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A federally authorized procedure by which a debtor—an individual, corporation, or municipality— is relieved of total liability for its debts by making court-approved arrangements for their partial repayment.

Once considered a shameful last resort, bankruptcy in the United States is emerging as an acceptable method of resolving serious financial troubles. A record one million individuals filed for bankruptcy protection in the United States in the peak year of 1992, and between 1984 and 1994 the number of personal bankruptcy filings doubled. Corporate bankruptcies are commonplace, particularly when corporations are the target of lawsuits, and even local governments seek debt relief through bankruptcy laws.

The goal of modern bankruptcy is to allow the debtor to have a "fresh start," and the creditor to be repaid. Through bankruptcy, debtors liquidate their assets or restructure their finances to fund their debts. Bankruptcy law provides that individual debtors may keep certain exempt assets, such as a home, a car, and common household goods, thus maintaining a basic standard of living while working to repay creditors. Debtors are then better able to emerge as productive members of society, albeit with significantly flawed credit records.

History of U.S. Bankruptcy Laws

U.S. bankruptcy laws have their roots in English laws dating from the sixteenth century. Early English laws punished debtors who sought to avoid their financial responsibilities, usually by imprisonment. Beginning in the eighteenth century, changing attitudes inspired the development of debt discharge. Courts began to nullify debts as a reward for the debtor's cooperation in trying to reduce them. The public increasingly viewed debtors with pity, as well as with a realization that punishments such as imprisonment often were useless to creditors. Thus, a law that was first designed to punish the debtor evolved into a law that protected the debtor while encouraging the resolution of outstanding monetary obligations.

England's eighteenth-century insight did not find its way into the first U.S. bankruptcy statutes; instead, laws based largely on England's earlier punitive bankruptcy statutes governed U.S. colonies. After the signing of the Declaration of Independence, individual states had their own laws addressing disputes between debtors and creditors, and these laws varied widely.

In 1789, the U.S. Constitution granted Congress the power to establish uniformity with a federal bankruptcy law, but more than a decade passed before Congress finally adopted the Bankruptcy Act of 1800. This act, like the early bankruptcy laws in England, emphasized creditor relief and did not allow debtors to file for relief voluntarily. Great public dissatisfaction prompted the act's repeal three years after its enactment.

Philosophical debates over whom bankruptcy laws should protect (i.e., debtor or creditor) had Congress struggling for the next forty years to pass uniform federal bankruptcy legislation. The passage of the Bankruptcy Act of 1841 offered debtors greater protections and for the first time allowed them the option of voluntarily seeking bankruptcy relief. This act lasted eighteen months. A third bankruptcy act passed in 1867 and was repealed in 1878.

The Bankruptcy Act of 1898 endured for eighty years, thanks in part to numerous amendments, and became the basis for current bankruptcy laws. The 1898 act established bankruptcy courts and provided for bankruptcy trustees. Congress replaced this act with the Bankruptcy Reform Act of 1978 (11 U.S.C.A. § 101 et seq.), which, along with major amendments passed in 1984, 1986, and 1994, is known as the Bankruptcy Code.

Federal versus State Bankruptcy Laws

In general, state laws govern financial obligations such as those involving debts created by contracts—rental leases, telephone service, and medical bills, for example. But once a debtor or creditor seeks bankruptcy relief, federal law applies, overriding state law. This is because the U.S. Constitution grants Congress the power to "establish … uniform Laws on the subject of Bankruptcies throughout the United States" (U.S. Const. art. I, § 8). Federal bankruptcy power maintains uniformity among the states, encouraging interstate commerce and promoting the country's economic stability. States retain jurisdiction over certain debtor-creditor issues that do not conflict with, or are not addressed by, federal bankruptcy law.

Types of Federal Bankruptcy Proceedings

Federal bankruptcy law provides two distinct forms of relief: liquidation and rehabilitation, also known as reorganization. The vast majority of bankruptcy filings in the United States involve liquidation, governed by chapter 7 of the Bankruptcy Code. In a chapter 7 liquidation case, a trustee collects the debtor's nonexempt assets and converts them into cash. The trustee then distributes the resulting fund to the creditors in order of priority described in the Bankruptcy Code. Creditors frequently receive only a portion, and sometimes none, of the money owed to them by the bankrupt debtor.

