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Bankruptcy Law's Ancient Origins and Current Trends

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A Brief History of Bankruptcy Law

Ye olde common law

Bankruptcy Law, or at least some variation thereof, existed as far back as the Roman Empire, although modern U.S. bankruptcy law springs from British bankruptcy statutes dating back to the sixteenth century. Bankruptcy was originally more of a sword than a shield, initiated by creditors and often leading to imprisonment for the delinquent debtor. A fresh start it wasn't.

The original thirteen - the United States colonies - adopted similar versions of these laws during pre-Revolutionary times, with some debtor-friendly modifications, such as the allowance of debtors to retain certain exempt assets (although imprisonment often remained an option). True to form, these laws varied from colony to colony, a melange - or mess - of local laws.

Start of a federal system... and growing pains

The framers of the U.S. Constitution attempted to render uniform this patchwork, deputizing Congress in Section 8, Article I "to establish . . . uniform Laws on the subject of bankruptcies throughout the United States." Great in theory, slow-in-coming in practice. In 1800, 1841 and 1867 Congress passed federal bankruptcy laws; in 1803, 1843 and 1878, it promptly changed its mind, repealing each respective act. During these brief windows- 1801 through 1803, 1841 through 1843, and 1867 through 1878 -the United States actually had uniform bankruptcy laws, mostly focusing on liquidation processes. During the other 82 years of the century, a debtor seeking relief turned to the hodgepodge of state insolvency proceedings, including assignments and receiverships, dating back to those colonial laws.

But slowly, slowly, the law was evolving, both within each state and with each federal bankruptcy act. The creditors' sword was becoming the debtors' shield; classes of exempted assets were expanded, and most significant, a debtor could see its debts discharged, albeit only with creditor approval. Best of all for debtors, imprisonment (except in cases of fraud or other grievous situations) eventually went the way of shackles and the guillotine, first in several state laws, then in the federal 1841 Act.

Opposition to the then-revolutionary debtor protections led to the quick repeal of the 1841 Act in 1843, and later the 1867 Act in 1878. Nonetheless, the foundations of today's bankruptcy practice were hammered into place.

One that stuck: the Bankruptcy Act of 1898

Finally, in 1898, Congress passed a bankruptcy law that stuck - the Bankruptcy Act of 1898, which sat on the books for eighty years. The 1898 Act acknowledged the fast-growing "credit economy" of the Industrial Age, placing bankruptcy's focus far more on the debtor than ever before; it provided for a full-fledged discharge of debts and more and broader exemptions of assets than previous acts. The 1898 Act also established the "bankruptcy referee," an officer of the district courts, as the predecessor to the modern-day bankruptcy judge. Most of the roots of the current bankruptcy system arc found in the 1898 Act. Most important, although the 1898 Act, like its predecessors, focused on liquidation, it also introduced several chapters for the rehabilitation of distressed businesses.

This trend towards reorganization continued through the next century, and the Chandler Act of 1938 created Chapters X and XI bankruptcies, which allowed public and privately-held companies, respectively, to reorganize themselves instead of liquidating their assets. The Chandler Act also significantly strengthened the authority of the bankruptcy referee, vesting him with quasi-judicial powers to help effectuate these reorganizations. Suddenly, bankruptcy was becoming a viable tool of survival instead of a method of tidy expiration.

The birth of modern bankruptcy

Then came the revolution. As with so many other revolutions, it emerged from a relatively minor event.

In the late 1960's, Congress proposed legislation to strengthen the effectiveness of an individual's discharge from his or her debts in liquidation proceedings. This narrow amendment eventually grew to a major shake-up in the bankruptcy bureaucracy: The Bankruptcy Reform Act of 1978.

The 1978 Act significantly strengthened the powers of bankruptcy judges and enhanced their jurisdiction (a Supreme Court rule had changed bankruptcy referees' title to "bankruptcy judge" five years earlier). The Act also supplanted Chapters X and XI with Chapter 11 corporate reorganizations and replaced the old consumer bankruptcy Chapter XIII with Chapter 13, with both new sections making it significantly easier for businesses and consumers to reorganize.

The 1978 Act changed everything. Previously, corporate bankruptcy was a backwater avoided by most white shoe firms. It was usually no more than a glorified auction process for small fry, neither fish nor fowl, typically devoid of sophisticated corporate transactions and exciting courtroom action. The 1978 Act legitimized the practice, creating new opportunities for sophisticated corporate debtors to use the Code as a reorganization tool, and allowing bankruptcy practitioners to argue cutting edge issues before federal judges who held broader powers than ever. Before the enactment of the 1978 Act, most major firms had no bankruptcy department; within 10 years, however, nearly every major firm developed a thriving
bankruptcy and restructuring group, observes Gregory Willard of Bryan Cave LLP.

