The Formation of Legal Institutions for Bankruptcy:
A Comparative Study of the Legislative History
(First draft, February 19, 2001)
Erik Berglöf*
Howard Rosenthal**
Ernst-Ludwig von Thadden***
*SITE, Stockholm School of Economics, email: [email protected]
**Politics Department, Princeton University, Princeton, NJ 08544, USA. E-mail:
[email protected].
***DEEP, University of Lausanne, email: [email protected]
1
The Formation of Legal Institutions for Bankruptcy:
A Comparative Study of the Legislative History
Abstract
This paper examines the legislative history of bankruptcy reform in four countries –
Germany, Sweden, the United Kingdom and United States – with the objective of extracting
lessons for developing and transition countries facing fundamental institutional choices. A
striking feature of bankruptcy law is the tremendous variation across countries and over time
within jurisdictions. We argue that this variation can only be understood by studying the
political economy of bankruptcy reform. The institutions we observe today are the result of
interplay between, on the one hand, technological development and fluctuations in the
economy, and on the other, political institutions and preferences. Fundamental changes in the
economy gradually rendered existing substantive rules and procedures inadequate, but reform
activity was typically triggered by severe economic downturns and, in the more tradedependent European countries, by pressures to harmonize. The success of these reform
initiatives depended on the prevailing political majorities and the specifics of the institutional
rules in the country in question. In the formative years bankruptcy reform was a high-profile
issue with intense discussions in legislative bodies. As modern bankruptcy laws took root
constituencies were formed and interest groups politics became more important in
institutional change.
2
1. Introduction
Bankruptcy reform is currently high on the agenda in many countries, in particular in the
developing world. The International Monetary Fund has even made bankruptcy reform part of
its conditionality. Many of the countries hit by the Asian Crises have had intense, highly
charged public debates over the design of bankruptcy institutions. The difficulties of foreign
creditors in Asian tiger bankruptcies have become lead stories in the financial press.
Recovery, it is claimed, has been retarded by the lack of adequate bankruptcy procedures.1 In
the developed market economies, various interests have pushed bankruptcy reform claiming
that, for example, innovations in financial technologies in the credit card industry and
international harmonization require substantial revisions of existing laws.
To understand the many issues involved in bankruptcy reform and their importance it may be
useful to look at Russia as an example. The introduction of the price mechanism and the
reduction in state subsidies forced tens of thousands of firms into financial distress
simultaneously. Yet there was no legal procedure for dealing with these firms. An elementary
bankruptcy law was introduced in 1992, but it soon proved largely ineffective. In 1997 a new
law was adopted, essentially an amalgamation of US and UK laws with some idiosyncratic
elements intended to accommodate the specifics of the Russian transition economy. It
provided for two procedures, one for liquidation and one for reorganization where
management is removed but the debtor remains in possession. But the most striking feature of
Russian bankruptcy law, and of Russian corporate law in general, is the enormous
discrepancy between laws on the book and the laws as they are enforced.2 Corporate insiders
and local governments have made use of the weakness of the courts to exploit federal tax
authorities and Moscow-based banks.3 In regions where the bankruptcy instrument is more
effective it has become the main device for corporate takeovers. Large inter-enterprise arrears
and the general expectation that this debt will never be paid made it possible for corporate
raiders to accumulate substantial blocks of shares in bankruptcy at low cost. Many of the
firms acquired in this way require substantial restructuring, but the methods used have often
been unlawful with little concern for other creditors.
1
See Robert Frank, “Fight in Bangkok: Bankruptcy Struggle At Thai Firm Shows Why Asia Still
Lags”, Wall Street Journal, Feb. 12, 2001.
2
Pistor, Raiser and Gelfer, “Law and Finance in Transition Countries,” Economics of Transition, Vol.
8, Issue 2, 2000.
3
Mogilyanski, Sonin and Zhuravskaya, “Capture of Bankruptcy: Theory and Evidence for Russia,”
CEFIR Working Paper, 2000.
3
This paper takes a look at the experience of Germany, Sweden, United Kingdom and United
States to understand the political economy of bankruptcy reform. The objective is to generate
insights useful both for transition countries, like Russia, and for developing countries
attempting to reform their bankruptcy law. We argue that legal origin, e.g., common law or
civil law, or French, German or Scandinavian law, is of limited importance in explaining the
tremendous variation of bankruptcy law across countries and, in particular, over time in
individual jurisdictions.4 Rather history shows a complex interplay between, on the one hand,
technological changes and fluctuations in the economy, and on the other, political institutions
and preferences. The growth of the large corporation and the need for large-scale investment
in the second half of the 19th century gave rise to large flows of outside finance and new,
sometimes complicated capital structures. Existing substantive legal rules and procedures
gradually became inadequate, but reform activity typically did not proceed smoothly. It was
often triggered by severe economic downturns and, in the more trade-dependent European
countries, by pressures to harmonize. In several cases, such as the French Code de Commerce
of 1807 and the German bankruptcy code of 1877, reform occurred in the aftermath of major
political changes that were far more general than the issues of bankruptcy. In these cases,
bankruptcy law was "ripe for change", but systemic inertia was probably too big for change to
occur within the existing system. In still other cases, such as the Prussian bankruptcy code of
1855, the new laws were adopted to strategically set the agenda for reform in other fields or in
other countries.
The outcomes of these reform initiatives were influenced by the prevailing political majorities
and the institutional rules in the country in question. In the formative years bankruptcy reform
was a high-profile issue with intense discussions in legislative bodies. The legislative
outcomes varied considerably across countries and over time in individual jurisdictions. As
modern bankruptcy laws took root interest groups politics became more important in
institutional fine-tuning; the law even created its own constituencies.5
We focus on the role of legislators and interest groups in shaping the agenda and affecting the
outcome of the reform process. 6 Obviously, legal thinking and case law have developed in
4
The importance of common law for financial development is emphasized by Rafael LaPorta,
Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, “Law and Finance”, Journal of
Political Economy, 106 (1998), 1113-1155. A view more similar to ours is found in Raghuram G.
Rajan and Luigi Zingales, “The Great Reversals: The Politics of Financial Development in the 20th
Century”, manuscript Graduate School of Business, University of Chicago, 2000.
5
The interest group story for the United States is developed in David A. Skeel, Debt’s Dominion,
Princeton, NL: Princeton University Press, forthcoming.
6
For an interesting analysis of the role of judges in United States and United Kingdom, see Julian
Franks and Oren Sussman, "Financial Innovations and Corporate Insolvency", manuscript London
Business School, 1999.
