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Bankruptcy law

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Description: Federal statutes that allow consumers and businesses unable to meet their financial obligations to discharge their debts and start over economically. Article I, section 8, clause 4, of the U.S. Constitution stipulates that Congress shall establish “uniform Laws on the subject of Bankruptcies throughout the United States.”


Significance: The Supreme Court hears appeals on issues that began in bankruptcy courts and applies bankruptcy court rules.


Business and personal finance is beset with a degree of unpredictability. Under capitalism, private individuals, public institutions, small businesses, partnerships, and major corporations sometimes face changes in the marketplace, technology, and consumer preferences that decrease income and profits, creating financial crises. Congress, in response to economic downturns, increasingly complex commercial transactions, expanding credit, and a larger number of entrepreneurships, produced major bankruptcy legislation in 1800, 1841, 1867, and 1898. A 1970 joint resolution of Congress created the Bankruptcy Commission, with members appointed by the president, chief justice, and Congress. In 1978 Congress passed the Bankruptcy Reform Act, which, with subsequent amendments, created laws that balanced creditor and debtor interests. The nine chapters in the code occupy nearly five hundred pages in Bankruptcy Code, Rules, and Forms(St. Paul, Minn.: West Publishing, 1999), and the ten chapters on rules fill nearly three hundred pages. After its passage, more than sixty bankruptcy cases have been decided by the Supreme Court. Bankruptcy court, district court, bankruptcy appellate panel, and court of appeals judges may differ in their interpretations of legislative history, legislation, rules, and the plain meaning of the text. Some court watchers believe sufficient scope exists for judges to engage in policy making while ostensibly interpreting the text of bankruptcy laws. Most bankruptcy cases reach the Supreme Court because of conflicting results on substantially identical facts reached by the various courts of appeals. The Court, seeking uniformity within the federal system, usually makes narrow decisions. The constitutionality of the 1978 bankruptcy laws was raised in Northern Pipeline Construction Co. v. Marathon Pipe Line Co. (1982). Before 1978, the bankruptcy court employed semijudicial referees. The 1978 code created Article I nontenured judges, whose salaries could be reduced and who served for renewable fourteen-year terms but gave them Article III powers, which the Court held unconstitutional.


Definitions and Procedures

Bankruptcy legislation, particularly chapter 11, has historically been concerned with businesses and corporations. In the twentieth century, personal consumer bankruptcies, chapter 7 and 13, became far more numerous than business cases. The Court in Local Loan Co. v. Hunt (1933) stated that honest debtors should have “a new opportunity in life and a clear field for future effort.” Toibb v. Radloff (1991) and Johnson v. Home State Bank (1991) expanded bankruptcy relief. In the 1990's the Court chipped away at the debtor-favorable 1978 bankruptcy laws and began to favor creditors, a trend paralleled by various legislative changes. Grogan v. Garner (1991) established a preponderance of the evidence test for determining fraud rather than a clear and convincing evidence test, an issue visited again in Field v. Mans (1995). Union Bank v. Wolas (1991) reiterated the plain language approach to interpreting statutes. Although “willful and malicious injury” is not dischargeable, the court in Kawaauhau v. Geiger (1998) distinguished between intentional and reckless torts. Deadlines, like statutes of limitation, are very important. Barnhill v. Johnson (1992) set the standard for computing a ninety-day period on the writing of a check, Taylor v. Freeland and Kronz (1992) dealt with trustee objections to exemptions, and Pioneer Investment Services Co. v. Brunswick Associates Ltd. Partnership (1993) dealt with deadlines for filing proofs of claim.


Property

The bankrupt debtor generally does not pay more for property than it is worth. Creditors dislike this and assert that mortgages in real estate should be treated differently than liens on cars, equipment, jewelry, and other consumer items. Lien stripping was the subject of Dewsnup v. Timm (1992) and Nobelman v. American Savings Bank (1993). BFP v. Resolution Trust Corp. (1994) established that when a property is sold at a noncollusive sale, such as an auction, it is presumed to satisfy the requirement of “reasonably equivalent value.” Even if it sells for much less than its appraisal, the sale is not a fraudulent conveyance (transfer of ownership of property). In Associates Commercial Corp. v. Rash (1997), the Court in distinguishing between retail and wholesale value of property, settled on replacement value. Secured claims, debts with collateral, are to be paid interest (adequate protection) according to United Savings Association of Texas v. Timbers of Inwood Forest Associates (1988), United States v. Ron Pair Enterprises (1989), and Rake v. Wade (1993). In United States v. Whiting Pools (1983), the Court held that property seized by the Internal Revenue Service before the bankruptcy filing was property of the estate, and in Patterson v. Shumate (1992) it determined that Employee Retirement Income Security Act-qualified pension funds were not property of the estate.


Other Issues

The federal system, the balance between state and federal government, increasingly protects governments from being sued without their permission. Hoffman v. Connecticut Department of Income Maintenance (1989), United States v. Nordic Village (1992), and Seminole Tribe v. Florida (1996) expanded the immunity and authority of governments and limited the ability of debtors and the trustees to bring government agencies into the bankruptcy. The trend in sovereign immunity cases appears to detract from the bankruptcy court status as a national forum for debt resolution. The wide range of Court decisions indicates the pervasiveness of economic issues and the bankruptcy court's role in American economic life. The Court has made decisions regarding taxes, transportation and common carriers, the absolute priority rule (an important creditor protection in devising chapter 11 reorganization plans), and family law regarding property settlements in divorces. Public and legislative dissatisfaction with Court decisions may result in corrective legislation. In Pennsylvania Department of Public Welfare v. Davenport (1990), the Court held that criminal restitution could be discharged (and therefore, not paid), and Congress passed the Violent Crime Control and Law Enforcement Act of 1994, making restitution nondischargeable. When Christians v. Crystal Evangelical Church (1997) threatened religious liberty and tithing, Congress passed the Religious Liberty and Charitable Donation Protection Act of 1998.



Further Reading

  • Epstein, David G., et al. Bankruptcy: Twenty-First Century Debtor-Creditor Law. St. Paul, Minn.: Thomson/West, 2005.
  • Frey, Martin, Phyllis Frey, and Sidney Swinson. 5th ed. An Introduction to Bankruptcy Law. Clifton Park: Thomson/Delmar, 2004.
  • Gross, Karen. Failure and Forgiveness, Rebalancing the Bankruptcy System. New Haven, Conn.: Yale University Press, 1997.
  • Skeel, David. Debt's Dominion: A History of Bankruptcy Law in America. Princeton, N.J.: Princeton University Press, 2003.