Bankruptcy Laws Must (and do) Change With the Economy (Continental Illinois v. Chicago, Rock Island)

By: Donald L Swanson

Federal bankruptcy laws, in these United States, began with the Bankruptcy Act of 1800. It was modeled after bankruptcy laws of England, to deal with a small and simple economy.

But transportation developments brought rapid expansion to both the country and the economy. So bankruptcy laws had to expand and develop too.

This process of an expanding country and economy, followed by expanding and developing bankruptcy laws, has continued to the present time.  And, fortunately, the “Bankruptcies” clause of the U.S. Constitution has been adequate to the task of incorporating needed adjustments.

Rapidly Expanding Economy

Back in 1800, these United States consist of 13 states located along the eastern seaboard, New York City’s population is 33,313, and there are no railroads, steamships, or Macadamized roads.

By 1850, there are 31 states, New York City’s population is 515,547, the Erie Canal, Ohio River and Missouri River are carrying extensive traffic, with further westward migrations happening by horse and wagon or afoot with a handcart.

By 1900, there are 45 states, New York City’s population is 3,437,202, transcontinental railroads are heavily utilized, Henry Ford is developing an assembly line, the Wright brothers are preparing to fly their first motorized airplane, and a grade school education is common.

By 1950, New York City’s population is 7,891,957, heavy and light machinery have largely replaced and displaced manual power and horse power (in its literal sense), Route 66 is in vogue, every farmer has at least one tractor, high school degrees are common, the Dow Jones is at 2,500, and the annual cost of attending Harvard University is <$1,000.

By 2000, we’ve escaped the Y2K fear of the sky falling and upgraded computer systems dramatically, space travel and satellite-based communications and technology are old hat, college degrees are common, and the Dow Jones is approaching 25,000.

By 2020, it can cost $78,000 to attend Harvard University for a year, total household debt in the U.S. is >$14 trillion, and we are in the midst of a pandemic.

U.S. Supreme Court Explains Expanding Bankruptcy Laws

An explanation from the U.S. Supreme Court, on how the “Bankruptcies” clause has accommodated the expanding economy, appears in the depression era opinion of Continental Illinois National Bank v. Chicago, Rock Island & Pacific Ry. Co., 294 U.S. 648 (1935).

–Facts

On June 7, 1933, the Chicago, Rock Island & Pacific Railway Co. files bankruptcy because it is “unable to meet its debts as they mature.” It has, at the time, over 8,000 miles of track.

On September 26, 1933, the debtor files a bankruptcy document alleging that:

• the value of collateral substantially exceeds the secured amounts (e.g., a $13.6 million debt is secured by $41.7 million of value, and a $4.1 million debt is secured by $14.4 million of value); but
• a forced sale of collateral might result in a deficiency to the bankruptcy estate and a loss to junior creditors.

So, the filing asks for an injunction to prevent secured creditors from exercising their rights to sell the collateral.

The Court grants the injunction, and creditors appeal. The Circuit Court of Appeals affirms, and creditors appeal to the U.S. Supreme Court.

–Constitutionality issue

The question before the Supreme Court deals with § 77 of the Bankruptcy Act, which allows for a railroad corporation’s bankruptcy filing and gives exclusive jurisdiction over the debtor and its property to the federal courts.

The question on appeal to the U.S. Supreme Court is this:

• Whether “the due process clause of the Constitution is infringed by” the grant of the injunction.
• More specifically, the question is whether § 77 constitute a “law on the subject of Bankruptcies” over which Congress has power under Article I, § 8, cl. 4, of the U.S. Constitution.

Bankruptcy expands with the economy

From the beginning, the U.S. Supreme Court says, the tendency of legislation and of judicial interpretation has been uniformly in the direction of expanding the use of the bankruptcy power to meet the needs of an expanding economy.