Gambling WITH Bankruptcy Exemptions

In bankruptcy cases, individual debtors have the privilege of retaining certain amounts or types of property that otherwise would be subject to liquidation or seizure by creditors in order to satisfy debts. Laws protecting these forms of property are called exemptions.

Consistent with the goal of allowing the debtor a "fresh start," exemptions in bankruptcy cases help ensure that the debtor, upon emerging from bankruptcy, is not destitute. Exemption statutes generally permit the debtor to keep such things as a home, a car, and personal goods like clothes. Although exemptions inhibit the creditor's ability to collect debts, they relieve the state of the burden of providing the debtor's basic needs.

The bankruptcy code provides a list of uniform exemptions but also allows individual states to opt out of (override) these exemptions (11 U.S.C.A. § 522 [1993 & Supp. 2003]). Thus, the types and amounts of property exemptions differ greatly and depend upon the debtor's state of residence.

A debtor residing in a state that has not opted out is entitled to the exemptions described in the bankruptcy code. Examples of code exemptions are the debtor's aggregate interest of up to $15,000 in a home; up to $2,400 in a motor vehicle; up to $8,000 in household furnishings, household goods, clothes, appliances, books, animals, crops, and musical instruments; up to $1,000 in jewelry; up to $1,500 in professional books or tools of the debtor's trade; and certain unmatured life insurance policies owned by the debtor. The debtor also may claim an exemption for professionally prescribed health aids, such as electric wheel-chairs.

The majority of states have chosen to opt out of the uniform federal exemptions, replacing them with exemptions created by their own legislatures. Homestead exemptions, which excuse all or part of the value in the debtor's home, are the most common state-mandated exemptions. These are not uniform across states. For instance, Missouri mimics the federal government by placing a dollar limit on the exemption, but at $8,000, its cap is meager in comparison (Mo. Ann. Stat. § 513.475 [Vernon 2002]). The bordering state of Iowa limits the homestead exemption by acreage rather than dollar amount (Iowa Code Ann. §§ 561.1, 561.2 [West 1992]). Florida allows a homestead exemption without limits (Fla. Const. art. X, § 4(a)(1)). This lack of uniformity raises the question of fairness: bankruptcy laws are federal in nature, yet a debtor in Florida may have a significant financial advantage over a debtor in Missouri, owing to different exemption laws.

Despite the broad variance among states when it comes to bankruptcy exemptions, critics charge that even the uniform federal system can be grossly unfair. For example, assume two debtors, Arlene and Ben, each have estates valued at $28,000. Arlene, a dentist, has $15,000 of Equity in her home. She has $8,000 worth of furniture and household goods. Her car is worth $4,000, and she owns dental tools valued at $1,000.

Ben is an art lover. He owns no car, no furniture, and no house, having chosen instead to spend his money on paintings and sculptures that are now worth $26,000. His clothes, musical instruments, and other household goods are worth $2,000.

Arlene and Ben have states of equal value, but when the federal exemption statute is followed, Arlene can claim $27,200 in exemptions, whereas Ben can claim only $16,300. Arlene receives exemptions worth $15,000 for her homestead, $8,000 for her household goods, $2,400 for her car, and $1,000 for her dental tools, and an $800 general exemption for property not covered by other exemptions. Ben may claim an $8,000 exemption for his art and other household goods, as well as a general exemption worth $8,300, which replaces his unused homestead exemption.

Critics suggest that one problem with exemption laws is that legislators must determine the property that will best enable the average debtor to remain self-sufficient following a bankruptcy. Unconventional debtors, such as Ben, frequently are penalized as a result. In addition, laws that place monetary limits on exemptions often do nothing to help the debtor achieve a fresh start. When the value of certain property is worth more than the exemption, it is said to be only partially exempt and must be completely liquidated. Following liquidation, the debtor receives the value of the exemption in cash from the liquidation proceeds. Thus, in the case of Arlene's $4,000 car, the bankruptcy trustee would sell the car and from the sale proceeds give Arlene $2,400, the amount of the exemption. Arlene could then spend the money on a tropical vacation instead of a replacement car, rendering the vehicle exemption law virtually meaningless.

Debtors may also take advantage of exemption laws by transferring assets before filing for bankruptcy protection. For example, Ben could sell nonexempt artwork and, with the proceeds, purchase a small condominium. He could then file for bankruptcy and claim a homestead exemption, increasing by $7,500 his post-bankruptcy estate.

