An excerpt from Bankruptcy: A New Beginning by Seth Hanson
I thought I’d start with the most difficult, if not the most common question people have. People don’t always come out and ask this question directly, but I believe it is almost universally on people’s mind. Nearly everyone who files bankruptcy asks themselves whether they are a bad person for filing. Within our Western culture we are taught, properly in my opinion, that we should tell the truth and honor our commitments. This is as it should be. We were taught this by our parents, our grandparents, and our teachers. I have taught my four children the same thing.
Without these fundamental values—honoring our commitments and telling the truth–our free market economy and our entire society would come unraveled. Without trust in the promises of others, people acting within the economy would be extremely reluctant to do business with anyone else. There would be such a level of distrust that economic interaction would slow dramatically if not come to a halt.
In America, contract law helps us have confidence in the economic promises of those we do business with. This is because the law provides a legal remedy when a contract is breached. When I enter into a contract with someone else, I know that I can sue the other person to the contract if that person fails to honor the contract. In order to form a binding contract there must be an offer, acceptance of that offer, usually referred to as a “meeting of the minds,” and consideration. Under these circumstances the law provides a remedy for the breach of that legally enforceable promise. Try to imagine the chilling effect that would enter into commercial transactions were it not for the predictability contract law brings to the free market. Almost no one would be willing to enter into commercial transactions, except perhaps for a mafia type loan shark with plenty of muscle to collect on the loans he extends. So what options are available when debtors don’t repay their debts? If you’ve done business with the mafia, Cousin Vinny shows up on your doorstep with his brass
Another historic option has been debtor’s prison. For example, in Greece debtor’s prison was common. (Greece only abolished debtor’s prisons in 2008.) Most
people know that Australia was largely populated with debtors who had been sent to prison for the nonpayment of their debts. European countries largely eliminated debtor’s prisons by the late 1800s. Great Britain eliminated debtor’s prisons with the Debtors Act of 1869. Sweden followed suit in 1879. Germany still allows for 6 months imprisonment for the intentional non-payment of debts. The United Arab Emirates imprisons people for failing to repay their debts. China has a life sentence for non-payment of debts incurred with malicious intent. Iran has debtor’s prison, among its other repressive laws. As a point of interest, one of my clients fled Iran with a death sentence because he was in possession of unauthorized written materials. If he ever returns to Iran, he will be executed.
In ancient Greece bankruptcy did not exist. If a father of the debtor could not pay his debts, his entire family (including wife, children, and servants) were forced into debt slavery until the creditor recouped his losses via the physical labor provided.
Many city states in ancient Greece limited debt slavery to a period of no more than 5 years. Slaves had protection of life and limb. After the 5 year period, the debt slaves were given a fresh start. Many countries still suffer from debt bondage or debt slavery. The majority of debt slavery occurs in Southeast Asia. However some still occurs in Africa. It is the leading cause of sex slavery including child sex trafficking. Debt slavery is the most common method of enslaving people. Debts are often issued to people who have no hope of repaying them. In this way the unscrupulous lender is planting seeds of enslavement through the extension of credit. Frequently children of the debtors are sold in repayment of the debts.
Historic Origins Of Bankruptcy
Another option instead of debtor’s prison or debt slavery, is a well regulated and carefully designed system of bankruptcy. The word bankruptcy is often attributed to the Latin words “bancus” (which means a bench or table) and “ruptus” (which means broken). In ancient Italian public markets a banker would often set up business using a particular bench. They used the bench to hold their money and to transact their business. When a banker went out of business, he broke his bench to let the public know he was out of business. As this practice was common in Italy, it is said that the term bankrupt is derived from the Italian “banco roto,” meaning broken bank.
