BANKRUPTCY IN THE UNITED STATES History.—In the United States control over the administra tion of insolvent estates is divided between the Federal and State governments. The Constitution (Art. 1, s. 8) gives to Congress power to establish "uniform laws on the subject of bankruptcies throughout the United States." But the Supreme Court has held that the States have power: (I) to establish and administer their own bankruptcy or insolvency laws in the absence of any regula tion of the subject by Congress and subject to certain restrictions on impairing the obligations of pre-existing contracts, and (2) to enact insolvency, assignment or stay laws that do not conflict with any statute which Congress may have enacted.
These statutes and amendments reveal a constant expansion of the federal power. The Act of 1800 was confined to merchants and traders, made no provision for voluntary proceedings, and put severe restrictions on discharge. In the Act of 1841 provision was made for voluntary proceedings by all debtors, involuntary proceedings against merchants and traders were retained, and the provisions for discharge were liberalized. The Act of 1867 abol ished the distinction between traders and other debtors, made pro vision for compositions, and made discharge still more easily ob tainable. Each of these changes was opposed or contested on con stitutional grounds and each was finally approved or acquiesced in by the Supreme Court.
The present Act is more comprehensive than any of its prede cessors. The statute of 1898, augmented by amendments adopted prior to 1933, offers voluntary proceedings to all debtors other than certain excepted corporations (municipal, railroad, insurance, banking, and building and loan) and provides for involuntary pro ceedings against all debtors other than farmers or wage earners (those working at a rate of compensation not exceeding $1500 a year) and the same excepted corporations. Discharge and com position provisions are more liberal than those of any previous act.
The most extensive innovations appear, however, in amend ments adopted during the past three years. Several new sections are grouped in a chapter (VIII) of "provisions for the relief of debtors." Section 74 extends, for the benefit of individual debtors, the scope of the old composition and provides for "ex tensions" that affect a secured creditor. Section 75 sets up an extremely complicated machinery designed to affect compositions and extensions for farmers burdened with mortgages. Section 77 offers a procedure for reorganization, supposedly more efficacious than the equity receivership, to railroads engaged in interstate commerce, and Section 77B offers a somewhat similar procedure to all corporations authorized to become voluntary bankrupts and to railroads not engaged in interstate commerce. Finally, Section 8o of another new chapter (IX) provides a plan for the readjust ment of municipal debts.
The constitutionality of some of these innovations is still a subject for conjecture. Two recent opinions by the Supreme Court offer an interesting contrast. In the first (294 U.S. 648) the Court gave its approval to the reorganization provisions of Section 77 by likening them to the older composition sections and remarked upon the striking capacity of the bankruptcy power to expand to meet new conditions. In the second (295 U.S. 555) the Court (by invoking the due process restriction of the Fifth Amendment) held unconstitutional Subsection (s) of Section 75, which in effect gave farmers who were willing to pay a reasonable rental value for property in their possession a five year morato rium from the claims of mortgagees. To distinguish the two cases the Court found "fundamental" differences between secured and unsecured creditors and between secured creditors who were members of a "class" and those who held their claims singly. The compulsion put on a dissenting bondholder in a reorganization was for the benefit of other creditors of the same class but compulsion put on a single secured creditor could be for the benefit of the mortgagor only. The result of the two decisions is to leave the judicial fate of the other innovations in some doubt ; the Court re tains a wide discretion to determine what Congress may or may not do by expanding or contracting either "bankruptcy" or "due process." The new Section 8o, providing a plan for the readjust ment of municipal debts must overcome the additional argument that it "impairs the sovereignty" of the States.