Congress actually supports this type of pre-bankruptcy planning, permitting the debtor "to make full use of the exemptions to which he is entitled under the law" (S. Rep. No. 989, 95th Cong., 2d Sess. [1978]). Still, courts view some pre-bankruptcy asset transfers as fraudulent, particularly when they involve large dollar amounts and there is evidence of intention to hinder, delay, or defraud creditors. Upon a finding of Fraud, the bankruptcy court may deny discharge of the debtor's debts. But what constitutes a fraudulent transfer is often unclear and seemingly Arbitrary.

Two bankruptcy cases from Minnesota exemplify the confusion surrounding fraudulent and nonfraudulent pre-bankruptcy transfers. The debtors in both cases were doctors who lost money in the same investment and who hired the same attorney to help them with their pre-bankruptcy planning. The outcomes of the cases differed significantly.

Before filing for bankruptcy, Omar Tveten liquidated most of his nonexempt assets, including his home. With the proceeds, he purchased life insurance and annuities valued at almost $700,000. Both the life insurance and the annuities were considered exempt under Minnesota law; however, the bankruptcy court held that the large amount converted was an indication of fraud and therefore refused to discharge Tveten's bankruptcy debts (Norwest Bank Nebraska v. Tveten, 848 F.2d 871 [8th Cir. 1988]).

Robert J. Johnson also transferred assets before filing for bankruptcy. Johnson converted nonexempt property into property exempt under Minnesota law: he purchased $8,000 in musical instruments, $4,000 in life insurance, and $250,000 in annuities from fraternal organizations, and he retired (paid off) $175,000 of the debt on his $285,000 home. The court focused on Johnson's claim for homestead exemption and in particular on the $175,000 mortgage payment made just before filing for bankruptcy. As the court in Tveten demonstrated, an unusually large asset transfer can indicate fraud. But in Johnson, the court held that the homestead exemption was valid, stating that the value of an asset transfer to homestead property, unlike the value of an asset transfer to property in another exemption category, is of little relevance because "no exemption is more central to the legitimate aims of state lawmakers than a homestead exemption" (Panuska v. Johnson, 880 F.2d 78 [8th Cir. 1989]).

Legal commentators have criticized the Tveten and Johnson decisions as being arbitrary and as providing no clear lines to assist debtors in pre-bankruptcy planning. Critics charge that the different outcomes are simply a result of different judges presiding at the initial bankruptcy court level, because the facts of the cases were so similar. Bankruptcy attorneys are frustrated by a lack of uniformity among court decisions that apply similar principles but reach different results, and also a lack of uniformity in exemption laws among states.

Indeed, forum shopping (searching for the most advantageous jurisdiction in which to file bankruptcy) is prevalent because of the wide diversity of state exemption laws. In re Coplan, 156 B.R. 88 (Bankr. M.D. Fla. 1993), illustrates the problem. The debtors, Lee Coplan and Rebecca Coplan, incurred substantial debt in their home state of Wisconsin before moving to Florida. After residing in Florida for one year and purchasing a house for $228,000, they sought bankruptcy relief and a homestead exemption under Florida law (West's F.S.A. Const. Art. 10, § 4(a)(1)), which allows an exemption for the full value of the homestead. The court found that the Coplans had engaged in a systematic conversion of assets by selling their home in Wisconsin and paying cash for their new home in Florida. This action was conducted, according to the court, solely for the purpose of placing the assets out of the reach of creditors. As a result, the bankruptcy court in Florida allowed a homestead exemption of only $40,000, the extent provided by Wisconsin law (W.S.A. § 815.20(1)). Yet other bankruptcy decisions have held that a conversion of nonexempt property to exempt property for the purpose of placing such property out of reach of creditors will not alone deprive the debtor of the exemption (see, e.g., In re Levine, 139 B.R. 551 [Bankr. M.D. Fla. 1992]).

Exemption is an integral part of bankruptcy law but a difficult area to navigate. Courts and legislatures must constantly determine whether exemptions constitute fair and just vehicles by which debtors can achieve a fresh start without getting a head start at the expense of creditors. Unfortunately for attorneys, debtors, creditors, and trustees, the laws regarding exemptions are inconsistent. Attempting to maximize the benefits granted by bankruptcy exemptions can be more of a gamble than a science.

Further readings

Epstein, David G. 2002. Bankruptcy and Related Law in a Nutshell. St. Paul, Minn.: West Group.

Resnick, Alan N. 2002. Bankruptcy Law Manual. Eagan, Minn.: Thompson West.