Bankruptcy is also documented anciently in East Asia. The Yassa of Genghis Khan contained a provision that mandated the death penalty for anyone who became bankrupt three times, indicating that bankruptcy was practiced. The concept of bankruptcy and fresh start can also be found in religious contexts. In the Torah, or Old Testament, Mosaic law proclaimed every seventh year a Sabbatical year wherein the release of all debts that are owned by Jews is mandated. Every seventh Sabbatical year, or 49th year, is then followed by another Sabbatical year known as the year of Jubilee, wherein the release of all debts is mandated, for Jews and non Jews alike. The release of all debts slaves is also mandated whether of Jewish or non-Jewish descent. The discharge of debts was introduced to Anglo American bankruptcy with the Statute of Anne in 1705, where the discharge of unpayable debts was offered as a reward to people who cooperated in the gathering of assets to present them as payment to their creditors.
Bankruptcy In The United States
American debtor’s prisons existed from the early colonial days through the mid-1800s. However, the concept of bankruptcy was of such importance to the Founders that they mentioned it in the Constitution. Bankruptcy is a matter placed under federal jurisdiction by the United States Constitution (Article 1, Section 8, Clause 4), which allows Congress to enact “uniform laws on the subject of bankruptcies throughout the United States.” Congress has periodically enacted statutes governing bankruptcy.
Congress’s first law on the subject was the Bankruptcy Act of 1800, which was limited to involuntary bankruptcy proceedings. This act was repealed in 1803. Voluntary bankruptcy in the United States was first allowed by the Bankruptcy Acts of 1841 and 1867, both of which were later repealed. The Bankruptcy Act of 1898 was the first permanent bankruptcy law in the United States. The Bankruptcy Reform Act of 1978 contained sweeping changes and established the fundamental structure of our modern bankruptcy system. There were a few other tweaks to the Bankruptcy Code up through 2005.
Bankruptcy Abuse Prevention And Consumer Protection Act of 2005
In 2005 Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act (also known as BAPCPA). This act introduced greater restrictions on those filing bankruptcy, and, as its name implies, was designed to curb abuses of bankruptcy filers under the prior bankruptcy laws. Among the most sweeping changes introduced by BAPCPA was the concept of means testing, whereby income restrictions were placed on those who can file Chapter 7 bankruptcy. Under the means testing provisions of BAPCPA, if a person who is filing bankruptcy has above median income based on household size and state of residence, that person has to go through a rigorous income and expense analysis to demonstrate they lack the financial means to repay any of their debt. The means test is based on income over the last six complete months. If a person does not pass the means test, it will be presumed abusive for that person to file a Chapter 7 bankruptcy. A person can overcome the presumption of abuse in proper circumstances.
For example, if a person who had a good job earning above median income was laid off and is now without income, that person can rebut the presumption of bad faith based on the change in circumstances. There is no way that person without income could repay any of the debt in a Chapter 13 bankruptcy. Our current American bankruptcy system seeks to strike a careful balance between the interests of debtors seeking a fresh start and that of creditors seeking a return on their business investments. Some of the safeguards ensuring bankruptcy is not used too often include the means test already discussed above, as well as the possibility of losing some of one’s property in a Chapter 7 (although California has very generous exemptions and my clients rarely lose property—see the section of this book below discussing the possible loss of property). Another safeguard in our current bankruptcy system is the investigation by the FBI and Department of Justice of fraudulent statements made by debtors in bankruptcy proceedings. The repercussions of dishonest statements—or willful failures to disclose— include fines, loss of bankruptcy discharge, and incarceration. The safeguards built into our current bankruptcy system make it far less likely that a debtor will file bankruptcy improperly.
Practical Benefits Of A Bankruptcy System
Our well-developed American system of bankruptcy has several practical benefits. When my clients come to understand these practical benefits, they often feel much more at ease about filing a bankruptcy.
First, our bankruptcy system results in improved productivity of individual debtors. When someone can file bankruptcy to rid themselves of oppressive debt they can become more productive members of society for the remainder of their lives. This in turn helps other members of their community, and contributes to the well being of the entire economy.
Second those who file bankruptcy and free themselves from the physical strain of burdensome debt often have improved health. This results in reduced medical costs
and freeing up of valuable resources for other legitimate pursuits.