For administration by State Courts or departments there re main the insolvencies of all corporations denied relief under any of the Federal provisions—insurance companies, building and loan associations, and State banks. A recent decision (294 U.S. 2 I I ) of the Supreme Court impairs effective administration of these estates where the corporate business transcends State lines. The Court held that an Iowa "statutory successor" to an insolvent Iowa insurance corporation took "title" to assets in Montana sub ject to the "lien" of a subsequent Montana judgment creditor. This makes necessary expensive ancillary proceedings in all States where the corporation being administered has property. Again, in its determinations of what State statutes "conflict" with the national Act the Supreme Court has been generous to the States. A State insolvency or assignment statute is in conflict only if it supplies a discharge for the debtor; and to determine whether or not a statute supplies discharge the Court promises to look to the "interpretation" of State courts (287 U.S. 527). Finally in theory equity receiverships in the State courts remain available to all classes of corporations; in practice Section 77B is likely to deprive the State courts of this business.
The statute proscribes as acts of bankruptcy: the making of a fraudulent conveyance, the giving of a preference while insolvent, suffering or permitting while insolvent a creditor to obtain a preference by legal proceedings, the making of a general assign ment for benefit of creditors or being subjected while insolvent to the appointment of a receiver, and lastly an admission in writ ing of inability to pay debts and willingness to be adjudged a bankrupt. The meaning of the various "acts" has been extensively litigated. A debtor is insolvent within this section of the statute whenever the aggregate of his property, excluding that fraudu lently conveyed, is not at a fair valuation sufficient in amount to pay his debts.
The petition must be filed in the Federal district court of a district where the debtor has had his principal place of business, resided, or had his domicile for the preceding six months or the greater portion thereof. When a voluntary petition showing (on its face) the necessary jurisdictional requirements is filed, adjudi cation may follow almost immediately. When an involuntary pe tition is filed, the debtor is given an opportunity to appear and has the right to a jury trial on the question of solvency and the commission of an act of bankruptcy. The court after a hearing either makes an order of adjudication or dismisses the petition. If an order of adjudication is made, the court normally refers the case to a referee.
Referees are appointed by the court for a term of two years. Their compensation is regulated by statute and depends on the size of the estate and number of claims filed. They have broad judicial and administrative powers over allowance of claims and collection of assets. Their orders, however, are always subject to a review by the Court.
The referee when a case is referred secures from the debtor a statement of assets and liabilities and calls a meeting of creditors. At this meeting a trustee is usually elected, a majority vote in number and amount of claims of all the creditors present whose claims have been allowed being necessary to elect. If the creditors are unable to agree, the court or referee may appoint a trustee. The trustee is an executive officer whose fee is fixed by the court within a statutory minimum. It is his duty to take possession of the property of the bankrupt and convert the property into cash. Creditors are given six months after the adjudication to file proofs of claims against the estate. Claims duly proved are allowed by the referee unless objected to by the trustee or creditors. Secured creditors are allowed to prove for the amount of their claims in excess of the value of the security. The valuation of the security is made under court supervision.
To facilitate liquidation, trustee is given title to all of the bank rupt's property as of the date of the adjudication except that by State law exempted from the payment of debts. He likewise gets title to property of the bankrupt conveyed in fraud of creditors within four months of the filing of the petition, and is further empowered to invoke any State law which any creditor of the bankrupt could have invoked to set aside conveyances by the bankrupt. Finally, he is subrogated to certain preferential liens obtained by creditors within four months of the filing of the pe tition and given power to recover certain preferential transfers made by the bankrupt within that period. All these rights and powers of the trustee are subject to various restrictions that have generated an enormous amount of litigation.
All property collected by the trustee is converted into cash under the supervision of the Court.
A limitation from the debtor's point of view is that he is not entitled to a discharge as a matter of right. Application must be made and trustee and creditors are given reasonable opportunity to object. If they do not object, the discharge is granted. They may successfully object by proving that the bankrupt has violated the penal provisions of the act; or destroyed, concealed, etc., books of account ; or, in exceptional cases, failed to keep books of account ; or obtained money or property on credit by making written false statements concerning his financial condition ; or transferred property, with intent to defraud creditors, within 12 months preceding the filing of the petition ; or received a discharge in bankruptcy within six years; or refused to obey any lawful order of the referee or court or to answer any material question approved by the referee or court ; or failed to explain satisfac torily any losses or deficiencies of assets. But this limitation is more apparent than real since lethargy of creditors has produced a situation where substantially all bankrupts who apply for a discharge are given one.