4
parallel and interacted with the political process. This paper does not study this development,
but the evidence suggests that the judges and courts played a secondary role in the four
countries covered. This observation is probably less surprising for countries with a civil law
tradition, but it seems to be true in the two common law countries, the United Kingdom and
the United States. In both countries, since 1800, the national legislature, Parliament and
Congress, has made the fundamental changes. Despite a common origin these two countries
have developed very different bankruptcy law traditions each with its own political dynamics.
Legislatures, after all, are responsive to constituent pressures.
The paper starts by exemplifying the tremendous variation in bankruptcy institutions across
countries and over time. We then outline some of the general lessons for reform that result
from inspection of the historical record. The current discussion of personal bankruptcy in
light of the expansion of the credit card industry in the United States is used to illustrate some
of the basic issues. In the following sections we examine the legislative history in each of our
four countries, with a focus on the second half of the 19th century. The final section draws
some conclusions for developing and transition countries.
Bankruptcy Law: Variation in Space and Time
Bankruptcy law deals with both conflicts between a debtor and his creditors, and between
creditors. Different laws are often classified as creditor-friendly or debtor-friendly but debtorcreditor orientation is only one dimension of the bankruptcy problem. A distinction must also
be made between the interests of the individual creditor and those of the creditors as a
collective. Related to this, a specific law may also be prone to liquidation, closing down firms
that should be continued, or to continuation, keeping unprofitable firms alive. A bankruptcy
law with a continuation bias is not necessarily debtor-oriented; it could also transfer assets to
investors who continue the operation even though they should liquidate. Similarly, a law
could be liquidation-prone and still favor management, for example, by allowing it to divert
assets.
Again in a different dimension, bankruptcy law must discriminate between different creditors
by providing a seniority structure and offering varying incentives for creditor involvement.
For example, a particular law may be debtor-friendly and have a continuation bias, but protect
bank creditors, while another is creditor-friendly and liquidation-prone but with a strong
protection of government and employee claims. Last, but not least, the degree of court
5
involvement is an important dimension along which bankruptcy laws have historically been
classified. An extreme view in this respect is the statement by the Austrian scholar Rudolf
Pollak, "The guiding principle of our civil law order is that everybody shall look after his own
rights: the state does not make up their minds for responsible citizens."7 On the other end of
the spectrum is a legal tradition that can be traced back at least to 17th century Spain and that
holds that free rider and coordination problems are of such overwhelming importance in
bankruptcy that only strong court involvement can lead to satisfactory outcomes.8
An important preliminary observation is that bankruptcy systems vary tremendously along
these dimensions and that various developed nations have achieved very high levels of
standards of living under very different arrangements. The following list provides some
examples:
Cross-Sectional Variation
•
Recent attempts to quantify cross-sectional variation show large differences in creditor
protection among countries, both between and among developing and developed
economies, and even within countries of the same legal tradition.9 For example, the
United States and the United Kingdom, two countries of the same legal origin, score
differently on four out of five binary measures of creditor protection. The US Bankruptcy
Code is also viewed as reorganization-prone, whereas the English Insolvency Act is often
described as having a liquidation bias. In United States banks are discouraged from
involvement, but in United Kingdom the holder of the so-called floating charge, typically
a bank, is in charge of the procedure.
•
In the United States, the norm for corporate bankruptcies is “debtor in possession”. This
not infrequently leads managers and others to be able to milk the assets of a firm in a
manner that results in creditors obtaining, in the end, less than the (present) value of
7
Rudolf Pollak, Das Concursrecht, Berlin 1897. Charles Warren (Bankruptcy in United States History.
(1935) Cambridge: Harvard University Press) provides similar views for the U.S.
8
Salgado de Samoza, Labyrinthus creditorum concurrentium ad litem per debitorem communem inter
illos causatam, 1663.
9
Rafael LaPorta, et al., “Law and Finance”, Journal of Political Economy, December 1998.
Unfortunately, these measures do not distinguish between the protection of individual creditor rights
and the rights of creditors as a collective, and they are not very precise about which creditors are more
or less protected. Moreover, the liquidation-continuation dimension is not measured.
11
See Lawrence A. Weiss, and Karen H. Wruck, “Information problems, conflicts of interest, and
asset stripping: Chapter 11’s failure in the case of Eastern Airlines” Journal of Financial Economics 48
(1998) 55-97.
6
immediate liquidation.11 Although the law allows for the possibility of a "trustee" to be
appointed, this rarely happens.12 In contrast, following the 1986 Bankruptcy Act, in the
United Kingdom, management almost automatically looses control in bankruptcy and is
replaced by either a (court appointed) "administrator" or by a (creditor appointed)
"receiver". In Germany, the 1999 Insolvency Act has unified the administration and
receivership proceedings. There, the bankruptcy court automatically appoints an outside
official ("Insolvenzverwalter") who manages the firm and is supervised by the bankruptcy
court.
•
There is a uniform system of appointing trustees in corporate bankruptcies throughout the
United States, with the notable exceptions of Alabama and North Carolina, which
retained the system used prior to 1978.13 Within the United Kingdom, Scotland and
Ireland had systems that different from that of England and Wales throughout the
nineteenth century.14 Similarly, important parts of the empire, notably Canada, India,
New Zealand, and South Africa, did not adopt the British system.15
•
American states vary enormously in the exemptions they permit to personal bankrupts.
Some states allow creditors to seize everything except modest amounts of clothing,
housing, and workmen’s tools. Others, particularly Florida and Texas, are particularly
generous and allow millions of dollars of debt to be sheltered in real estate, automobiles,
racehorses, and other assets.16 There are perennial calls for reform of this system, but
nothing has happened. The bankruptcy bars in Florida and Texas have a special interest in
protecting the status quo.
•
Despite the same legal framework there can even be tremendous regional variation in
implementation within a country, as the examples of Argentine and Russia show.17 In the
19th century, this regional variation was a feature of Swedish bankruptcy law and state
debtor-creditor law in the United States, the fallback in periods when there was no federal
bankruptcy law. On a broader scale, a study using similar but more refined measures than
the ones of LaPorta et al. (1998) shows that the countries in Eastern Europe that designed
12
See L. LoPucki, "The Debtor in Full Control: Systems Failure under Chapter 11 of the Bankruptcy
Code?", American Bankruptcy Law Journal 57 (1983), 99-126, and L. LoPucki and W. Whitford,
"Bargaining over Equity's Share in the Bankruptcy Reorganization of Large, Publicly Held
Companies", University of Pennsylvania Law Review 139 (1990), 125-196
13
See Eric A. Posner “The Political Economy of the Bankruptcy Reform Act of 1978”, Michigan Law
Review 96 (October, 1997): 47-126, p. 94.