When the debtor is an individual, once the liquidation and distribution are complete, the bankruptcy court may discharge any remaining debt. When the debtor is a corporation, upon liquidation and distribution, the corporation becomes defunct. Remaining corporate debts are not formally discharged, as they are with individuals. Instead, creditors face the impossibility of pursuing debts against a corporation that no longer exists, making formal discharge unnecessary.

Rehabilitation, or reorganization, of debt is an option that courts usually favor because it provides creditors with a better opportunity to recoup what is owed to them. Rehabilitative bankruptcies are governed most often by chapter 11 or chapter 13 of the Bankruptcy Code. Chapter 11 typically applies to individuals with excessive or complex debts, or to large commercial entities such as corporations. Chapter 13 typically applies to individual consumers with smaller debts.

Unlike liquidation, rehabilitation provides the debtor with an opportunity to retain nonexempt assets. In return, the debtor must agree to pay debts in strict accordance with a Reorganization Plan approved by the bankruptcy court. During this repayment period, creditors are unable to pursue debts beyond the provisions of the reorganization plan. This gives the debtor the chance to restructure affairs in the effort to meet financial obligations.

To be eligible for rehabilitative bankruptcy, the debtor must have sufficient income to make a reorganization plan feasible. If the debtor fails to comply with the reorganization plan, the bankruptcy court may order liquidation. A debtor who successfully completes the reorganization plan is entitled to a discharge of remaining debts. In keeping with the general preference for bankruptcy rehabilitation rather than liquidation, the goal of this policy is to reward the conscientious debtor who works to help creditors by resolving his or her debts.

Farmers and municipalities may seek reorganization through the Bankruptcy Code's special chapters. Chapter 12 assists debt-ridden family farmers, who also may be entitled to relief under chapters 11 or 13. When a local government seeks bankruptcy protection, it must turn to the debt reorganization provisions of chapter 9.

Orange County Bankruptcy and Chapter 9 Seldom used, chapter 9 attained notoriety in late 1994 following the bankruptcy of Orange County, California, the largest municipal bankruptcy in history. A county of 2.6 million people with one of the highest per capita incomes in the United States, Orange County held an investment fund that was composed largely of derivatives that were based on speculation on the direction of interest rates. The problem was made worse because the county had borrowed the money it was investing. When interest rates began to climb in 1994, Orange County's leveraged investments drained the investment fund's value, prompting lenders to require additional collateral. The only way to raise the collateral was to sell the investments at the worst possible time. The result was a $1.7 billion loss. After consulting with finance experts and reviewing alternatives, county officials filed for chapter 9 protection on December 6, 1994.

Residents of the affluent county faced immediate repercussions. Close to 10 percent of the fifteen thousand Orange County employees lost their jobs. School budgets were slashed, infrastructure improvements were put on hold, and experts predicted that property values in Orange County would decline. Legal fees involved in a bankruptcy of this complexity are extensive, and officials did not expect Orange County to emerge from bankruptcy for several years.

Critics of current bankruptcy law argue that irresponsible debtors too frequently receive protection at the expense of noncreditors, such as the residents of Orange County. Victims who allege corporate Negligence and sue for injuries from dangerous products also become unwilling creditors when a corporation files for bankruptcy. But negligent or not, corporations battling multiple lawsuits often rely on the traditional rationale supporting bankruptcy: that it offers an opportunity to pay debts that otherwise might go unpaid.

Dow Corning Corporation and Chapter 11 Dow Corning Corporation was a major manufacturer of silicone breast implants used in reconstructive and plastic surgeries. In 1991, after receiving thousands of complaints of health problems from women with silicone implants, the U.S. Food and Drug Administration banned the devices from widespread use. Women who had obtained the silicone implants in breast reconstruction or breast enlargement surgeries complained that the implants leaked, causing a variety of adverse conditions such as crippling pain, memory loss, lupus, and connective tissue disease. Dow Corning soon became a defendant in a worldwide product liability class action suit as well as at least nineteen thousand individual lawsuits.

Citing an inability to contribute $2 billion to a $4.2 billion settlement fund and pay for the defense of thousands of individual lawsuits, Dow Corning filed for chapter 11 bankruptcy protection in May 1995. The bankruptcy move halted new lawsuits and enabled the company to consolidate existing claims while preserving business operations. As a result of the filing, Dow Corning stalled its obligation to contribute to the settlement fund.