Another limitation from the debtor's point of view is that even though a discharge is granted all debts are not thereby released. Only provable debts are dischargeable. But debts due as a tax levied by the Federal or State Government or a political subdi vision thereof; liabilities for certain fraudulent acts, wilful and malicious injuries, or certain immoral conduct ; certain wages and moneys owing to employees ; claims known to the bankrupt but not filed by the creditor because of his lack of notice or knowledge of the proceedings; and, of course, debts incurred subsequent to the filing of the petition are not discharged. And all debts which are not provable are not discharged. What debts are not provable has been a question of extended litigation clue to the ambiguous wording of the statute ; but the claims against the normal business are provable and thus dischargeable.
Operation—Reorganization, Compositions, Extensions. —The recent amendments to the Bankruptcy Act are designed not to produce liquidation, i.e., distribution of the debtor's assets among his creditors, but to permit the debtor to retain control of assets after liabilities have been reduced in amount or extended. This is accomplished by giving the bankruptcy court power to confirm plans of reorganization, composition, or extension that bind dissenting minorities of each class of a debtor's creditors. These amendments, though often defended upon the ground that creditors will ultimately receive more from such capitalization of a debtor's future earning power than they would receive from liquidation at forced sale prices, are, Of course, primarily de signed for the relief of distressed debtors.
The amendment of most practical importance is Section 77B which supplies a procedure for the reorganization of all corpora tions authorized to file voluntary petitions in bankruptcy. This procedure is similar to that of the equity receivership previously developed by the federal courts. Yet substantial changes have been made. The debtor is permitted to file a petition without shopping around for a friendly creditor. Ancillary receivers are no longer necessary; the bankruptcy court is given exclusive jurisdiction of the debtor and its property wherever located. Cash is not always required for the payment of dissenters nor a judicial sale for determining the participation of dissenters; the court may on certain conditions confirm a plan by decree. The con ditions for confirmation without sale are that creditors holding two thirds of the amount of each class of claims allowed accept the plan ; that, if the corporation is not found insolvent, a ma jority of the stockholders of each class accept; and that provision be made, in securities or otherwise, for dissenters to the extent that the judge finds fair under the circumstances of the particular case. However, a judge may still, it appears, find a plan fair that has not been accepted by a definite percentage of creditors or stockholders and order a judicial sale at an upset price in order to determine cash payments to dissenters. To obtain the benefits of this section a corporation need not allege that it is insolvent, as that term is defined in liquidation sections of the Act, but only that it is unable to meet its debts as they mature. Three or more creditors with provable claims which amount in an aggregate, in excess of security, to $i000 or over may file a petition against the corporation.
Elaborate provisions for the relief of individual debtors are found in Section 74. Their chief attraction is that they offer the debtor a chance of getting his secured debts extended. Here again the debtor need not allege that he is insolvent but only that he is unable to meet his debts as they mature. He may apply for confirmation of a plan of composition or extension only after it has been accepted in writing by a majority in number of all creditors whose claims if unsecured have been allowed, or if se cured are proposed to be affected by an extension. This number must also represent a majority in amount of claims. The plan may not reduce the amount or impair the lien of any secured creditors; but, if enough of the other creditors so vote, it may affect the time and method of his liquidation. The court (referee) shall confirm a proposal if satisfied of its fairness to creditor and feasibility for the debtor.
The details of Section 75 on Agricultural Compositions and Ex tensions, of Section 8o on Municipal Debt Readjustment and of Section 77 on reorganization of Railroads Engaged in Interstate Commerce Commission are too complex for brief summary. See Glenn, Liquidation 5) • (W. O. D. ; M. S. McD.)