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How Bankruptcy Works


Origins of Bankruptcy
Bankruptcy Outside the United States
Laws and attitudes regarding bankruptcy are different outside the United States, but the basic elements are usually the same -- debtors can have their debts legally discharged or they can formulate a repayment plan.

In Japan, corporate bankruptcy laws are similar to U.S. laws. However, bankruptcies were once extremely rare in Japan. Financially troubled companies were more likely to deal with their debt privately by arranging a bank loan or working out their own payment plan with creditors. The Asian economic crisis of the 1990s forced many Japanese companies into bankruptcy, since the banks themselves were in serious financial trouble.

European bankruptcies are usually referred to as insolvencies. As part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the United States adopted a United Nations model cross-border insolvency law originally drafted in 1997. This should lead to more countries adopting the model law, which encourages cooperation between the courts of the nations involved.

Initially, bankruptcy was an involuntary state -- people who were forced into bankruptcy were considered criminals, and could be thrown into debtor's prison or even executed. The word bankruptcy is said to stem from an Italian tradition of destroying the workbench of a tradesman who couldn't pay his debts. The Italian phrase for broken bench, banca rotta, is the origin of the word [ref].

In the 1800s, United States bankruptcy laws were limited and usually passed to help the country through difficult economic periods. The Bankruptcy Act of 1898 was the first modern bankruptcy law, and it was further refined during the Depression with the Bankruptcy Act of 1933, the Bankruptcy Act of 1934 and the Chandler Act of 1938. Individuals were given the power to have their debts discharged, and corporations were given the opportunity to reorganize and pay their debts while they were in bankruptcy.

With the exception of railroad companies, few bankruptcies were filed after World War II. The Bankruptcy Reform Act of 1978 was a landmark in United States bankruptcy legislation. This law created the chapters of bankruptcy that we have today and expanded the powers and rights of both consumer and corporate debtors to file bankruptcy. Filings increased in the following decades, leading to fears that the bankruptcy system was too lenient and wasteful. This also created a backlog in bankruptcy courts, leading to a push for "fast track" bankruptcies for small businesses and "prepackaged" bankruptcies to help streamline the process and ease the caseload. Reform laws were also passed to encourage more Chapter 13 filings instead of Chapter 7 filings [ref].

The bankruptcy reforms passed in 2005 are just the latest changes to these laws, as the pendulum swings from empowerment of debtors to the empowerment of creditors. Changes in the political landscape, the views of the public and the economic situation all affect future bankruptcy laws.

For lots more information about bankruptcy, check out the links on the next page.