference with said petitioners’ fiscal or governmental affairs is not authorized.

Although bankruptcy legislation must be consistent across states, Congress may still acknowledge state laws regarding dower, exemption, the validity of mortgages and related matters. This is because the required uniformity pertains to geography, not individuals.

The power of Congress to allow entities that are not Article III federal courts to preside over bankruptcy claims is unclear. This may mean that non-Article III courts do not have the authority to hear state law claims brought before them only because they are relevant to a bankruptcy proceeding.

Constitutional Status of State Insolvency Laws: Preemption

Before the year 1898, Congress only had the authority to establish laws related to bankruptcy sporadically. The first national law was passed in 1800 but repealed shortly after in 1803; the second one was enacted in 1841 but also repealed two years later. A third bankruptcy law became active in 1867 but quickly got rescinded in 1878.

Overall, national bankruptcy law was only active for sixteen out of the eighty-nine years it has existed since the Constitution was put into place. The most debated issue during that time frame related to how state law would be affected by the clause.

The Supreme Court ruled long ago that, if Congress doesn’t act, individual states may pass their insolvency laws. This is because it’s not the power itself that causes issues, but rather its exercise when done concurrently by both state and federal governments.

Subsequent cases determined that the passage of a national bankruptcy law does not nullify state laws that conflict with it, but instead only suspends them until the national statute is repealed. at which point they would go back into effect without needing to be re-enacted.

A state cannot legally enforce any law related to bankruptcies that go against contracts, includes persons or property located outside of the state, or disagrees with national bankruptcy laws.

By the policy of the federal statute, the Court has ruled that a state statute regulating this distribution of assets among insolvent individuals was suspended by that law. Furthermore, a state court does not have the authority to continue with pending foreclosure proceedings if a farmer-debtor files a petition in federal bankruptcy court requesting extra time to pay his debts or seeking arrangements for those payments.

A state court injunction that ordered a defendant to clean up a waste-disposal site was held as something that could be discharged in bankruptcy law. This is because the state had appointed a receiver to take charge of the defendant’s property and comply with the said injunction, which federal law states is allowed under those circumstances.

However, the Justices have intensely disagreed on one specific issue, to the point of having three five-to-four decisions. These decisions were: first upholding state laws, and then voiding them. The laws in question provided that if a person was bankrupt and couldn’t pay off their debts from an automobile accident, their driver’s license would be suspended.

The state statutes were based on the Uniform Motor Vehicle Safety Responsibility Act, which permits drivers who don’t pay judgments related to traffic accidents to have their licenses suspended. A section of the law specifically says that filing for bankruptcy won’t exempt debtors from paying or having their licenses suspended.

The Court majorities ruled that the state law was not designed to ensure that judgments were paid, but rather to safeguard the public against reckless driving. 

The last case held that the act did not align with federal bankruptcy law, which gives people a clean slate without debt.

A state that wants to share in the proceeds of bankruptcy must comply with the filing requirements of the bankruptcy court, including deadlines for claiming taxes.

For more on bankruptcy in the US see Justia.

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