14
See V. Markham Lester, Victorian Insolvency: Bankruptcy, Imprisonment for Debt, and Company
Winding-up in Nineteenth Century England. Oxford: Clarendon Press, 1995, p. 11.
15
Ibid., p. 296.
16
See Posner “The Political Economy of the Bankruptcy Reform Act of 1978”, and Richard Hynes,
Anup Malani, and Eric A. Posner, “The Political Economy of State Bankruptcy Exemptions”, 1999,
manuscript, the University of Chicago.
17
Mogilyanski, Sonin and Zhuravskaya, op. cit.
7
their bankruptcy laws more or less from scratch in the 1990s have opted for a broad range
of formal arrangements and with different degrees of enforcement.18
•
Also in the 19th century, countries of similar legal traditions and geographic proximity
have adopted widely differing bankruptcy codes. A striking example is provided by
Austria and Prussia who adopted their bankruptcy codes in 1868 and 1855, respectively.
The Austrian code was widely regarded as highly creditor-friendly with little involvement
by courts; the Prussian code gave a greater role to the courts and was less creditorfriendly. One of the reasons for this differentiation was that law makers in both countries
faced different types of business interests and were influenced by different legal traditions
in their work: ancient Italian statuary law in Austria and the French civil law in Prussia.19
These examples are instructive from the viewpoint of policy reform. The persistence of
internal variations suggests that it may not be necessary, or even desirable, to impose
uniformity on the member states of regional economic alliances, such as the EU or the
economies of the southern cone of South America. On the other hand, many variations in the
history of bankruptcy legislation also have had an experimental nature and were replaced by
more appropriate laws when the political environment permitted this. This explains part of the
variation across time in legislation, to which we turn now.
Time-Series Variation Within a Jurisdiction
Bankruptcy law also exhibits tremendous variation across time. Sweden is an example of a
country with a bankruptcy law influenced by old German and Saxon law that undertook
significant reforms inspired by the Napoleonic code during the 19th century. Also some
German states and even England took on many of the features of the French bankruptcy
procedures. At the same time, other German states, stayed with their traditional legislation.
However, the primary example of intertemporal variation within a jurisdiction is probably the
United States.
•
In 1800, the United States adopted a bankruptcy act modeled on the English Statute of
Anne. Yet, the Bankruptcy Act of 1898 was in substance and procedure almost
diametrically opposed to that of the England. The various bankruptcy acts passed during
18
Pistor, Raiser and Gelfer, op.cit.
See Anton Rintelen, Handbuch des österreichischen Konkurs-und Ausgleichsrechts, München,
Leipzig, 1915, Jürgen Thieme, "Zur Entstehung der Konkursordnung", in W. Uhlenbruck, B.
Klasmeyer, B. Kübler (eds.), Einhundert Jahre Konkursordnung, Köln, 1977, 35-69, Jürgen Kohler,
Lehrbuch des Konkursrechts, Stuttgart 1891
19
8
the 19th century spanned a wide spectrum in terms of debtor-creditor orientation,
liquidation bias and relative treatment of different creditors.
•
Both before and after the passage of a permanent national bankruptcy law in 1898,
reorganization of major corporations (as against small firms and personal bankruptcies)
were typically pre-packaged negotiations run by a major private creditor or investment
banker, such as J. P. Morgan. The courts then ratified the negotiations. When major
reform legislation was passed in the late 1930s, the Securities and Exchange Commission
was given an active seat at the table for the bankruptcy of any publicly held firm. The
result was a virtual dearth of observed bankruptcies. Debtors and some creditors found
they had an interest in making arrangements, in anticipation of bankruptcy that would
keep the S.E.C. out of the picture. Over the next 40 years, private players became adept
at exploiting unintended loopholes in the legislation. The role of the S.E.C. was gradually
diminished. Finally, in 1978, managers emerged triumphant. The S.E.C. was totally
eliminated; the modern Chapter 11, with debtor-in-possession was instituted.20 With the
S.E.C. out of the picture, managers found it useful to use the courts as a weapon in
dealing with creditors and used Chapter 11 bankruptcies strategically.
•
Over time, personal bankruptcy in the United States became increasingly pro-debtor. The
1978 bankruptcy code retained a complete discharge in Chapter 7. All debts are written
off; the debtor keeps “exempt” assets and gets a “fresh start”; but the ability to borrow is
severely restricted for a period of 7 years. (N.b. Credit bureaus in the U.S. must, by law,
delete all negative credit information that goes back more than 7 years.) The alternative,
Chapter 13, allows the debtor to keep more assets in return for establishing a schedule for
partial repayment. In 1978, access to Chapter 13, particularly with regard to fraudulent
debtors, was made sweeter for debtors. The choice between 7 and 13 became a strategic
choice for the debtor.21 There is now pressure, largely from issuers of credit cards, to
change this system. Chapter 7 would be removed as an option for debtors whose income
or assets exceeded levels fixed by law. These debtors would be pushed into chapter 13
where creditors obtain rights to a portion of the future income streams of debtors.22
Germany, on the other hand, is an example of extreme inertia in the reform of a law with
considerable merits, but also widely noted flaws. The German bankruptcy code of 1877 was
widely praised as a major piece of legislation, characterized by consistency, clarity, and
practicability. On the other hand, important flaws such as the absence of a reorganization
procedure or the destructive role of net-worth standards for the opening of bankruptcy
procedures had been criticized for more than a century without substantial reform occurring.
20
21
This paragraph has relied heavily on Skeel, Debt’s Dominion.
Skeel, Debt’s Dominion.
9
Decades of attempts at reform only succeeded in 1999 when the code was replaced by the
new Insolvency Code. Part of this inertia may be due to the nature of legislation in the civil
law tradition. While in the U.S. runs of trial and error in the courts often precede changes in
legislation, the civil law tradition with its intricate codifications lends itself less to piecemeal
change. A telling illustration is the following quote by the eminent German bankruptcy
scholar Ernst Jaeger during the height of the debate about reform of the German bankruptcy
code in the Weimar republic: "All tampering with the fine structure of the masterpiece, which
the bankruptcy act undoubtedly is, must be pondered with utmost care. It is easy to bungle,
but difficult to improve."23
Efficiency, Redistribution, Credit Markets, and Economic
Growth: Where Does Bankruptcy Law Fit In?