Third, a well-developed system of bankruptcy helps provide for the optimal use of scarce resources. When a lender knows there is a possibility of filing bankruptcy, the lender will be more selective in deciding which person it extends loans to. This will result in the best
commercial ventures and the most promising and profitable activities receiving funding. On the other hand, business ideas and proposed ventures that have little perceived chance of success will not receive funding due to the threat of bankruptcy.
Fourth, a well-developed system of bankruptcy can lead to improved economic growth as a result of appropriate risk-taking. If debtor’s prison was the cost of risks taken that ultimately materialized, there would be far less risk taking and far less entrepreneurism. As a case in point, look at the nation of Israel. In their book Start-Up Nation: The Story of Israel’s Economic Miracle, written in 2009, the authors discuss how Israel, a 60 year old nation with a population of 7.1 million was able to reach such economic growth that “at the start of 2009, some 63 Israeli companies were listed on the NASDAQ, more than those of any other foreign country.” This willingness to take risks, and the resulting economic growth, may have something to do with Israel’s bankruptcy system. Israel’s bankruptcy system is very similar to the American model.
Famous People Who Have Filed Bankruptcy
As I stated in the introduction to this book, hard financial times come to all sorts of people. Just because you are famous and were rich at one point in your life does not mean you are immune to financial difficulties. Many people are surprised to learn that several famous people have filed for bankruptcy including Kim Basinger, Toni Braxton, Samuel Clemens, Gary Coleman, Walt Disney, Mick Fleetwood, Ulysses S. Grant, MC Hammer, Larry King, Cyndi Lauper, Stan Lee, Willie Nelson, Tom Petty, Burt Reynolds, Mickey Rooney, and Mike Tyson to name just a few.
So When Is Bankruptcy Morally Justified?
While all of this history may be interesting, the fundamental question remains: is filing bankruptcy morally right? Am I a bad person if I file bankruptcy? Just because something is legally permissible does not make it right. For example, it may be legal to watch someone drown so long as you didn’t push them in. But that does not make it morally right. In my opinion, the answer to this question depends on why the person needs to file bankruptcy. If you are not able to repay the debts and they were incurred as a result of a sudden change in circumstances that was beyond your control, such as with sickness or job loss, then I believe filing bankruptcy is morally justified.
If the debts were incurred intentionally as part of a premediated plan to steal from creditors, then purposely incurring debt with a plan to file bankruptcy is clearly unjustified and is totally wrong. It is a more challenging issue when someone incurred the debts fully intending to pay them off as agreed, but the debt may have been incurred through irresponsible conduct and would have been avoidable with adequate planning and budgeting. For example if you were living right on the edge of your financial means such that the slightest hiccup in your income would cause great financial turmoil, then filing bankruptcy may or may not be morally justified.
In analyzing their debt, I ask clients to focus on the intermediate to long term, say three to five years. If it is reasonable to think clients can repay their debt over that time frame, or to make substantial progress in paying it down, then I believe they should avoid bankruptcy and pay down their debt. If however, someone would be in the same hopeless situation three to five years from now and still be caught in the cycle of being forced to use their debt for living expenses because they used all their disposable income earlier in the month for debt payments, then I believe bankruptcy is worth considering. Once you get caught in the vicious whirlpool of debt, it is almost impossible to break free without the assistance of the bankruptcy statutes. Bankruptcy at that point is probably morally justified because society
will be far better off if you rid yourself of the crushing burden of debt and once again become a productive member of society. At that point you will have paid your own personal “stupid tax”—something each of us pays sooner or later—and learned some painful lessons.
Hopefully, you will become a much wiser person as a result of your financial hardships.
Another thing to consider in evaluating the morality of bankruptcy filing is your obligation once your bankruptcy is over. Even though your creditors will not be able to legally force you to honor your contractual obligations to them, I believe you still have a moral obligation to pay back your creditors if you ever achieve the financial wherewithal to do so.
For more information contact your Yuba City bankruptcy attorney.
Categorized in: Filing Bankruptcy