The Dow Corning strategy was similar to that employed in the mid–1980s by A.H. Robins Company, distributor of the Dalkon Shield intrauterine device for Birth Control. Like Dow Corning, A.H. Robins faced financial ruin owing to thousands of product liability lawsuits filed at the same time. Also like Dow Corning, A.H. Robins sought relief under chapter 11 of the Bankruptcy Code, which allowed the company time to formulate a plan to pay the many outstanding claims. A reorganization plan approved by the courts involved the merger of A.H. Robins with American Home Products Corporation, which agreed to establish a $2.5 billion trust fund to pay outstanding product liability claims (In re A.H. Robins Co., 880 F.2d 694 [4th Cir. 1989]).

On May 22, 1995, Dow Corning filed a request to stay all litigation against its parent companies, Dow Chemical Company and Corning Incorporated, so that company lawyers could concentrate on the bankruptcy reorganization. That move further threatened the chance of recovery for the plaintiffs seeking compensation for injury.

Family Farmers and Chapter 12 In 1986, responding to an economic farm crisis in the United States, Congress designed chapter 12 to apply to family farmers whose aggregate debts did not exceed $1.5 million. Congress passed the law to help farmers attain a financial fresh start through reorganization rather than liquidation. Before chapter 12's existence, family farmers found it difficult to meet the prerequisites of bankruptcy reorganization under chapters 11 or 13, often because they were unable to demonstrate sufficient income to make a reorganization plan feasible. Chapter 12 eased some requirements for qualifying farmers.

Congress created chapter 12 as an experiment, and scheduled its automatic repeal for 1993. Determining that additional time was necessary to evaluate the effectiveness of the law, Congress in 1993 voted to extend it until 1998. It was either extended or allowed to expire—then restored—eight times between November 1998 and January 1, 2004, when it expired again.

Federal Bankruptcy Jurisdiction and Procedure

Regardless of the type of bankruptcy and the parties involved, basic key jurisdictional and procedural issues affect every bankruptcy case. Procedural uniformity makes bankruptcies more consistent, predictable, efficient, and fair.

Judges and Trustees Pursuant to federal statute, U.S. Courts of Appeals appoint bankruptcy judges to preside over bankruptcy cases (28 U.S.C.A. § 152 [1995]). Bankruptcy judges make up a unit of the federal district courts called bankruptcy court. Actual jurisdiction over bankruptcy matters lies with the district court judges, who then refer the matters to the bankruptcy court unit and to the bankruptcy judges.

A trustee is appointed to conduct an impartial administration of the bankrupt's nonexempt assets, known as the bankruptcy estate. The trustee represents the bankruptcy estate, which upon the filing of bankruptcy becomes a legal entity separate from the debtor. The trustee may sue or be sued on behalf of the estate. Other trustee powers vary depending on the type of bankruptcy, and can include challenging transfers of estate assets, selling or liquidating assets, objecting to the claims of creditors, and objecting to the discharge of debts. All bankruptcy cases except chapter 11 cases require trustees, who are most commonly private citizens elected by creditors or appointed by the U.S. trustee.

The office of the U.S. trustee, permanently established in 1986, is responsible for overseeing the administration of bankruptcy cases. The U.S. Attorney General appoints a U.S. trustee to each bankruptcy region. It is the job of the U.S. trustee in some cases to appoint trustees, and in all cases to ensure that trustees administer bankruptcy estates competently and honestly. U.S. trustees also monitor and report debtor abuse and Fraud, and oversee certain debtor activity such as the filing of fees and reports.

Procedures Today, debtors file the vast majority of bankruptcy cases. A bankruptcy filing by a debtor is known as voluntary bankruptcy. The mere filing of a voluntary petition for bankruptcy operates as a judicial order for relief, and allows the debtor immediate protection from creditors without the necessity of a hearing or other formal adjudication.

Chapters 7 and 11 of the Bankruptcy Code allow creditors the option of filing for relief against the debtor, also known as involuntary bankruptcy. The law requires that before a debtor can be subjected to involuntary bankruptcy, there must be a minimum number of creditors or a minimum amount of debt. Further protecting the debtor is the right to file a response, or answer, to the allegations in the creditors' petition for involuntary bankruptcy. Unlike voluntary bankruptcies, which allow relief immediately upon the filing of the petition, involuntary bankruptcies do not provide creditors with relief until the debtor has had an opportunity to respond and the court has determined that relief is appropriate.

