THE HISTORY OF AMERICAN BANKRUPTCY LAW

1. THE HISTORY OF AMERICAN BANKRUPTCY LAW David Skeel 25 November 2008

2. Roadmap for the Two Lectures • Today: brief history of American bankruptcy regulation • start with corporate reorganization • then consumer bankruptcy • Tomorrow: simple theory of relationship between corporate law and corporate bankruptcy

3. 1) The Creation of Corp Reorganization • The Context: Failures of the railroads, America’s first large scale corp’s (Jay Gould, Daniel Drew and robber barons) • The Problem: No authority to devise solution (Constitutional lim’s on Congress and individual states)

4. The Original Innovation: 19th Century “Equity Receiverships” • Devised by courts (and Wall Street investment banks and lawyers) • Theoretically, a foreclosure sale • Actually, debtor and committees renegotiated capital structure • U.S. Chapter 11 = still based on the same principles • Not codified until 1933 and 1934

5. The New Deal Revolution in 1938 • This = the one time scandals contributed to major bankruptcy reform • Reforms based on SEC study overseen by William Douglas • Chapter X = aimed at Wall Street

6. Key Features of Chapter X • Managers replaced by court appointed trustee • Disinterestedness requirement: current banks and lawyers excluded • SEC has major role, evaluates reorg plans • Result: Wall Street disappears

7. 1978 Code and the Return of Wall Street • Corporate debtors spent next forty years evading Chapter X • Bankruptcy laws re-written in 1978: managers continue running debtor; no trustee; SEC role reduced • Result: Corp reorg is Wall Street practice once again • One difference: commercial banks and hedge funds as key players

8. Why the shift to commercial bank control? • Chapter 11 has extraordinarily generous financing provisions • Commercial banks and other lenders used to tighten control over debtors in 1990s • The WorldCom example (choose any CRO you want …) • Restrictive covenants force sales etc • Baird & Rasmussen; Skeel • Implication: Chapter 11 is much less debtor friendly than before

9. 2) Personal Bankruptcy in the United States • Key historical point: personal bankruptcy was entirely separate from large scale corporate bankruptcy • The pattern: occasional laws (1800, 1841, 1867) then quick repeal • No federal bankruptcy law for most of nineteenth century

10. Why this pattern? • Creditors wanted bankruptcy regulation (to clarify/simplify collection) • Debtors feared regulation (worried about losing farms) • Bankruptcy laws passed only when: • Economic crisis • Republicans (conservatives) controlled presidency and Congress

11. Why did the 1898 Act endure? • Key is compromise between debtor and creditor views • Creditors got a bankruptcy law outlawing preferential transfers etc • Debtors got: state exemptions; tough limits on involuntary bankruptcy • Weak administrative structure created need for lawyers • Bankruptcy bar created a stable constituency for retaining the law

12. Key innovation in 1930s • “Wage earner” plans (Chapter XIII) added in 1938 • Distinction between immediate discharge (Ch. VII, now Ch. 7) and repayment plan (Ch. XIII, now Ch. 13)

13. Significance of the 1978 Code • Terminology shift: now “debtors,” not “bankrupts” • Incentives to file for Chapter 13 (more expansive discharge, co-debtor stay) • New Federal exemptions • Who uses Chapter 13? • Those with house to save, need discharge • But most important: local legal culture

14. The 2005 Changes • Force some debtors to use Chapter 13 (above median income, able to repay) • Require credit counseling • Does this change the overall shape of American bankruptcy • Hansen: yes, due to credit cards • Skeel: no

15. What to Watch For in 2009 • Mortgage write-down provision • Obama supported • Revisit 2005 reforms? • More limits on exec compensation in corporate bankruptcy? • General Motors bankruptcy?