Anyone who has casually read the business press over the last few months cannot help but be aware of the high-profile bankruptcies currently pending. Out of the numerous restatements of financial statements have arisen the Enron and WorldCom Chapter 11 filings. The already cost-bloated airline industry was tipped over the edge by the events of 9/11, with US Airways leading the way, recently to be followed by the country's second-largest airline, United (much to the chagrin of we Chicagoans with many frequent flier miles). These series of filings follow upon those by companies that have sought the refuge of the Bankruptcy Code to cope with unquantified contingent liabilities arising out of seemingly endless litigation, such as Johns Manville, A.H. Robins, and Dow Corning.

At the same time, followers of the federal legislative process will have noticed the ongoing tussle between the consumer credit-card lobby, trying to toughen up the laws pertaining to personal bankruptcy, and the consumer advocate lobby, trying to maintain the status quo. In a strange twist, even by Washington standards, during the most recently completed session of Congress a bill which would have placed tighter restrictions on personal bankruptcy, particularly for high-income filers, failed to garner the support of socially conservative Republicans. The sticking point? Inclusion of a provision intended to appease wavering liberals that would have prohibited those responsible for bombing abortion clinics from avoiding damage payments by declaring bankruptcy.

What the average reader may not realize is that the prevalence of bankruptcy in the United States today, both for individuals and for businesses, is unparalleled in any other society in the world, spiraling upward from approximately 200,000 individual filings in 1979 to nearly 1.4 million in 1998.

Why is bankruptcy so uniquely part of the American landscape? One might be tempted to assume that somehow the country's early Christian foundations are relevant. After all, the themes of grace and redemption seem to feed nicely into the institutionalized forgiveness of debt; on the other side of the ledger, meeting one's obligations could be seen as drawing on a Puritanical sense of responsibility.

David Skeel, however, in his book Debt's Dominion, A History of Bankruptcy Law in America, explains today's Bankruptcy Code and its evolution over the past 200 years not in terms of any grand philosophical or religious inclinations of the American people, but rather much more mundanely as the result of three secular influences over much of the last 200 years.

First among Skeel's three root causes is the banding together of creditors, largely from the eastern United States where the major financial institutions were located, to seek federal bankruptcy legislation that would enable the orderly distribution of a debtor's insufficient assets. For creditors, bankruptcy was a means to enable collective action which would produce a better result for most creditors than an anarchic system in which each creditor pursued only its own interests. The consequence of these creditors' lobbying was the repeated passage of bankruptcy laws during the 19th century.

Second among Skeel's three major influences is the counterweight to the Eastern creditors' efforts—namely, the populist agrarian influences, often in the South and West. Farmers and ranchers feared Eastern bankers would seize control of mortgaged farms and ranch land if a bankruptcy law gave too much power to creditors. The populist influence succeeded in the repeated repeal of the various pieces of legislation enacted in the 19th century and, within that legislation, the inclusion of pro-debtor protections.

The third of Skeel's dominant influencing factors did not completely come into play until the 1898 bankruptcy legislation—by virtue of a relatively stable period of Republican control of Congress thereafter—had remained in place for a substantial period of time, unlike its 19th-century predecessors. As a result, for the first time a group of lawyers and bankruptcy professionals developed a vested interest in maintaining a bankruptcy structure, and were able to play a significant role in protecting bankruptcy substantially as we know it against attempts to alter it.

While Skeel focuses largely on commercial influences, Bruce Mann, writing about an earlier era in his new illuminating book, Republic of Debtors, identifies a fundamental societal change in attitude toward debtors. In what could be seen as a prequel to Skeel's book, Mann traces the evolution of American attitudes toward debt and insolvency throughout the 1700s, culminating in the first federal bankruptcy law in 1800, which is just about the point at which Skeel picks up. At the beginning of the 18th century, Mann says, there was still a moral economy of debt: inability to pay was a moral failure, not a business risk. Indeed, even into the early 19th century, the ultimate recourse for a creditor generally was to bring an action to put his debtor in prison. But with the passage of the bankruptcy act in 1800, and concurrent developments in many of the states, Mann says, the nation was set along the path toward "the redefinition of insolvency from sin to risk, from moral failure to economic failure."