Economic Efficiency vs. Redistribution
Different levels of economic development can explain some of the time-series variation. In
agrarian societies the main form of lending is from rich to poor farmers. Even though poor
farmers often have little influence over legislation and the development of practices, it is in
their interest to find ways to credibly commit to pay back their debts. Much of early
bankruptcy-type laws and practices are trying to discourage moral hazard by poor farmers,
typically by preventing transfers of assets prior to default and imposing harsh penalties in
case of default. In these agrarian societies the ultimate threat to poor farmers was to surrender
whatever independence they enjoyed to serfdom. But this punishment had dubious effects in
that servitude undermined the farmer’s incentives. Moreover, with the political mobilization
of poor farmers such punishments became more difficult to enforce.
The real push for bankruptcy reform came from the merchant class where servitude typically
was not an option and where mobility of assets and human capital could be considerable.
Debtor prison was an extreme, but commonly used, form of punishment in these situations.
But debtor prison was also inefficient in that the debtor could not generate much cash flow
when in prison, and he could not provide for his family who instead easily became a burden
22
N.b. A bankruptcy lawyer has been heard advertising, on WCBS radio, New York, urging
consumers to file for Chapter 7 before the law is changed.
10
for the local community. In addition, the trading economy was very vulnerable to various
shocks. Social norms came to recognize that default often was not strategic but caused by
forces beyond the control of the individual creditor. Much of the bankruptcy legislation at the
time was about distinguishing between cases where the debtor was at fault and where he was
not. Behind this concern about fairness were also the efficiency costs of discouraging
entrepreneurial activity.
With the advent of the large corporation and modern banking the concern for the individual
debtor had to give way for the interest of the financial system as whole. Generous exemptions
and ex post softness on individual debtors undermined credit markets. When firms had many
creditors the old bankruptcy procedures with separate treatment of each claim became
unwieldy. Efforts were made to speed up the procedure to bring down the cost of distress. But
multiple creditors also gave rise to conflicts between creditors. These conflicts opened up new
opportunities for debtors to commit, e.g., by exposing themselves to creditor runs for assets
and by distorting incentives of individual creditors, the old procedures also allowed the debtor
to play out creditors against each other. Bankruptcy legislation came to focus on the tradeoff
between the incentives of individual creditors, e.g., to run for assets, and those of the creditors
as a collective to preserve the value of all the assets. Bankruptcy law, through the provision of
composition of the rights of creditors, moderates the incentive of individual creditors to start a
run on the assets of the firm. In addition, multiple creditors could undermine the incentives of
individual creditors to monitor an insolvent debtor and tempt large creditors to exploit smaller
ones. Bankruptcy law inserts governmental control both to mitigate free riding and to insure
adequate representation of the interests of small creditors.24
Why then, given the universal efficiency tradeoffs, is there so much variation, particularly
cross-sectionally? An obvious answer is that differences among the variants may not be all
that important for economic growth. If the law is close to the optimum with respect to overall
growth, tilting, to oversimplify, in a pro-debtor or pro-creditor direction may have only
second-order efficiency consequences but first-order consequences with respect to
redistribution between creditors and debtors. It is not obvious what the broader effects on the
distribution of wealth would be of redistributing from debtors to creditor; most people are
both debtors and creditors in the economy and the likelihood of being one or the other may
23
Proceedings of the 1. International Congress for Creditor Protection, Vienna 1930, p. 195 (our
translation), cited (approvingly) in W. Uhlenbruck, "Einhundert Jahre Konkursordnung", in
Uhlenbruck et al., Einhundert Jahre, 3-34.
24
The free-rider problem was important to 19th century French procedures and their adoption by
England. See Lester, Victorian Insolvency. Small creditor protection was a primary motivation for
changes in the United States in the 1930s. See Skeel, Debt’s Dominion.
11
change over an individual’s lifecycle. However, in general poor people should be less likely
to become creditors. In addition, economically poor people may also be poor in terms of
political and social capital. The framers of laws often attempt to take this into account
To make the discussion concrete, consider the current debate about personal bankruptcy law
in the United States. Those favoring tightening, the credit card issues, will see lower loan
losses. They need government intervention for two reasons. First, computerized screening of
credit applications is imperfect. Second, it is particularly imperfect with respect to the young
who have no credit histories, and issuers, in search of future market share, lend rather blindly
to the young. The bottom line is that the development of a new financial technology, the
mass credit card industry, has generated a demand for a change in bankruptcy proceedings.
The major consequences of such a change are likely to be at least as much distributional as
efficiency-related. The changes in the law might lower strategic personal bankruptcies. Were
there sufficient competition in the consumer loan industry, consumer loan rates might fall
without an increase in industry profits. But the very fact that there is intense industry
lobbying suggests that the industry expects an increase in profits. Thus, there would be some
redistribution from consumers who “take the money and run” to lenders. More importantly,
credit card loans are frequently used to fund risky, small startup businesses.25 If, say, an
independent software developer knows that, if he fails, a share of his future earnings as a
Microsoft employee will go to a past lender, he will be less likely to initiate the startup. Thus,
the efficiency gains from reducing the number of “take the money and run” consumers can
potentially be lost by eliminating risk-taking in the economy. The net effect will be a transfer
away from both small entrepreneurs and profligate spenders to lenders, on the one hand, and,
on the other, to non-strategic consumers who do not default.
Because bankruptcy law has such sharp distributional consequences, the development of
bankruptcy law will be inherently political. The credit card industry in the United States is
almost unanimously supported by Republican members of Congress and by a number of
Democrats, many of who receive campaign contributions from the industry. Only relatively
liberal Democrats, consumer activists, the bankruptcy bar, and President Clinton opposed this
change in the law in the nineties. The law is more likely to be changed with the election of a
Republican president. If the law is changed, it is likely to remain in effect for a very long
time because it is very difficult to change the status quo in the United States. What historical
evidence suggests would be required would be unified control of the Presidency and both
12
Houses of Congress by the Democrats combined with circumstances where consumer groups
and the bankruptcy bar was able to exert more political pressure than the credit card industry.
Economic Efficiency vs. Administrative Efficiency
An important issue in developing bankruptcy law surrounds the possible opportunities for
corruption, misinterpretation of the law, and excessive administrative costs once matters enter
the courts. That the bankruptcy bar opposes the changes proposed by the credit card industry
almost certainly reflects less the bar’s view of the public interest than an expectation that
strategic bankruptcy filings, hence, fees will be reduced. On the other hand, for those
bankruptcy cases that do reach the courts, additional costs, will be incurred. Resources will
be expended in litigation over whether the bankrupt continues to qualify for Chapter 7 or will
be forced into the new procedure. “Robin Hood” judges, likely to be Democratic appointees,
will tend to side with debtors who claim they are entitled to Chapter 7 while other judges,
likely to be Republican appointees, will tend to side with creditors.