When the debtor timely responds to an involuntary bankruptcy filing, the court will grant relief to the creditors and formally place the debtor in bankruptcy only under certain circumstances, such as when the debtor generally is failing to pay debts on time. When, after litigation, the court dismisses an involuntary bankruptcy filing, it may order the creditors to pay the debtor's attorney fees, Compensatory Damages for loss of property or loss of business, or Punitive Damages. This reduces the likelihood that creditors will file involuntary bankruptcy petitions frivolously or abusively.

One of the most important rights that a debtor in bankruptcy receives is called the automatic stay. The automatic stay essentially freezes all debt-collection activity, forcing creditors and other interested parties to wait for the bankruptcy court to resolve the case equitably and evenhandedly. The relief is automatic, taking effect as soon as a party files a bankruptcy petition. In a voluntary chapter 7 case, the automatic stay gives the trustee time to collect, and then distribute to creditors, property in the bankruptcy estate. In voluntary chapter 11 and chapter 13 cases, the automatic stay gives the debtor time to establish a plan of financial reorganization. In involuntary bankruptcy cases, the automatic stay gives the debtor time to respond to the petition. The automatic stay terminates once the bankruptcy court dismisses, discharges, or otherwise terminates the bankruptcy case, but a party in interest (a party with a valid claim against the bankruptcy estate) may petition the court for relief from the automatic stay by showing good cause.

The Bankruptcy Code allows bankruptcy judges to dismiss bankruptcy cases when certain conditions exist. The debtor, the creditor, or another interested party may ask the court to dismiss the case. Petitioners—debtors in a voluntary case, or creditors in an involuntary case—may seek to withdraw their petitions. In some types of bankruptcy cases, a petitioner's right to dismissal is absolute; other types of bankruptcy cases require a hearing and judicial approval before the case is dismissed. Particularly with voluntary bankruptcies, creditors, the court, or the U.S. trustee has the power to terminate bankruptcy cases when the debtor engages in dilatory or uncooperative behavior, or when the debtor substantially abuses the rights granted under bankruptcy laws.

Recent Developments in Federal Bankruptcy Law

Brought about by a surge in bankruptcy filings and public concern over inequities in the system, the Bankruptcy Reform Act of 1994 is one illustration of Congress's continuing effort to protect the rights of debtors and creditors. Consistent with Congress's goal of promoting reorganization over liquidation, the legislation made it easier for individual debtors to qualify for chapter 13 reorganization. Previously, individuals with more than $450,000 in debt were not eligible to file under chapter 13, and instead were forced to reorganize under the more complex and expensive chapter 11 or to liquidate under chapter 7. The 1994 amendments allow debtors with up to $1 million in outstanding financial obligations to reorganize under chapter 13.

The new law helps creditors by prohibiting the discharge of credit card debts used to pay federal taxes, or those exceeding $1,000 incurred within sixty days before the bankruptcy filing. In this way, the law deters debtors from shopping sprees and other abuses just before filing for bankruptcy. Creditors also benefit from new provisions that set forth additional grounds for obtaining relief from the automatic stay, and require speedier adjudication of requests for relief from the stay.

It looked as though the bankruptcy system would see more reform with the introduction of the Bankruptcy Reform Act of 1998. The act was a response to a report issued by the National Bankruptcy Review Commission, which recommended that the existing code be fine-tuned in order to provide incentives to debtors to file chapter 13 reorganization and to increase debt repayment. The report was issued in response to concern that debtors were taking advantage of the bankruptcy system, evidenced by the fact that a record number of consumers filed for bankruptcy during a time of economic prosperity.

But the Bankruptcy Reform Act of 1998 was never enacted, and it turned out to be only the beginning volley in one of the most tortuous paths any legislation has seen. The House of Representatives has passed a bankruptcy reform bill no fewer than seven times since 1998, with the Senate close behind, and yet bankruptcy reform has yet to be passed into law as of the time of this writing, despite the fact that President george w. bush and the majorities in the current House and Senate all currently favor some sort of bankruptcy reform.

All of the bankruptcy reform legislation introduced since 1997 shares the same main thrust. Individual debtors would be discouraged from filing under chapter 7, which allows them to liquidate their debts, and would be encouraged to file under chapter 13 instead. The filing under chapter 7 will be presumed abusive if the debtor is deemed able to pay a portion of his debts under a formula set forth in the Reform Act. Debtors who have an ability to repay a portion of their debts out of future income will be forced to reorganize under chapter 13.