–Olde England Model

The English law of bankruptcy serves as a model for early U.S. bankruptcy laws. Such English law, as it existed at the time of adopting the U.S. Constitution:

• was conceived wholly in the interest of creditors;
• proceeded upon the assumption that debtors are to be dealt with as offenders; and
• knew nothing of a voluntary bankruptcy.

The notion that the framers of the Constitution, by the bankruptcy clause, intended to limit the power of Congress to the then existing English law and practice on bankruptcy has long since been dispelled.

–Historical and Judicial Expansion

The nature and extent of the bankruptcy power, and its expansion over time, can be understood by looking at the gradual process of historical and judicial inclusion and exclusion. Here are some examples of the expansion process:

1. While the first U.S. bankruptcy law, that of 1800, may have followed English laws, it also departs therefrom by expanding the list of potential debtors from traders only, to include bankers, brokers, and underwriters;
2. The second U.S. bankruptcy law, that of 1841, expands the list of possible debtors to include “practically all classes of persons and corporations”;
3. The bankruptcy act of 1800 exists exclusively to protect the interests of creditors, while the act of 1841 takes the then-radical-step of allowing debtors to file a voluntary petition and, by surrendering property, obtain a discharge of debts.
4. The act of 1800, like the English law, views the bankrupt as dishonest, while the act of 1841 and the later acts assume that the debtor might be honest but unfortunate.
5. By the time of the U.S. bankruptcy law of 1867, a debtor is permitted, for the first time, to propose a plan to creditors for their votes and to the court for confirmation.

Such changes are “fundamental and radical” extensions of the bankruptcy laws. Yet, “all have been judicially approved or accepted as falling within the power conferred by the bankruptcy clause of the Constitution.”

Taken together, these extensions “demonstrate the capacity of the bankruptcy clause to meet new conditions” arising from “the tremendous growth of business and development of human activities from 1800 to the present day.”

Such extensions, “far-reaching though they be,” are within “the limit of congressional power” and are moving further “into a field whose boundaries” are not yet “fully revealed.”

–Bankruptcy for Railroads

Section 77 is merely one more step in the development of the law on bankruptcies to meet the needs of an expanding economy.  And it is specifically for railroads.

Here is the progression of bankruptcy laws in the early 1900s for railroads.

• Back in 1910, Congress excludes railroad companies from its bankruptcy laws, because: (i) a railway is a unit that cannot be divided up and disposed of piecemeal—it must be sold, if at all, in its entirety as a going concern, and (ii) a railway’s activities cannot be halted, because of the public interest.
• But insolvent railroads need to reorganize, somehow, and there are no satisfactory alternatives for reorganizing, beyond bankruptcy—receiverships, for example, have never provided a satisfactory means for reorganizing a business.
• So, Congress, by § 77, provides for the reorganization of insolvent railroads under the bankruptcy clause of the Constitution.
• A plan of reorganization under § 77 cannot be distinguished in principle from plan provisions authorized by the Bankruptcy Act of 1867, the constitutionality of which “is not open to doubt.”

The Supreme Court’s conclusion is that § 77 merely follows the prior line of historical and radical developments of bankruptcy laws to meet the needs of a radically expanding economy.

Implications for Today

Today’s economy is not like yesterday’s—nor is it like the economies of decades and centuries past. Each era has its own challenges, and our bankruptcy laws have adjusted to meet them.

Today’s economic realities are new: we’ve had pandemics before, but not like this one in a society that is as mobile and interconnected as ours of today.

These new realities create new bankruptcy needs for both individuals and businesses. Such needs include:

• Dealing with heavy household debt;
• Dealing with employment uncertainties and unemployment realities;
• Dealing with heavy student loans in a distressed economy;
• Dealing with business failures and the fallout for entrepreneurs;
• Dealing with multiple effects on businesses of social distancing;
• Dealing with new ways of doing business and life;
• Etc., etc., etc.

Conclusion

Congress and the courts will need to grapple with today’s new realities and adjust the bankruptcy laws accordingly. And these adjustments are already under way (see, e.g., the CARES Act).

But more must, and will, come.

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