Bankruptcy Essay ⋆ Business Essay Examples ⋆ EssayEmpire

Bankruptcy is the legal state of being unable to make good on one’s debts. Originally a crime—the accusatory origins of the word are retained when we refer to someone as “morally bankrupt”—ideas about and practices concerning bankruptcy have evolved over thousands of years, changing as do economic systems. Though the negative connotations of the word remain, it is now a thing that can be entered into strategically, even to the benefit of all concerned parties.

History

The need to deal in some fashion with an individual’s inability to pay his or her debts is as old as debt, as old as money. A wide variety of remedies developed in different economies. In ancient Jewish law, the debts of Jews are cleared every seventh year, and every 50th year is the Year of Jubilee, clearing all debts, Jewish and otherwise. At the other extreme, Genghis Khan prescribed the death penalty for anyone who had become bankrupt three times.

More widespread, with a good deal of variation, is the ancient Greek practice of debt slavery, in which families and their servants were forced to labor without recompense in order to pay off the debt of the head of household. Debt slaves were not “sold into slavery”—they had more rights than other slaves, and indentured servitude might be a more accurate term for the practice. “Debt slavery” continues to be used figuratively, to refer to the necessity of continuing to earn a certain amount in order to pay off one’s debts—the lifestyle one is locked into when one has had to enter into debt in order to acquire necessary luxuries like a financed car, a mortgaged house, and a college education. However, in that modern figurative use, bankruptcy is the remedy (as it were) to debt slavery, rather than the other way around.

In the Middle Ages, individuals accused of bankruptcy (or operating businesses accused of bankruptcy) could be publicly flogged, a solution that helped no one per se but was intended as a deterrent and to satisfy the public need for the service of justice. In England, they could have their ears cut off, or nailed to a wall—punishments which, while more vicious than sending them to debtors’ prison, did not prevent them from continuing to work to try to pay off their debts, nor did it add the cost of their upkeep to the state’s bills.

The common thread here is that bankruptcy was a form of fraud. The debtor had agreed to pay a debt he proved unable to pay. The word bankrupt comes from the Latin bancus ruptus, broken table; a bancus (from which both bank and bench derive) was a table at which the ancient bankers sat in marketplaces and other public places. When he could no longer do business, he broke the table (or it was broken for him) as a sign that he was no longer doing business. From the start, then, bankruptcy has been a figurative term, used to refer to people who were as bereft as these broken bankers.

The modern form of clearing debts through the act of declaring bankruptcy dates from English law in 1705. As economic, political, and technological changes changed the nature of individual economic life, attitudes towards debt and bankruptcy shifted. In various countries, legal systems developed designed to liquidate assets and pay off debts, in part or in whole, when an individual or business went bankrupt; and as businesses became more sophisticated (and publicly held businesses accountable to shareholders came into being), laws and practices had to develop to accommodate them as well.

In the United States, the criminal associations of bankruptcy fell away in the 19th century, when a series of economic crises hastened the repeated softening of state and local laws, in part because of the growing awareness of circumstances in which a debtor could find himself bankrupt through no wrongdoing of his own—the “hard luck case.” Chapter 13 bankruptcy was introduced in the aftermath of the Great Depression, in order to allow debtors to retain their property and residence while repaying their debts over a three-to-five-year period. Chapter 11 bankruptcy came in the 1970s during stagflation, designed to reorganize bankrupt businesses, and the farm crisis of the end of that decade brought about Chapter 12 bankruptcy to provide similar options for family farms.

In the 21st century, in most of the Western world the emphasis is neither on punishment nor liquidation, but on finding ways to resolve debts while maintaining the economic health of the debtor, whether a business or individual. Bankruptcy is more often declared than accused, and often is the operative word: the end of the 20th century saw the beginning of a boom time for bankruptcy, with 1 in 76 Americans filing for personal bankruptcy in 1997. Texaco and Continental Airlines, once robust giants, joined them in corporate bankruptcy, with the infamous cases of Worldcom and Enron following at the cusp of the new century.

Title 11 In The United States

In the United States, as in most countries, bankruptcy is a federal matter—in fact, it is specifically mentioned in the Constitution (Article 1, Section 8, Clause 4), which gives Congress the power to adopt “uniform laws on the subject of bankruptcies.” Such laws form the Bankruptcy Code, Title 11 of the United States Code, which defines six types of bankruptcy, commonly referred to according to the chapter in which they appear: Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13, and Chapter 15.

