How Bankruptcy Works

Origins of Bankruptcy

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 that follow.

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More Great Links


  • Beltran, Luisa. "WorldCom files largest bankruptcy ever." CNN Online, July 19, 2002.
  • Business bankruptcy FAQ. LexisNexis.
  • Bankruptcy Information, FAQs, Chapter 7 & 13 Information. Bankruptcy Action.
  • Crawford, Krysten. "Ex-WorldCom CEO Ebbers guilty." CNN Online, March 15, 2005.
  • "Delphi files for bankruptcy." CNN Online. October 8, 2005.
  • "Kmart files chapter 11." CNN Online, January 22, 2002.
  • Leonard, Robin. "Bankruptcy: Is it the right solution to your debt problems?" Nolo, 2004. ISBN 0-87337-973-x.
  • Lisante, Joan E. "New Bankruptcy Law Tightens Rules, Adds Paperwork." Consumer Affairs, October 14, 2005.
  • The New Bankruptcy Law. NOLO, 2005. objectId/B0B66870-4C52-4303-919B10B9611D3EF9/213/161/ART
  • "An Overview of Corporate Bankruptcy." Investopedia, July 8, 2005.
  • "Reorganization under the bankruptcy code, chapter 11." Public Information Series of the Bankruptcy Judges Division. U.S. Courts, December 1998.
  • Summers, Mark S. "Bankruptcy Explained: A guide for businesses." John Wiley & Sons, 1989. 0-471-61982-5.
  • The United States Trustee Program. U.S. Dept of Justice.