American experience has routinely been one where governmental regulation of business
failures has been exorbitantly costly. Charles Warren indicates that creditors recovered only
10 cents on a dollar in bankruptcy proceedings during the brief duration of the 1841 Bankrupt
Act.26 Edward Balleisen describes in detail how the procedure was exploited by collusions
involving debtors, friendly creditors, and bankruptcy judges, many of whom were former
bankrupts.27 Warren also indicates dissatisfaction with the administrative costs of the 1867
Act. The 1898 Act only partially remedied these earlier failures. In particular, state courts,
largely friendly to local debtors, were the designated venue for claims of fraudulent
conveyance until the 1920s.28 The system where federal bankruptcy judges had discretion to
appoint local cronies as bankruptcy trustees continued in most jurisdictions until 1986.29
Even today, federal bankruptcy judges (typically appointed only with the approbation of a
state’s members of the United States Senate) are likely to favor the managers of local firms
who file in their jurisdiction over creditors from outside the area.30 Localism is one reason
25
White, Michelle, 1997, ``Personal Bankruptcy and Credit Supply and Demand'' with J. Karl Scholz
and Reint Gropp. Quarterly Journal of Economics, v. CXII, pp. 217-252.
26
Charles Warren. Bankruptcy in United States History.
27
Edward J. Balleisen, Edward “Vulture Capitalism in Antebellum American: The 1841 Federal
Bankruptcy Act and the Exploitation of Financial Distress”. Business History Review, 70 (Winter,
1996): 473-516.
28
Skeel, Debt’s Dominion.
29
Posner, “The Political Economy of the Bankruptcy Reform Act”, p. 93.
30
Localism pertains even to Fortune 500 companies. For example, we have anecdotal reports that
Philadelphia creditors did poorly in the Federal district court in Pittsburgh in proceedings against
Allegheny Ludlum, a Pittsburgh steel firm.
13
why judges, moreover, may have a continuation bias when prompt liquidation would be better
policy.31
Furthermore, the efficiency and the bias of the court system will vary regionally. That has
almost certainly been the case in the United States, with the more “Populist” West and South
historically having been more debtor friendly than the more creditor friendly Northeast. This
pattern reappears in Argentina where there is enormous variation in enforcement across
provinces.33.
Historically, administrative inefficiency was also a dominant theme in Europe. The old
German bankruptcy principles, pervasive in Europe prior to the Code Napoleon and lasting in
Sweden and Germany until the second half of the 19th century, were exceedingly slow in
cases that involved many creditors.34 This slowness was mentioned as an advantage during
the crisis of 1857 in that it prevented excessive liquidations, but on the whole the
cumbersome nature of the process was very costly for creditors as a collective and ultimately
for debtors. An important element of the French legal influence during this period was to
speed up the bankruptcy procedure and make the management of assets more efficient during
the process.
Even the purportedly better run British system was not without its costs. In the 1850s, British
creditors were doing better than their American counterparts in 1841 but still only recovering
less than 50% of the assets from cases that went to bankruptcy; the remainder was eaten by
administrative costs.35 Inefficiency of the court system does have one benefit; creditors and
debtors have incentives to settle privately.
The preceding discussion of administrative efficiency contains substantial policy lessons. Not
much can be expected of legislated reforms in bankruptcy matters unless the courts and the
bureaucracy are likely to implement these reforms faithfully. Given the long experience of
31
Weiss and Wruck, “Information Problems”.
Papers dealing with Argentina and other nations in Latin America will appear in Marco Pagano, ed.,
Preventing Default: Incentives and Institutions. Baltimore: Johns Hopkins University Press for the
InterAmerican Development Bank, forthcoming.
34
An eloquent description of the inefficiency and slowness of these procedure is given by Kohler,
Lehrbuch (p. 44): "the long-windedness, the abundance of normal difficulties, the bureaucratic
procedures of the administrators, the disgrace, which made the best creditors, those with liens and
mortgages, wait for years for some payment … Years passed until the creditors achieved their often
miserable goal."
35
Lester, Victorian Insolvency, p. 77.
33
14
the United States and even England, an experience that extends into the present, such
expectations may be wishful thinking for much of the Third World. It may be more
productive to think of procedures that will structure incentives for debtors and creditors to be
able to rely on private, non-governmental mechanisms of enforcement of contracts.
Perversely, the lack of a reputable public sector may be a boon to the development of private
capitalism. The development of Anglo-American investment banks such as Drexel Morgan
and Brown Shipley may have been stimulated by the lack of credibility of debts incurred by
U.S. governments and the inefficiency of the court system for dealing with private debt.36
Bankruptcy During Economic Crises: The Case for Moratoria in the
Event of Administrative Overload
Assume that the above problems of court inefficiency can be solved and that bankruptcy
courts can be made to function in a “fair and unbiased” manner. Presumably the role of the
court would be to determine if a firm is viable once its nominal debt overhang has been
removed and that its assets are worth more as a unit than if liquidated. In the contrary case,
the firm would be liquidated (perhaps by selling all the assets as a unit) with creditors
receiving their “fair” shares.
In essence, the role of the court is to determine whether the bankruptcy is the result of “bad
luck” in the short-term or more systematic factors. When there is a downturn in the economy,
most notably a severe macroeconomic crisis, there is likely to be an increase in the proportion
of firms that are likely to face bankruptcy purely as a matter of bad luck. At the same time,
formal bankruptcy courts are apt to be deluged by cases. Their ability to make a fair and
timely determination is likely to be severely impaired.
Aghion, Hart, and Moore have proposed an auction like process for dealing with bankruptcy.
An advantage of their procedure is that it places the responsibility for information acquisition
with the creditors—who may have much information and can elect, via their bids, to maintain
the firm as a going concern—rather than the courts. 37 But even the creditors will be
36
The point for the lack of credibility of public borrowing is made by Lance Davis and Robert
Gallman, “Lessons from the Past: Capital Imports and the Evolution of Domestic Capital Markets,
1870-1914. Manuscript, Pasadena, CA. School of Humanities and Social Sciences, California Institute
of Technology, 1999.
37
See Phillipe Aghion, Phillipe, Oliver Hart and John Moore. “The Economics of Bankruptcy
Reform”, Journal of Law, Economics and Organization 8 (1992), 523-546. An additional problem
15
overloaded in a crisis. Consider, for example, a pension fund holding industrial bonds in
hundreds or thousands of firms. Moreover, the liquidation of many assets nearly
simultaneously may unrealistically depress prices.