But first, there was chaos. In 1982, with the new bankruptcy system still in its infancy, the Supreme Court struck down the 1978 Act in the Marathon case. The Court held that Congress overstepped its bounds, impermissibly granting bankruptcy courts, created under Article II of the Constitution, powers restricted to full-fledged "Article III" courts. Then, adding insult to injury, Congress missed its court-imposed deadline to amend the act, throwing the bankruptcy system into complete havoc.

Fortunately, Congress got its act together and passed the Bankruptcy Amendments and Federal Judgeship Act of 1984. The 1984 Act addressed Marathon by reconstituting bankruptcy courts as units of the district court, with proceedings officially "referred" to bankruptcy courts under district courts' standing orders.

Attorneys who entered the bankruptcy practice in the early 1980s remember this time as a brave - and chaotic - new world, between the 1978 Act, Marathon, and the 1984 amendments. All attorneys, whether veterans or just out of law school, stood on a "level playing field, learning a brand new law," remembers Florida attorney Brian Behar, echoing many veteran attorneys' memories of the time. In the process, modern bankruptcy practice took shape.

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Developments since the 1978 act

Since 1984 the Code has been amended several times. In 1986 an amendment nationalized the Office of the United States Trustee, a unit of the Department of Justice, which enforces the Code and oversees many of the administrative functions of bankruptcies, such as appointing Chapter 7 trustees, and which had previously been an experimental program in a handful of judicial districts. The Bankruptcy Reform Act of 1994 also significantly amended both the corporate and consumer provisions of the Code

More recently, in 2002, Congress tried once again to amend the Bankruptcy Reform Act, and proposed, among other changes, limits on the ability of individual debtors to discharge credit card debt. These amendments died in Congress in large part as a result of the most controversial amendment, a minor detail in the Code but a nuclear bomb in the political landscape: restrictions on the ability of anti-abortion activists to discharge debts arising from judgments in lawsuits, reflecting the role of politics and social policy in shaping the Code.

The bankruptcy gold rush

Many observers think this boom will continue for several more years. But when the bankruptcy bull market is over - and the economy gets back on its feet - what will happen then? Will demand for bankruptcy lawyers plummet? Will there be a corresponding bankruptcy bust?

Surely some of the rules that applied to the recent dot-com implosion will apply here, as firms that overexpanded their bankruptcy departments will be forced to lay off, or at least shift to other departments, some bankruptcy attorneys. Like any other practice, bankruptcy is cyclical.

Nonetheless, many bankruptcy practitioners believe the bankruptcy bar will hold onto its recent gains and, in fact, continue to grow as the economy improves. The reasons are several: increasing respect and publicity for the field as an attractive career choice; the increasingly complex nature of bankruptcy proceedings; and the rising acceptance by debtors of bankruptcy as just another tool in their financial planning arsenal.

"The stigma of filing for bankruptcy has been substantially eliminated, particularly as to corporate bankruptcy filings," says Gregory Willard of Bryan Cave LLP, echoing many practitioners' thoughts. "No one is afraid to speak about bankruptcy anymore," adds Brian Behar. Corporations are now more willing than before to go through the bankruptcy process and use it to reorganize and further long-term goals. Bankruptcy no longer means the end; more and more often, it means a new beginning, with a debtor emerging slimmer and trimmer than before. Bankruptcy is now part of the economic fabric, recession or not.

This increasing use of bankruptcy as part of corporate existence has directly affected the face of corporate dealmaking. In the 1980s, tax specialists were on the front lines of most corporate transactions, notes Willard, structuring deals to navigate the tax code. Now, bankruptcy lawyers have joined tax specialists, or even taken their place, at the negotiation table anticipating the ramifications of a future bankruptcy by any of the involved (or potentially involved) parties, and structuring those deals to protect their clients.

If these trends hold, bankruptcy lawyers will continue to be very much in demand.

Shifting centers of gravity

Throughout the 1990s, the bankruptcy courts of Wilmington, Delaware were the most common site for bankruptcy filings of public companies, typically the largest, most complex proceedings. Why? Delaware achieved a reputation as a particularly debtor-friendly jurisdiction, with procedures and substantial precedent guiding debtors and allowing them to reorganize swiftly - a "comfort factor," as described by New Jersey-based practitioner Ben Becker.

But no expansion lasts forever, and Delaware appears to have lost some of its popularity. As they say in economics, Delaware's equilibrium was out of whack, and the demand for its bankruptcy services began to overwhelm the supply: Delaware became so beloved by debtors that its docket grew too thick, shrinking available court time for debtors and creditors and forcing the courts to bring in visiting judges or send cases outside of the district.The result has been the increasing popularity of other available forums.

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