The main criticism of all the bankruptcy reform acts that have been passed since 1997 is that they favor creditors at the expense of debtors who truly might not be able to pay, but who technically fail the means test that is used to determine whether they can make some form of repayment. But this criticism has not been the only reason why bankruptcy reform has not passed. For example, the Bankruptcy Reform Act of 2001 failed because a provision was included to prevent anti-abortion protesters from avoiding criminal fines by claiming bankruptcy. Anti-abortion legislators who otherwise would have supported the bill joined forces with opponents of the bill to defeat it. Another bankruptcy reform act passed in the House of Representatives by a vote of 315–113 in March 2003.

While Congress was considering bankruptcy reform, the U.S. Supreme Court handed down two decisions that further defined the limits of bankruptcy law. In Cohen v. De La Cruz 523 U.S. 213, 118 S. Ct. 1212, 140 L. Ed. 2d 341, a unanimous court held that where a debtor committed actual fraud and was assessed punitive damages, the debt would be not dischargeable because the Bankruptcy Code's prohibition against the discharge of fraudulently incurred debts is not restricted to the value of the money, property, or services received by the debtor. In Young v. U.S., 535 U.S. 43, 122 S. Ct. 1036, 152 L. Ed. 2d 79. The court held that three-year lookback period allowing IRS to collect taxes against a debtor was tolled during pendency of a debtor's earlier chapter 13 proceeding.

Apart from developments in the law, bankruptcy was much in the news during the opening years of the twenty-first century as an economic downturn forced many of American's most prominent companies into chapter 11 bankruptcy. In 2001, the energy-trading firm Enron filed for the biggest corporate bankruptcy in history, with $64 billion in assets. Less than a year later, Telecommunications firm World-Com topped that record when it listed $104 billion in assets in its bankruptcy filing. Other prominent American companies filing for bankruptcy included retailer K-Mart, financial services firm Conseco, and United Airlines parent company UAL.

Further readings

Anderson, Nick. 2003. "House Passes Bankruptcy Reform Bill For the 7th Time."Los Angeles Times (March 20).

Hubler, James T. 2002. "The End Justifies the Means: The Legal, Social, and Economic Justifications for Means Testing Under the Bankruptcy Reform Act of 2001." American University Law Review (October).Jewell, Mark. 2002. "Conseco Bankruptcy Ranks Third in U.S." Associated Press (December 19).

Reid, Linda. 2001."Bankruptcy Reform Legislation"Arkansas Lawyer (fall).


Petition in Bankruptcy.


n. a Federal system of statutes and courts which permits persons and businesses which are insolvent (debtors) or (in some cases) face potential insolvency, to place his/her/its financial affairs under the control of the bankruptcy court. The procedure is that when the debtor's debts exceed his/her/its assets or ability to pay the debtor can file a petition with the bankruptcy court for voluntary bankruptcy or the debtor's unpaid creditors can file an "involuntary" petition to force the debtor into bankruptcy, although voluntary bankruptcy is far more common. The most common petition is under Chapter 7, in which a trustee is appointed by the court, the current assets are counted up by the trustee (with many of them exempt from bankruptcy) who pays debts to the extent possible with priority for taxes, then secured debts (mortgages or some judgments), and finally unsecured debts. Then the court adjudicates (officially declares) the debtor a bankrupt and discharges the unpayable debts, to the loss of the creditors. Exempt from sale to pay debts are a portion of the value of a home (equal to a homestead), secured notes that can be kept current, an automobile, tools of the trade, furniture, and some other items. The concept is to give someone a fresh start, but it has often led to careless, profligate business operations and casual running up of bills with those giving credit being badly hurt by bankruptcies. Not dischargeable in bankruptcy are alimony and child support, taxes, and fraudulent transactions.

Filing a bankruptcy petition automatically suspends all existing legal actions (even on the eve of trial or judgment, or on the day of foreclosure on real property), and is often used to forestall foreclosure or imposition of judgment. After 45 or more days a creditor with a debt secured by real or personal property can petition the court to have the "automatic stay" of legal rights removed, and a foreclosure to proceed.