An alternative to bankruptcy procedures on a firm-by-firm or individual-by-individual basis is
economy-wide debt moratoria or bailouts. These have the disadvantage of inducing strategic
default by debtors in fact able to repay but the advantage of eliminating the costs (including
corruption) of administration of defaulted firms and the costs of acquisition of firm-specific
information. Another, major, advantage of sector or economy-wide moratoria in bad times is
that the proportion of firms that are failing simply as a matter of bad luck is much greater than
in normal times.
Moratoria have been widely used in American history, particularly in the period of wide
economic swings that persisted from independence in 1776 until the mid-nineteenth century.
State governments enacted most of the moratoria. The federal government wrote off a large
portion of its loans for purchases of land following the Panic of 1819.38 Even the bankruptcy
laws in this period were, in practice, more like moratoria than like firm procedures for the
disposition of assets of economic failures. The 1800, 1841, and 1867 laws were enacted in
response to economic crises (the panics of 1797 and 1837 and the dislocations of the Civil
War) and fully repealed within 3, 1, and 11 years respectively. Thus, in practice, the laws
were a mechanism to write off the downturns.39
In the twentieth century, moratoria on farm mortgages were instituted by 21 states during the
Great Depression.40 Furthermore, the Roosevelt administration reduced, by 31%, the real
value of almost all corporate debt by coupling a devaluation of the dollar against gold with
the ex post voiding of gold clauses in private debt contracts.41 Moratoria on farm mortgages
were again actively proposed, but not enacted, during the severe recession of 1981-82. One
can safely predict that political pressures for debt forgiveness would arise were the United
with this procedure is that creditors who are owed only small amounts may find it costly to monitor a
bankrupt firm. This problem has been recognized in debates over bankruptcy law since at least the
early 1800s. See Lester, op. cit., p. 33.
38
The literature on this period is summarized in Patrick Bolton and Howard Rosenthal, “The Political
Economy of Debt Moratoriums, Bailouts and Bankruptcy” in Pagano, Preventing Default.
39
The early bankruptcy laws are discussed in more detail in Erik Berglöf and Howard Rosenthal “The
Political Economy of American Bankruptcy: The Evidence from Roll Call Voting, 1800-1978”, paper
presented at the UFA meeting, Frankfurt, Nov. 2000
40
See Lee Alston, “Farm Foreclosure Moratorium Legislation: A Lesson from the Past. American
Economic Review, 74 (March, 1983): 445-57.
41
See Randall S. Kroszner, 1999. “Is It Better to Forgive than to Receive? Repudiation of the Gold
Indexation Clause in Long-Term Debt During the Great Depression”, working paper, Chicago,
University of Chicago.
16
States to enter a recession more severe than that of 1981-82, even in a dip less severe than the
Great Depression. These pressures are likely to be turned into legislation if the voters shift
support massively to the Democrats, as happened in the Great Depression.
Our discussion of moratoria in macroeconomic crises leads to a policy recommendation.
Bankruptcy law should perhaps not be written in a manner that removes all flexibility for the
government to recognize macroeconomic circumstances as well as the circumstances of the
firm. U.S. law is not written in this manner, but the political system does intervene, ex post,
in debt contracts during crises. It might pay to consider mechanisms that make such
intervention more predictable and systematic, an “indexing” if you will, of bankruptcy law.
Interest Groups, Ideology, and the Evolution of Bankruptcy
Law
When does bankruptcy law change in a democracy? When are reforms instituted? The
historical record indicates a mixture of forces that reflect political ideologies, interest group
pressures, and politicians seeking support from both the mass electorate and campaign
contributors. In essence, beliefs, money, and votes determine policy.
The United States: Overview
The legislative history of federal bankruptcy law in the United States provides an interesting
example of how institutions evolve. The U.S. Bankruptcy Act of 1800 was a direct copy from
the Statute of Anne in English law. The Act was repealed three years later by Congress, and it
took a century of severe financial crises, intense political strife and six major reform attempts
to get a lasting bankruptcy law. This law, the Bankruptcy Act of 1898, was in the three central
dimensions of debtor-creditor law an opposite of English law. While English insolvency law
was creditor-oriented with a particularly favorable treatment of banks and potential
liquidation bias, the U.S. act was debtor-friendly and reorganization prone with a strong bias
against banks.
The evolution of the law can be traced through the legislative history. All attempts to put in
place a federal bankruptcy law came in periods of severe downturns in the economy. These
attempts were only successful when conservative interests controlled both houses of Congress
and the Presidency. The bankruptcy legislation was thus shaped in an interaction of economic
conditions, institutional rules and political preferences. In parallel, legal thinking evolved
17
through case law in state courts and in the legal profession. All these factors contributed to the
evolution of a lasting law. During the 20th century there has been several bankruptcy reforms
but no genuine challenge to the need for a federal bankruptcy law. From having been one of
the most controversial and visible issues of 19th century U.S. politics bankruptcy legislation
moved into the less visible world of lobbying.
The United States: Sources of Political Support and Ideological
Opposition
In the eighteenth and nineteenth centuries, the core support for a national bankruptcy law
came from commercial interests in the Northeast. The adoption of the law became a national
partisan issue with the main party of the right, first Federalists, then Whigs, and later
Republicans favoring a national law and the main party of the left, first Jeffersonian
Republicans and then Jacksonian Democrats, opposing one.
Opposition to a federal role before the Civil War was perhaps not predominantly a matter of
whether bankruptcy procedures should tilt toward debtors or creditors. After the Panic of
1819 state legislatures controlled by the Democrats stayed debts only on the frontier and not
in the conservative states on the Atlantic coast. Where the Democrats were more united was
in a more basic ideological opposition to a larger federal role, an opposition undoubtedly
strengthened by the conflict over slavery.
After the Civil War, opposition appeared to reflect Populist concerns that federal bankruptcy
institutions would be manipulated by capital interests in the Northeast. The populist
opposition to bankruptcy was part of a broader ideological economic package that included
fostering railroad regulation and antitrust laws and barring or regulating trading in
commodities futures.42 Because bankruptcy law was part of a much larger economic debate,
it remained a visible, partisan issue subject to important roll call votes on the floor of
Congress.
42
On the various elements of Populist economics, see Mark Roe, Strong managers, weak owners: the
political roots of American corporate finance. (1994) Princeton, N.J.: Princeton University Press; Keith
T. Poole and Howard Rosenthal. “The Enduring Nineteenth Century Battle for Economic Regulation:
The Interstate Commerce Act Revisited”. Journal of Law and Economics, 36 (1993): 837-60; idem.
“Congress and Railroad Regulation: 1874-1887”. In Claudia Goldin and Gary Libecapp, eds., The
Regulated Economy. (1994) Chicago: University of Chicago Press. Roberta Romano “The Political
Dynamics of Derivative Securities Regulation”. Yale Journal of Regulation, 14 (1997): 279-406.
