Bankruptcy Power – Sturges v. Crowninshield, 17 U.S. 122 (1819) and Ogden v. Saunders, 25 U.S. 213 (1827)
Shortly after the first person mixed her labor with a thing and called it “mine,” some person furnished property to another, together with an obligation to return it. With that, the problems of debtor and creditor were born.
Adequate rules governing debtors and creditors, and restructurings of their debts, have ever been an essential feature of a happy society. When Moses gave law to a people just emerged from slavery and an itinerant life in the desert, their property was limited to what could be carried (mostly tents) and what could follow (livestock). Yet, Moses saw the future of commerce in the Promised Land and wisely included, at the behest of a Higher Authority, a Jubilee Year every seven years, during which debts would be discharged and slaves freed.
Aeneas narrowly escaped the bloody debts of Troy, and his Roman descendants would provide creditors with inhumane rights over liberty and lives of delinquent debtors. Perhaps no lesser threat had the power to compel a debtor to pay, where payment was possible. Still Rome in its wisdom saw fit to mitigate this sanction.
The Roman Cessio Bonorum, or surrender of goods, provided for the voluntary surrender of all of a debtor’s property to creditors, whereupon the physical person of the debtor was discharged. Free from imprisonment and death, the debtor’s obligation remained. Creditors could reach the fruits of the debtor’s future labors until payment in full, a condition only modestly distinguishable from slavery.
The problem of who owned what and the associated problem of the collection of debt drove key aspects of the severity of the law of debtor and creditor. Where communications and records are primitive, laws define property mainly by possession and the general knowledge of the community. When Norman conquerors in 1179 recorded the ownership of real property in the Domesday Book, juries assembled the data by a survey conducted in situ in towns and villages. To determine who owned what, the juries simply asked. Once recorded in the Domesday Book, there was no right of appeal.
But the limits of recordation and the use of conveyances might obscure interests in land, and for personal property, if an owner did not volunteer title, detection could be difficult. The ease of concealment of property meant the primary means of debt collection – and the basic structure of debtor-creditor law – would continue to be the imprisonment of the debtor.
Cessio Bonorum, like so many things Roman, survived the death of the Roman Empire, but Anglo-Saxons were not without innovations in law. The inability to discharge a debtor from the obligation of repayment, as Moses had provided through the Jubilee, rendered an insolvent debtor a useless person, without incentive for productivity. Anglo-Saxon law in time (in 1705, to be precise) made available a discharge of obligation in cases where there was no fraud or misdeed. Cessio Bonorum came to be considered an “insolvent law” in contradistinction to a “bankrupt law.” An “insolvent law” discharged the person of the debtor; a “bankrupt law” discharged the obligation of the debtor.
When the Articles of Confederation of the United States failed in 1787, its inability to deal with the deep recession that followed the Revolutionary War was a chief feature of national incompetence. A multiplicity of debt-burdened states fashioned a quilt of laws affecting debts, breeding uncertainty and impeding commerce. Indeed, one of the first tests of the new government was a rebellion in 1786 of languishing debtor-farmers in Massachusetts known as Shays’ Rebellion. Sagging under the weight of many limitations, the Articles gave way, and the convention brought forth a new Constitution.
To remedy the particular defect of the Articles relating to debts, the Constitution inserted the national government into, and limited the states interference in, the relationship of debtors and creditors. Article I, Section 8 of the Constitution includes among the enumerated powers of Congress the power “To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.” Article I, Section 10 provides “No State shall . . . pass any . . . Law impairing the Obligation of Contracts.”
Two landmark cases, Sturges v. Crowninshield, 17 U.S. 122 (1819) and Ogden v. Saunders, 25 U.S. 213 (1827), established the relative power of the federal government and the states with respect to insolvent and bankruptcy laws. Sturges and Ogden together established that the United States’ bankruptcy power is not exclusive. A state may adopt a bankruptcy law so long as any exercise of that power does not conflict with any law of the United States establishing a uniform system of bankruptcy, and the law does not impair any obligation of contracts. Sturges and Ogden established that a state bankruptcy law does not impair the obligation of contracts, except where a state passes such law after the contract has arisen, on the theory that a contract incorporates existing state law at the time of formation. Ogden further established that a discharge could only apply as between citizens of the state granting the discharge.
These rulings therefore preserved for states only the rump of bankruptcy power. Bankruptcy thus has been preeminently the domain of federal law. The Bankruptcy Reform Act of 1978, as amended, is now the remedy nearly universally sought for distressed debtors and their creditors. A chapter 11 case under the United States Bankruptcy Code, Title 11 U.S.C., consists in its simplest terms of –
(i) an injunction barring creditor action,
(ii) court supervision of the debtor,
(iii) the proposal of a plan organizing creditors by classes,
(iv) solicitations of creditors to vote to support the plan,
(v) limitations of holdout power permitting consent by less than unanimous approval and less than all classes, and
(vi) confirmation of a plan and a discharge of debts.
The purpose of chapter 11 is the preservation of value of a debtor’s business to maximize the recovery of all creditors, who in the absence of protections of the debtor would figuratively tear the debtor limb from limb, reducing the overall recovery for all creditors. The Bankruptcy Code also provides for a liquidation (chapter 7), personal reorganization (chapter 13) and municipal reorganization (chapter 9).
The potency of the bankruptcy power and prohibition on the state impairment of contracts has never been more evident than in recent years. When Treasury Secretary Henry Paulson determined not to extend the “window” for overnight borrowing to Lehman Brothers in September of 2008, Lehman Brothers filed for chapter 11 bankruptcy, triggering a meltdown of global financial markets.
A wave of debtors filed petitions in bankruptcy, eventually even General Motors, an institution once synonymous with the welfare of the United States. With the financial markets in catastrophic distress, General Motors had to look to Treasury to finance in its chapter 11. The conversion of that debt into equity of new General Motors stained the struggling enterprise with the nickname “Government Motors” until Treasury disposed of its interest.
Yet, despite the trillions of dollars at stake, the crisis of 2008 was navigated using the enormous bankruptcy power of the United States through the rules established by the Bankruptcy Code in an orderly, and above all, peaceful, manner. There are worthy particular discontents over the intrusions of the federal government in the financial crisis of 2008. Nonetheless, the success of the federal bankruptcy power and its expression in the Bankruptcy Code, and indirectly the scheme established by Sturges and Ogden, is remarkable.
Moses doubtless would agree.
Sturges v. Crowninshield (1819) Supreme Court decision: https://supreme.justia.com/cases/federal/us/17/122/
Ogden v. Saunders (1827) Supreme Court decision: https://supreme.justia.com/cases/federal/us/25/213/
J. Eric Wise is an attorney practicing in New York.