Not that moral questions have not continued to shape attitudes toward insolvency and how a society should deal with debtors. Indeed, it seems to have been moral questions of the type which today surround debacles like Enron's that influenced William O. Douglas, the post-Depression New Deal chairman of the Securities and Exchange Commission, and later prominent Supreme Court Justice, in shaping the provisions pertaining to corporate reorganizations in the1938 Chandler Act.

According to Skeel, Douglas was determined to take away the corporate reorganization practice from the New York investment bankers and lawyers, who had dominated it from the time of the first large railroad insolvencies in the late 19th century. Douglas' desire was consistent with the general anti-investment banker sentiment of the New Dealers—perhaps not too dissimilar from the post-Enron feelings toward not only investment bankers but also accountants and corporate chieftains. Douglas succeeded, but the next 40 years saw what may have been an unintended consequence. Until the enactment of the present Bankruptcy Code in 1978, corporate reorganization practice fell into disuse for large, publicly traded corporations. Perhaps there is a lesson here for those who might over-react to recent corporate criminal conduct. It may be better to concentrate on enforcing the laws that currently exist, as opposed to dramatically changing them in a fashion that may have unintended unfavorable consequences for the economy as a whole.

The demise of reorganization under the Douglas-inspired legislation highlights the uniqueness of U.S. bankruptcy legislation as it largely existed prior to 1938 and as it has been since the enactment of the Code in 1978. In the corporate arena, what makes the U.S. system so distinctive is that it generally leaves existing management in place to lead the reorganization. In contrast, in most countries' systems—and in the U.S. during the 40-year period from 1938 to 1978—once a corporation wishes to be reorganized, a trustee or other administrator is appointed to take over the business. This, in fact, generally leads to the liquidation of the corporation.

Another distinguishing feature of the American system is that it is a judicial process, not an administrative one. In this regard, as the North American general counsel for an English company, I often find myself responding to comments from my British colleagues as to the prevalence of lawyers in so many aspects of U.S. society. Bankruptcy is yet another of those aspects. In England, an appointed administrator, generally an accountant by background, tallies up the assets and the debts and attempts to distribute the former in an appropriate manner. In the U.S. system, reorganization is carried out through judicial processes, with existing management of the debtor, represented by sophisticated bankruptcy counsel, and influenced by the creditors, also represented by high-powered legal counsel, often playing a leading role in shaping the plan of reorganization, including who gets what among the creditors, and what the debtor looks like upon discharge from bankruptcy.

It is the discharge, Skeel explains, which is the third peculiarity of American bankruptcy. In no other system can the debtor so easily walk away from all its pre-bankruptcy obligations once a plan is approved by the court and/or the requisite creditors. In more recent times the discharge has become a tool to be used by debtors facing massive contingent tort liabilities, such as those arising from asbestos exposure, even prior to those claims having been filed.

Nevertheless, Skeel concludes that as some of the other social protections that have been prevalent in the societies of Europe and Japan become unsustainable in the face of globalization, it is likely that those societies will need bankruptcy laws more like those of the United States, which make it easier for people and companies to start over. Already, Skeel says, there are steps in this direction. Like others who have written about globalization more generally (for example, Thomas Friedman in The Lexus and the Olive Tree with respect to the ascendancy of market capitalism), Skeel does not disallow the possibility that some major jolt could disrupt the seeming inevitability of the spread of U.S.-style bankruptcy laws. Nevertheless, Skeel concludes that America's horse-and-buggy era laws are most likely to be adequate for at least another century, not only for the United States, but increasingly for other societies as well.

Stephen Smith is general counsel for the North American operations of GKN PLC, an English automotive and aerospace manufacturer.

Copyright © 2003 by the author or Christianity Today/Books & Culture magazine.
Click here for reprint information on Books & Culture.