Why Do We Have Bankruptcy Laws?

Bankruptcy isn’t a new concept by any means, but did you know that it is so fundamental to our national economy that it was actually enshrined in the US constitutional laws? Yes, if you are filing for bankruptcy, not only should you not be ashamed of doing so, but by doing so, you are exercising your rights as an American citizen.

Why did our founding fathers think bankruptcy was so vital? And why is our current system structured the way it is? And is there a room for improvement, even after about two and a half centuries of evolution of our system?

Read on for more about the history and possible future of our bankruptcy system.

A National Economy Necessitated National Bankruptcy Powers

Our government was set up by a bunch of former British citizens that were terrified of giving the federal government too many powers. As a result, they outlined a constitution that explicitly limited what the federal government could do, reserving everything else to the states. This is why your local state government decides how fast you can drive, whether you are allowed to murder people, or what age your child has to be to attend kindergarten.

Why, in such a limited system, did our founding fathers think it was so necessary to explicitly include bankruptcy as a federal power? The answer lies in the few years between the United States of America defeating England and the time when they passed the US Constitution into law. During that period, the government was run under a system called the Articles of Confederation that essentially let the states all set up their own governments, with barely any federal powers reserved – only things like warfare. In theory, this kept the federal government from becoming too tyrannical, like England was, but in practice, it also meant everything was an economic disaster. Debts forgiven in one state may not have been forgiven in another state. And a bankruptcy filed in Connecticut may not have been recognized in Rhode Island. It was literally 13 pseudo-countries all making up their own rules, trying to masquerade as a single country. It was making interstate commerce pretty much impossible.

One of the first things the constitution outlined was a federal power to regulate interstate commerce, so that we didn’t have states taxing each other and destroying any sort of national economy. And part of that interstate commerce concept was this bankruptcy power.

Over time, that vague bankruptcy power evolved into our present-day formal system of bankruptcy courts that are all ruled by federal law, with states being allowed to fill in some gaps, such as passing their own rules with regards to what property is exempt from sale in an individual’s Chapter 7 filing.

Is Our Bankruptcy System Fair?

In many ways, it is. And in other ways, it is not. Great answer, huh?

Some may argue that allowing an individual to amass debt and then discharge it through a court filing is unfair – what happens to the businesses that lent money or property to this person, only to have the person escape that debt? Keep in mind that there are tax breaks or write-offs when debt is eliminated in bankruptcy, so these businesses are not completely left out in the cold. It is not perfect, but it is a compromise that allows individuals and businesses drowning in debt to move forward even after their finances have taken a downturn. It’s certainly better than indentured servitude and lifelong debt that cripples any hope of ever recovering, which was more of the norm in the days before our nation was founded. Back then, the only fresh start was to hop on a boat and float to the other side of the world. ¿Hablas español?

Even with that, our system is very much not perfect. It has been a constant balancing act between lawmakers ostensibly fighting fraud (by placing limits on exempt property that you get to keep or the types of debt that you can discharge) and empowering people to discharge debt that has ruined their lives so that they may get a fresh financial start that allows them to not only rebuild their lives, but to benefit the economy as a whole.

The Future Reforms of Our System

There is definitely still work to do to improve our bankruptcy system. One long-standing critic of the system is Senator Elizabeth Warren, who made bankruptcy reform one of her many proposed plans as part of her campaign for president and the primary elections leading up to the 2020 election. She outlined a number of major flaws with our system, such as the racial disparity in bankruptcy filings and the near impossibility of discharging student loan debt, as areas where our system can be greatly improved.

There are also issues of fairness between filers of different states — while one state may allow a married couple to exempt $300,000 worth of real estate while discharging the remainder of their debt, the state right next to it has no exemption for one’s home at all – and as a result, the home is sold off for the benefit of creditors.

Where Do You Go For Practical Advice?

Many people who are forced to take advantage of relief programs, such as unemployment insurance, disability, or a bankruptcy filing that helps to eliminate troublesome debt, feel ashamed about needing help. They should not. Everybody needs help at times, and bankruptcy was seen as so vital to the economic health of our country, that our founding fathers who built this government that has evolved from a handful of aristocratic white men to a more representative democracy, even recognized how important of a right bankruptcy was. Much like our imperfect country, our bankruptcy system is still a work in progress, so individuals availing themselves of this imperfect country’s imperfect bankruptcy system, should not feel ashamed of their own imperfect finances.

If you are feeling at all guilty or ashamed about your need for bankruptcy, know that you are not alone and millions of Americans have been where you are, including presidents and politicians, leaders, and great men and women of all walks of life.

When you are ready to discuss your constitutional right to bankruptcy and to get down to the practical advice of exempt property and filing types, we have a network of attorneys that are here to help you get to that next stage in your life. They can discuss the property that is important to you, the property that is financially significant, and how you may best go about preserving the things that matter while emerging with the healthiest financial future possible, ready to build your life back up and contribute to our national economy. Get started with a consultation today.