A 1909 Perspective On Bankruptcy Laws v. Similar State Laws (From Samuel Williston)

Food for thought? (Photo by Marilyn Swanson)

By: Donald L Swanson

Every now and then we get a glimpse into the past . . . that casts light on issues and events of today.

One such glimpse is a Harvard Law Review article from 1909: “The Effect of a National Bankruptcy Law upon State Laws.”[Fn. 1]. It’s by Samuel Williston—the same Samuel Williston who authored “Williston on Contracts” and who served as professor of law at Harvard Law School from 1895 to 1938. 

Bankruptcy v. State Laws—in 1909

By 1909, four National Bankruptcy Acts have been passed since the adoption of the Constitution, under the grant of authority to Congress “to establish . . . uniform laws o the subject of bankruptcies throughout the United States.”‘ But it is still (in 1909) to some degree uncertain what the effect of such national laws might be upon powers of the states.

It is clearly established that, when no national bankruptcy act is in force, states have full power to pass bankruptcy laws, with the only limitation being the constitutional prohibition against impairing the obligation of contracts. 

But when a federal bankruptcy law exists, the powers of the states are unclear:

  • the federal law is certainly paramount, and states must yield to its authority if collision arises; but
  • conflicting state laws are not destroyed—they are merely suspended during the existence of the federal statute; and
  • Beyond this, there is the greatest difference of opinion.

Some History—As Viewed From 1909

Early bankruptcy laws were intended solely for the benefit of creditors, and a bankrupt was regarded as a quasi-criminal.  No discharge was allowed until the reign of Queen Anne, and voluntary bankruptcy was allowed only later.

Discharge was viewed as a reward, inducing the bankrupt to make a full disclosure of assets and to aid creditors in obtaining the largest possible dividend—not as something to which the bankrupt is of right entitled or an important bankruptcy objective. 

Voluntary bankruptcy petitions were not authorized until the nineteenth century; however, friendly creditors might, at the bankrupt’s request, file a petition against the bankrupt so that a discharge might be secured.

Superseding v. Existing Side by Side

If, hypothetically, Congress were to pass a bankruptcy law that touches on the same subject as all state laws for the relief of poor debtors from imprisonment, what would be the effect? 

It is not to be assumed that superseding is the proper effect, unless the bankruptcy statute clearly expresses such a purpose: the assumption should rather be that Congress expected such state laws to exist side by side with the bankruptcy statute.

What follows are some examples/illustrations of how this works.

–Discharge from prison

A law confined to relieving debtors from arrest or imprisonment are not suspended by a federal bankruptcy law.  That’s true, even if the state law incorporates a bankruptcy-type element.

Let’s assume a state statute makes assignment of a debtor’s property for ratable distribution among creditors (an essential element of bankruptcy law) a condition of freeing that debtor from arrest and imprisonment.  Such a state statute should continue in force after the passage of a national bankruptcy law, despite its assignment and ratable distribution element.   

–Probate

Similarly, state statutes conferring on probate courts the distribution of insolvent estates of deceased persons are not superseded by the enactment of a federal bankruptcy law.

The care and distribution of probate estates has long been entrusted to probate courts, and unless Congress clearly manifests an intention to include such matters within the national system, state probate laws will continue in force.

–Assignments for Benefit of Creditors

A debtor’s right to make an assignment for benefit of creditors is not affected by passage of a federal bankruptcy law—the U.S. Supreme Court has so declared.

This is also true on principal.  Such assignments derive from common law principles governing conveyances and trusts: if the owner of property may convey it to a trustee for one person, the owner may also convey it to a trustee for any number of persons, including for any or all of that person’s creditors.

Prior to enactment of the Bankruptcy Act of 1898 many states passed statutes limiting the right of debtors to make assignments for benefit of creditors—or giving statutory effect to such assignments only if certain rules are followed. Many states prohibited preferences (i.e., the assignment must be for the benefit of all creditors).  Other states required court supervision (similar to what happens in bankruptcy courts).  

–Discharge of Debts

Some state assignment for benefit of creditor statutes even provide for discharge of the assigning debtor’s debts. That they cannot do.

State statutory provisions granting a discharge of a debtor’s debts are suspended by the federal bankruptcy law—this is settled law, according to the U.S. Supreme Court.

Additionally, a bare majority of the U.S. Supreme Court has declared that suspension of the discharge portion of a state statute on assignments for benefit of creditors does not invalidate the assignment itself.

–Involuntary Assignment of Debtor’s Assets

Laws on assignments for benefit of creditors provide a remedy only the debtor can choose—not a remedy creditors can impose upon debtors.

So, in most states:

  • a debtor cannot be forced to assign property for distribution; and
  • debtor’s creditors are left to enforce other common law remedies against debtor’s property.

However, a few states have a peculiar form of statute (back in 1909) that, in certain instances, operates as an involuntary transfer of debtor’s property.  Laws in Alabama, Connecticut, New Mexico, Pennsylvania, Tennessee, West Virginia and Wisconsin, provide that an insolvent debtor’s assignment for the benefit of some, but not all, creditors operates as an assignment of all debtor’s property for distribution ratably among all creditors.

Such a statute conflicts with the national bankruptcy law and is suspended by it.  Such a statute is intended either as punishment of the debtor or for redress to creditors.  Either way, such a provision:

  • “is contained in all bankruptcy statutes as an act of bankruptcy”; and 
  • “enforces the very consequences which are provided for in the bankruptcy act; namely, the sequestration and distribution of the debtor’s property.”

–Receiverships

Receiverships of insolvent corporations are similar to assignments for benefit of creditors:

  • The appointment of receivers is not dependent on statute—it is a recognized branch of equity jurisprudence;
  • The primary object of appointing a receiver is to protect the rights of a plaintiff as mortgagee or judgment creditor; and
  • The ratable distribution of an insolvent estate in the hands of the receiver, when it occurs, rests on the desire of a court of equity, which has once taken jurisdiction, to dispose equitably of the property under its control.

In England, receiverships are allowed by the side of the bankruptcy laws. Accordingly, the enactment of a federal bankruptcy law in the U.S. should not suspend the equity powers of state courts to appoint receivers.  

Legislation in some states attaches incidents of bankruptcy to statutes regulating receiverships. Such statutes must be suspended to the extent to which they infringe upon the field appropriate for bankruptcy legislation, as has happened in Maine, Pennsylvania, and Rhode Island.  

However, the ordinary equity jurisdiction to appoint a receiver is not lost, simply because a federal bankruptcy statute has been passed.

Conclusion

Here’s hoping everyone enjoys (and finds enlightening) this gem of history from 1909 as much as I have.

————————

Footnote 1.  The article is published at Harvard Law Review, Vol. 22, No. 8, pp. 547-563 (June 1909).

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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