Chapter 11 bankruptcy allows a business to reorganize and refinance to be able to prevent final insolvency. Often there is no trustee, but a "debtor in possession," and considerable time to present a plan of reorganization. Sometimes this works, but often it is just a bottomless pit of more debt and delay. The final plan often requires creditors to take only a small percentage of the debts due (what is owed them) or to take payment over a long period of time. Chapter 13 is similar to Chapter 11, but is for individuals to work out payment schedules, which is more likely to be worthwhile. Upon adjudication (officially declared) as a bankrupt a party cannot file for bankruptcy again for seven years.

Bankruptcy law has become a specialty due to complex regulation as well as administration. Initial fees must be paid up front by the petitioner or the creditors, but much of the assets may be eaten up by the court-approved fees of the trustees and attorneys (although often the attorneys find no assets available for payment).

There are some limited state bankruptcy laws to aid debtors, but they are seldom employed, except to create creditors' committees, which can be developed voluntarily. (See: bankruptcy court, bankruptcy proceedings, trustee in bankruptcy)


noun defaulting, destituteness, failure, financial disaster, financial failure, financial ruin, impecuniosity, inability to pay, indigence, insolvency, invollntary liquidation, loss, loss of fortune, pauperism, penury, privation, ruin, ruination
Associated concepts: adverse claims, arrangement for the benefit of creditors, bankruptcy act, bankruptcy assets, bankkuptcy court, bankruptcy estate, bankruptcy proceedings, composition in bankruptcy, composition proceedings, dissharge in bankruptcy, foreclosure, fraudulent conveyance, fraudulent transfers, involuntary bankruptcy, preferences, provable debts, receivers in bankruptcy, referees in bankruptcy, reorganization proceedings, sale of assets, trustee in bankruptcy, valuation, void preference, voidable transfer


the process taken to have a person declared bankrupt and to have his property administered for the benefit of his creditors. The property of the bankrupt becomes vested in a trustee in bankruptcy whose function is to identify and gather in assets belonging to the bankrupt; these are subsequently distributed among the creditors towards satisfaction of their claims, with the debtor being released from future liability in respect of his debts upon giving all the assistance in his power towards the realization and distribution of his estate and fulfilling any other conditions required by the law for his discharge. The distribution is so many pennies for each pound of debt. Similar provisions apply in Scotland, but there are significant differences. See BANKRUPTCY RESTRICTION ORDER LIQUIDATION, RECEIVER, INSOLVENCY.

BANKRUPTCY. The state or condition of a bankrupt.
     2. Bankrupt laws are an encroachment upon the common law. The first in England was the stat. 34 and 35 H. VIII., c. 4, although the word bankrupt appears only in the title, not in the body of the act. The stat. 13 Eliz. c. 7, is the first that defines the term bankrupt, and discriminates bankruptcy from mere insolvency. Out of a great number of bankrupt laws passed from time to time, the most considerable are the statutes 13 Eliz. c. 7; 1 James I., c. 19 21 James I., c. 19 5 Geo. II., c. 30. A careful consideration of these statutes is sufficient to give am adequate idea of the system of bankruptcy in England. See Burgess on Insolvency, 202-230.
     3. The Constitution of the United States, art. 1, s. 8, authorizes congress "to establish an uniform rule of naturalization, and uniform laws on the subject of bankruptcies throughout the United States." With the exception of a short interval during which bankrupt laws existed in this country, this power lay dormant till the passage of the act of 1841, since repealed.
     4. Any one of the states may pass a bankrupt law, but no state bankrupt or insolvent law can be permitted to impair the obligation of contracts; nor can the several states pass laws conflicting with an act of congress on this subject 4 Wheat. and the bankrupt laws of a state cannot affect the rights of citizens of another state. 12 Wheat. It. 213. Vide 3 Story on the Const. Sec. 1100 to 1110 2 Kent, Com. 321 Serg. on Const. Law, 322 Rawle on the Const. c. 9 6 Pet. R. 348 Bouv. Inst. Index, h. t. Vide Bankrupt.

References in periodicals archive ?
She added that NECA also is arguing in bankrupcy court that its members provide a utility service, and, therefore, deserve a higher priority for payment.
They have just weeks to find the money, or face the threat of bankrupcy in the courts.
His bankrupcy trustee allows him pounds 500 a month for rent.
Considering the earnings stability of the business, it is anticipated that the company would retain value as a business enterprise in the event of a bankrupcy.
The Edinburgh tycoon is notorious for his hands-off approach to the club he and his grandfather helped save from bankrupcy at different times in the past 120 years.
Once the wealthy owner of a large iron foundry, his business has recently into bankrupcy and his beloved wife has died.