Chapter 7 liquidation or “straight bankruptcy,” for which both individuals and businesses are eligible, is the oldest and most common form of bankruptcy filing, accounting for more than half of personal bankruptcies. In such liquidations, a bankruptcy trustee liquidates the debtor’s property to create a pool of funds from which to pay the creditors. As long as the debtor is guilty of no fraud or other deceitful behavior, a certain amount of debt is forgiven regardless of the size of the pool of funds, but there are debts that cannot be discharged or reduced at all, such as child support, alimony payments, fines imposed by a court in answer to a crime, property taxes, income taxes less than three years old, and student loan payments. Certain property—typical a residence and vehicle—is exempt from being liquidated.

Though a declaration of Chapter 7 bankruptcy remains on an individual’s credit report for 10 years, it is such a tempting maneuver for so many victims of debt that in recent years trustees have been much more aggressive in verifying that the filer is indeed entitled to file Chapter 7 rather than Chapter 13. False filing—declaring Chapter 7 when one is capable of filing Chapter 13—is called “abusive filing,” and is contested in order to protect creditors. Anyone who is found to have falsely filed is forced into Chapter 13 bankruptcy. In the case of a business, Chapter 7 liquidation means suspending the business’s operations unless the trustee resumes them. The business is usually dismantled in the course of paying off its debts.

2005 Changes

The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, passed in response to the rise of bankruptcies, requires that any individual filing for bankruptcy receive a briefing from a credit counseling agency and complete an instructional course in personal financial management, prior to filing; the rationale for this is that it will reduce abusive filings. BAPCPA also made it extraordinarily difficult to discharge student loan debt through appeals, which had previously been uncommon but not unheard-of.

As the above implies, Chapter 13 is increasingly encouraged as the bankruptcy filing for individuals. Rather than a liquidation, this is a reorganization and rehabilitation of debt, creating a plan by which the debtor pays off his or her debts in a short time frame (three to five years). The debtor is responsible for proposing the plan, and there are codified limits— calculated according to an equation that accounts for the cost of living—on how much debt a debtor can possess when filing. A Chapter 13 filing remains on the debtor’s credit record for seven years.

Chapter 11 is the equivalent for businesses, a reorganization filing. The business proposes a plan, and a bankruptcy court determines whether it is fair and equitable and complies with the goals of the relevant laws. This can result in canceling contracts the business could not otherwise cancel (such as union agreements) and usually causes it to be delisted from its primary stock exchange, if applicable—though in such cases, stocks always continue to be traded over-the-counter. The final outcome of a Chapter 11 plan often terminates shares in the company.

As of 2009, 12 of the 15 largest Chapter 11 bankruptcies had been filed in the 21st century, a result of the many disastrous misadventures of large corporations. Technically, individuals can file Chapter 11; in practice, this rarely occurs, and there is rarely any advantage to it compared to Chapter 7 or Chapter 13.

Other Types

Chapter 9 bankruptcy is less familiar to most people, and is a debt restructuring made available to municipalities. The most notable case of a Chapter 9 filing is that of Orange County, California, in 1994. Reasons for filing range from that of Millport, Alabama, in 2005, when the close of a factory meant a loss of sales tax revenue and income dropped below that necessary to pay off debts; to the Pierce County (Washington state) Housing Authority’s 2008 filing because of a class-action lawsuit over mold. One reason Orange County’s filing made headlines was because its losses had been the result of bad investments.

Chapter 12 bankruptcy is quite similar to 11 and 13, but is meant for family farms, which faced a significant economic crisis in the late 1970s and early 1980s when incomes failed to keep up with the massive size of the loans offered to farms, much like the more recent subprime mortgage crisis, albeit with stubbier tendrils of consequence. Compared to the thousands of Chapter 11s and hundreds of thousands of Chapter 7 and 13s filed each year, Chapter 12 filings number in the hundreds.

Chapter 15 codifies into federal law the Model Law On Cross Border Insolvency drafted by the United Nations Commission on International Trade Law, making provisions for dealing with cross-border bankruptcy, when a bankruptcy case involves both American and foreign jurisdictions.

Any of the above can constitute either voluntary or involuntary bankruptcies. Involuntary bankruptcies are filed by the creditors rather than the debtor, but are quite uncommon, particularly in the age of debt collection agencies.

Bibliography:

Douglas G. Baird, The Elements of Bankruptcy (Foundation Press, 2005);
Brian A. Blum, Bankruptcy and Debtor/Creditor: Examples and Explanations (Aspen, 2006);
Kelly DePonte, The Guide to Distressed Debt and Turnaround Investing: Making, Managing and Exiting Investments in Distressed Companies and Their Securities (Private Equity International, 2007);
David G. Epstein and Steve H. Nickles, Principles of Bankruptcy Law (Thomson West, 2007);
Scott A. Sandage, Born Losers: A History of Failure in America (Harvard University Press, 2006);
James D. Scurlock, Maxed Out: Hard Times, Easy Credit, and the Era of Predatory Lenders (Scribner, 2007).

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