Bankruptcy History
Legal Historian Charles Warren describes Bankruptcy as a "gloomy and depressing subject." The treatment of debtors throughout history has been rather harsh. Debtors were treated like criminals and subject to imprisonment in a debtor's prison, public humiliation, and in some instances even death.
The first Bankruptcy laws were passed over 400 years ago in England during the reign of Henry VIII, but these laws contained no protections at all for individual debtors. The laws only applied to merchants and mostly served to ensure the orderly sale and distribution of assets so to protect creditors. The Bankruptcy Chancellor had complete authority to break into a debtor's house and seize assets for sale. Early English Bankruptcy laws did not even provide for a discharge upon the conclusion of the case. Instead, after the debtor was stripped of his assets, any unpaid creditors were still free to pursue him.
Debtor's Prisons
The use of Debtor's Prisons to incarcerate those unable to pay their debts dates to the mid 1500's. Originally, the purpose of the law was to imprison debtors who refused to turn over their assets to the Chancellor overseeing their Bankruptcy proceeding. Uncooperative debtors could be imprisoned or subjected to public humiliation. Debtors could have an ear cut off or be placed in a pillory in the public square with an ear nailed to the pillory. Unfortunately, the practice grew to allow the imprisonment of most anyone owing money. Charles Dickens set several of his novels in such prisons in England, basing his work on his own experience as a child when his father was imprisoned in Marshalsea debtor's prison.
Unfortunately, this nasty practice was brought to the English Colonies in America and continued here until the mid-1800's. Perhaps the most famous American ever locked away in a debtor's prison was Robert Morris, a wealth Pennsylvania businessman who signed the Declaration of Independence and helped finance Washington's army out of his own pocket. Conditions in these jails were often horrific. In 1766 the debtor's prison in Annapolis MD was described as "so filthy and nasty that it is excessively Nauseous." Poor debtors were incarcerated for debts of a dollar or two. In 1833 the Federal Government outlawed the use of debtor's prison and most states followed suit soon thereafter. Virginia had many such prisons, similar to the one pictured to the right.
American Bankruptcy Laws
Although the Constitution gave Congress the authority to enact Bankruptcy laws as early as 1789, Congress did little to act in this area for the next century. Three short-lived statutes were passed in response to times of financial crisis and were quickly repealed, leaving the control of these matters to the several states for most of the Nineteenth Century. Finally, in 1898 Congress passed the first permanent Bankruptcy Act. This Act marked a fundamental shift in Bankruptcy law, because it provided for discharges on fairly liberal grounds. It was the first such law aimed more at protecting debtors than creditors. This law remained in effect, with many amendments, until 1978. The most significant amendment was the Chandler Act of 1938 which created the various "Chapters" which are still in use today.
The Bankruptcy Code of 1978 completely overhauled the operation of the Bankruptcy system. It expanded the power of Bankruptcy Judges, streamlined many procedures, created what we now know as Chapter 11 by combining two older provisions, and encouraged expanded use of Chapter 13 repayment plans.
Most recently, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has altered this field of law dramatically. The new law instituted a system of "means testing" which was designed to force high income debtors into repayment plans. Additionally, the law requires all debtors to undergo credit counseling prior to filing. While many believed that the new law would make it more difficult to obtain bankruptcy relief, it appears that the new law has really served to clarify who is eligible for Chapter 7.