18
The United States: Interest Groups and the Evolution of the Law
Bankruptcy law became permanent in the United States in 1898. Business associations began
pushing for a new federal law in 1890. Hansen views the development of national
organizations uniting local groups of trade creditors as fundamental to providing an interest
group strong enough to bring about legislation.43 But it is important to note that interest
group pressure, if effective at all, was effective only after the Panic of 1893 created an
economic crisis and the Republicans took unified control of the executive and legislative
branches of government following the elections of 1896. Econometric analysis indeed
suggests that, after controlling for ideology and partisanship, support for a relatively strong
federal law was more linked to the presence of a banking center in a congressional district
than to the presence of trade creditor groups.44
One consequence of having a permanent law is that permanency created interest groups with
a vested interest in maintaining and shaping the federal law. One such group is represented
by bankruptcy judges, interested in increasing their prestige, compensation, and tenure in
office to match that of other federal judges.45 Even more important is the bankruptcy bar,
those lawyers specializing in bankruptcies. The development of a powerful national lobby
was particularly fostered by the reforms of the 1930s that made it illegal for a law firm that
had represented a firm in investment banking operations to represent the firm in bankruptcy.
This removed the Wall Street bar from bankruptcy proceedings for many years. The 30s were
also marked by Democratic dominance of Congress, a dominance broken only in 1994. The
bar developed a special lobbying relationship with the congressional majority, a relationship
that moved corporate bankruptcy toward a continuation bias favorable to managers of
publicly held corporations.46
The corporate bankruptcy status quo remains unchallenged. The status quo of consumer
bankruptcy is being challenged as the result of a vast increase in the number of consumer
bankruptcies, the revolution in consumer banking, including credit cards, engendering a
lobbying counterweight to the bankruptcy bar, and the Republican hold on Congress for the
past four congressional elections.
43
Bradley Hansen. “Commercial Associations and the Creation of a National Economy: The Demand
for a Federal Bankruptcy Law”. Business History Review, 72 (Spring, 1996): 86-113.
44
Berglöf and Rosenthal, “The Political Economy of American Bankruptcy”.
45
Posner, “The Political Economy of the Bankruptcy Reform Act”.
46
Skeel, Debt’s Dominion.
19
The United States: Regulatory Capture
The United States experience represents a lesson for policy reform elsewhere. Any new
legislation creates institutions subject to what George Stigler long ago identified as regulatory
capture.47 We have seen that the bankruptcy bar had a disproportionate influence on
congressional committees responsible for shaping bankruptcy legislation. Under the guise of
advocacy of the public interest, they succeeded in shaping legislation in a manner that was
likely to increase their fees. There is now a countervailing lobby represented by issuers of
credit cards. While economists do not have a well worked out model that predicts which
interest groups triumph,48 one can say that interest groups, through understandable selfinterest, seek to generate distortions that confer rents.
It might be argued that the distortions are particularly prevalent in the United States as the
result of the lack of any public funding of political campaigns and the lack of effective
constraints on corporate and personal contributions. But as major scandals in Germany, Italy,
France, and Belgium in recent years indicate, money inevitably talks in democracies. Those
with concentrated interests are likely to impose distortions. Consequently, authors of reform
packages that “look good on paper” should be aware of the potential for interested parties to
distort the operation of new institutions.
Reformers should also note that distortions could arise from outside the business community.
The Chamber of Commerce proposal in 1898, known as the Torrey Bill, probably represented
something close to what the IMF or the World Bank might regard as a decent reform for a
developing nation today. But, in order to obtain a passable political compromise, the stronger
provisions for involuntary bankruptcy were gutted, and states were allowed to continue to set
exemptions and priorities and to handle fraudulent conveyance claims.49 Reform turned out
to be half a loaf.
47
George J. Stigler, “The theory of economic regulation." Bell Journal of Economics and
Management Science, 2 (1971): 3-21.
48
Indeed, as Randall S. Kroszner and Thomas Stratmann Kroszner have shown for banking, interest
groups may counterbalance one another, leading to vetoes of any change from the status quo. Kroszner
and Stratmann, “Interest group Competition and the Organization of Congress: Theory and Evidence
from Financial Services Political Action Committees”, American Economic Review, 88 (Dec. 1998),
1163-87.
49
Skeel, Debt’s Dominion.
20
England and Wales: A Contrast
As stated previously, in 1800 the United States and Britain had very similar bankruptcy
proceedings. By 1893, Britain had developed the basic structure of its modern system. The
United States passed its very stable national law in 1898. The two systems that have resulted
are strikingly different. Important differences include:
•
In the United Kingdom it is often argued that insolvency law until the reform in 1986 was
purely based on case law. The law evolved through consecutive decisions by judges
adjudicating in specific cases. More recently, Lester has argued that the dominance of
case law occurred prior to Parliament assuming an active role in 1831. Subsequently,
bankruptcy law constitutes an exception to the common law tradition. The legislative
process, through statutes, was dominant, particularly with regard to the administrative
role of the government. 50. On the other hand, Parliament was mainly concerned with
technical perfection of the bankruptcy system. At least prior to 1831, bankruptcy was
never a partisan issue.51 The 1861 bill, however, became a highly partisan issue and
engendered substantial Tory opposition.52 The 1883 bill was debated for over 5 months.53
The Insolvency Code of 1985 was adopted without much public debate, but after intense
lobbying from strong interest groups.54
•
Corporate bankruptcy law is termed “company winding-up law”. The phrase alone
conveys the opposite of the continuation bias of debtor-in-possession in the United
States.55
•
Personal bankruptcy law in England formed the template for corporate bankruptcy law.
“After 1893 the two systems were virtually identical.”56 In the United States, major
corporate bankruptcies have always been handled by their own regime. Initially, by
reorganizations organized by investment bankers, later under threat of SEC intervention,
and today largely under Chapter 11.
•
The United States is more debtor-friendly. A very important distinction is that in the
United States (and Canada) wage earners and farmers are not subject to involuntary
50
Lester, Victorian Insolvency, p. 8.
Ibid., p. 37. On the other hand, Lester does mention several close roll call votes on bankruptcy
provisions (e.g., p. 66, p. 210) and indicates that abolition of debtor’s prisons was a lively political
issue, with the business community being adamantly opposed (op. cit., pp. 110-111). The Lester
volume unfortunately has minimal coverage of the parliamentary politics of changes in statutes.
52
Ibid. p. 140.
53
Ibid. p. 200.
