Some Bankruptcy Law History: Debtor Benefits Are Always A Tough Sell (Part III, The Bankruptcy Code)

By: Donald L Swanson

Bankruptcy benefits for individual debtors are a tough sell—always have been.  That’s because no one likes bankruptcy—unless they need it.

But relieving people from debts in unfortunate circumstances is essential to our collective way of life in these United States.  That’s always been true.

What follows is the third of three installments on some history of bankruptcy laws through the ages, beginning with ancient times—and to the present in these United States.

Bankruptcy Code

Bankruptcy Code (aka, the Bankruptcy Reform Act of 1978) is unique in the history of federal bankruptcy legislation in this respect: it is the first such law enacted without being spurred-along by an economic depression.

The Bankruptcy Code is enacted in 1978 and becomes effective in 1979. It is the result of a commission established by Congress in 1970 to study the then-existing bankruptcy law and propose changes.

Enactment of the Bankruptcy Code occurs without substantial controversy.  The response of the U.S. Supreme Court to the Bankruptcy Code, however, is otherwise: both antagonistic and belligerent!

I started practicing in 1980—at the very beginning of the Bankruptcy Code’s existence—and have known nothing else.  To me, the Bankruptcy Code has always made sense.  And among my elders who practiced under the prior system, there may have been some initial angst toward the Bankruptcy Code (under the old dogs, new tricks adage), but I rarely saw any such thing. 

So, the antagonistic/belligerent reactions of the U.S. Supreme Court toward the Bankruptcy Code on constitutional grounds (even after the Bankruptcy Code is decades old) has been a surprise, creating a sense of frustration and incredulity.

Supreme Court’s Constitutional Antagonism

From the beginning, the U.S. Supreme Court reacts negatively toward the Bankruptcy Code.  They don’t like it . . . and they come within a single vote of declaring the entire thing unconstitutional in 1982.

They find various provisions of the Bankruptc Code to be constitutionally offensive, over an extended period of time, in such cases as Northern Pipeline v. Marathon Pipe Line (1982), Granfinanciera v. Nordberg (1989), and Stern v. Marshall (2011).

Illustrating competing majority/minority views among justices at the U.S. Supreme Court are these disparate points from Granfinanciera:

• footnote 16 of the majority opinion disparages the Bankruptcy Code’s “sweeping changes” and “radical reforms”; while    
• a two-justice dissent declares that Congress is entitled “at long last to fashion a modern bankruptcy system which places the basic rudiments of the bankruptcy process in the hands of an expert equitable tribunal.”

It’s not until the 2015 opinion in Wellness International v. Sharif that the U.S. Supreme Court finally, (i) steps away from efforts to limit the Bankruptcy Code’s scope on constitutional grounds, and (ii) starts focusing on how to make its administration work more effectively.

Chapter 12 — 1986

Even under the Bankruptcy Code . . . and even in the late 1900s . . . Congress reverts back to the old 1800s practice and idea of enacting bankruptcy laws as a temporary response to a financial calamity.  Chapter 12 is that reversion.  It’s a special bankruptcy provision for farmers:

• enacted as an emergency response to the 1980s Farm Crisis and resulting bank failures; and
• intended as a temporary remedy—enacted in 1986 with a 1993 sunset, but extended a number of times without expiring, and made permanent in 2005.

BAPCPA — 2005

In 2005 Congress, having been offended by the large number of middle-class debtors receiving Chapter 7 discharges, enacts the “Bankruptcy Abuse Prevention and Consumer Protection Act” (“BAPCPA”).

BAPCPA is designed to (i) prevent middle class debtors from obtaining a Chapter 7 discharge, and (ii) require that middle class debtors use a five-years Chapter 13 plan process instead. 

In BAPCPA, Congress provides that, unless a Chapter 7 consumer debtor is dirt-poor, a bankruptcy court “shall presume abuse exists” and dismiss the Chapter 7 case as “an abuse of the provisions” of the Bankruptcy Code (see § 706(b)(1)&(2)).

BAPCPA has Congress’s desired effect:

• more than 2 million bankruptcy cases are filed in 2005—that’s an all-time high, with one out of every 55 households filing bankruptcy; but
• In the following year, bankruptcy filings dip to about 600,000—that’s the lowest number in 20 years.[Fn. 1]

Subchapter V —  2019

Congress responds to the Covid Pandemic by enacting the Small Business Reorganization Act of 2019.  This law creates a special provision within Chapter 11 (designated “Subchapter V”) for reorganizing small businesses. 

Subchapter V is a long-overdue and much-needed law.  That’s because regular Chapter 11 is designed for very-large businesses and is mostly-ineffective for the needs of small businesses. 

However, in creating Subchapter V, Congress reverts to the 1800’s idea that federal bankruptcy laws are a short-term fix to a financial catastrophe.  Congress does so by embedding a sunset provision within the Small Business Reorganization Act—so that it lasts for only a single year.  The idea, presumably, is that once the Pandemic effects are gone, Subchapter V won’t be needed any more.

A year later, the Pandemic effects are still around, so Congress renews Subchapter V—but includes another one-year sunset.  A year later, Congress lets Subchapter V expire but shortly thereafter reenacts Subchapter V—but, once again, with a sunset provisions (this time, for two years instead of one).

Incorporating the sunset idea (from the 1800s) into Subchapter V is odd.  That’s because, on every occasion Subchapter V is addressed in Congress (initially and in the sunset renewals), it passes both houses of Congress by overwhelming majorities and is signed by two different presidents (of two different parties), all during a time of hyper-partisan division.

Today: U.S. Supreme Court Antagonism Toward Individual Debtors

Today, it appears that justices on the U.S. Supreme Court have a general bias against benefits for individual debtors.  It appears that, when debtor-benefits language in the Bankruptcy Code is anything but clear and precise, the justices are open to analytic gymnastics for ruling against or minimizing those benefits for individual debtors.  The City of Chicago v. Fulton opinion is an example.

Additionally, the U.S. Supreme Court justices occasionally solicit input from the Solicitor General on issues that might benefit individual debtors.  They do this knowing full well that the Solicitor General, (i) represents the largest creditor in the entire bankruptcy world (i.e., the U.S. Government), and (ii) will always come down on the creditor side of any issue—and against the debtor (the Wells v. McCallister case is an example). 

Such solicitations of Solicitor General’s input give this appearance: that the justices want and need the Solicitor General’s expertise in developing the analytic gymnastics for ruling against the debtor.  Time and experience will tell whether this appearance is accurate or not.  

Conclusion

Debtor benefits in bankruptcy have come a long way from the capital offense rules of ancient times to the latest iteration of the Bankruptcy Code.

Such developments have gone hand-in-hand with the development of commercial activity and economic societies over time.

It is, actually, an amazing thing to behold–despite the struggles and difficulties along the way!

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Footnote 1. Bill Fay, Bankruptcy Statistics, published by Debt.org, (November 29, 2022).

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