54
Bruce G. Carruthers and Terrence C. Halliday, Rescuing Business: The Making of Corporate
Bankruptcy Law in England and the United States, 1998, Oxford, Clarendon Press, p. 527.
55
Lester, Victorian Insolvency. p. 1.
56
Ibid. p. 1.
51
21
bankruptcy. In contrast, the thrust of British bankruptcy law was entirely to protect
creditors from fraud. (Bankruptcy fraud was once even subject to the death penalty.57)
Even the concept of discharge, introduced in 1705, was motivated by the aim of
encouraging debtors to cooperate in repaying creditors.58 The idea of encouraging risktaking by debtors was absent from the debate.59 In particular, while imprisonment for debt
in the United States largely disappeared by the 1830s, it was formally abolished in
England only in 1869. But small debtors could continue to be imprisoned for up to six
weeks. The prison regimen was even made harsher in 1899. In 1929, there were still
3,594 imprisoned debtors. Full abolition by Parliament occurred only in 1970.60 England
appears to be relatively unique in its harsh treatment of small debtors. By 1894, there was
no imprisonment for debt not only in the United States but also in France, Belgium,
Switzerland, Norway, Italy, and Scotland.61
•
From 1833 to 1985, with a brief interruption from 1869 to 1883, government bureaucrats,
and not trustees/assignees appointed by bankruptcy judges or by creditors, supervised
bankrupt estates that were not wound up voluntarily.62 After 1883, the assignment of
trustees was made not by a court but by an administrative agency, the Board of Trade.
The BOT could approve a creditor nominated trustee or assign its own appointee. The
innovation was copied from France. (Also copied was a procedure for placing liquid
assets into a government account that generated revenue for the BOT bureaucracy.
Private country banks that previously held these accounts, not surprisingly, opposed this
procedure.)63 The major motivation for this system was the problem of free riding among
creditors. It was felt, as Smith and Ricardo had argued, that no single creditor would give
sufficient attention to managing the bankrupt firm. The Bankruptcy Department of the
Board of Trade was, in the 1890s, both in budget and employees, one of the largest
operations of the British government.
It should be noted that the business community was not supportive of this aspect of the
system, and that the 1831 Bankruptcy bill was a Whig creation, opposed by Tories.
57
Ibid. p. 30.
Ibid. p. 17.
59
Ibid. p. 3.
60
Ibid. pp. 116-120. The fact that only small debtors could be jailed responds to the concept that credit
markets for the poor can be maintained only if the poor are threatened with some disutility that cannot
be imposed by seizure of assets. See Lester, Victorian Insolvency, p. 101.
61
Ibid. p. 121.
62
Lester, Victorian Insolvency, is not very explicit on the changes in 1985 and 1986, but they seem to
have shifted power over trustees from the government to creditors, a not unexpected change for the
Thatcher years.
63
Ibid. pp. 195, 205.
58
22
Opponents of the bill pointed to the possibilities for patronage in the creation of a full
time government bureaucracy.64
Experience with creditor control after passage of the 1869 Act was negative. The freerider problem, information-gathering problem, and debtor-creditor collusion problem
appeared to generate greater costs than those engendered by bureaucracy.65 Pessimism
grew about having a bankruptcy system that would be preferable to use of common law
suits. A vocal minority went so far as to urge that England follow the lead set by the
United States in 1879 and abolish bankruptcy law altogether.66
The system adopted in 1883 appears to have been stable in part because it was judged to
have been relatively successful, returning more to creditors than the system in the United
States. Gains were believed to be particularly important in eliminating free riding of
creditors in bankruptcies of small firms.67
•
During a period when the United States largely did not have a bankruptcy law, Parliament
devoted continual attention to perfecting or altering bankruptcy law. Between 1831 and
1914, Parliament passed over 30 bankruptcy acts.68 In fact, the tradition of a national
bankruptcy law in Britain begins with the Act of 1543, which provided for rateable
distribution of assets among creditors. The procedure comes from Roman law; the
multiple creditor problem is ageless.
•
Capture of the legislative process by business interests, particularly from the late 1850s
onward and particularly from large rather than small firms, appears more pronounced in
Britain than in the United States. This capture does much to explain the pro-creditor
orientation of British law. Business interests succeeded in having assignees shifted from
the bureaucracy to creditors.69 Business interests also appear to have organized into
Chambers of Commerce at an earlier date in the United States. The Chambers of
Commerce were a major lobby for the 1861 Bankruptcy Act.70 Their major objective was
to transfer administration of a bankrupt case entirely to creditors, as in Scotland. They
claimed that estate management in Scotland consumer only about 12.5% of assets as
against 30% in England. (The veracity of the comparison is subject to considerable
64
Ibid. pp. 1-2, 5, 47, 59.
Ibid. p. 172.
66
Ibid. p. 184.
67
Ibid. pp. 290-294.
68
Ibid. p. 2.
69
Ibid. p. 124. Similarly, the reforms of the 1980s, in contrast to the US, strengthened secured
creditors and trade creditors at the expense of managers, consumers, and unsecured creditors. See
Carruthers and Halliday, Rescuing Business, p. 525.
70
Ibid. p. 133.
65
23
debate.) 71 Banking interests also appeared to organize earlier than in the United States;
they supported the return to a bureaucratic system in 1883.72
•
Important nineteenth century legislation was passed, most notably in 1869, at the height
of a business cycle and not, as in the US, only after downturns. Consistent with the
hypothesis of Domowitz and Tamer, the legislation moved in a direction sought by
creditors.73
•
Accountants and civil servants, as well as lawyers, represented major professional interest
groups with an impact on legislation.74
•
The Bankruptcy Act of 1883 was a template for many other nations and colonies,
including Australia, Hong Kong, Mauritius, Jamaica, Trinidad and Tobago, Barbados,
Nyasaland, Cyprus, Kenya, Uganda, and Fiji.75
Britain and the United States—Some Common Themes
The distinctions between the United States and Britain should not obscure some common
historical developments:
•
The United States law of 1800 was very similar to British law of the time. Both applied
only to “traders”, both had only involuntary bankruptcy, and both provided for discharge.
•
The evolution to voluntary bankruptcy occurred at roughly the same time. Voluntary
bankruptcy, with the assent of at least one friendly creditor, was permitted in England and
Wales in 1825.76 Voluntary bankruptcy appears in the United States law of 1841.77
•
Specialized court systems were established for bankruptcy cases in both systems. The
British bankruptcy court began in 1831 (but appears to have lapsed for a period starting in
1847).78 This observation leads to an important policy recommendation. Such
specialized courts would be desirable in many nations where they currently do not exist.
•
Similarly, bankruptcy is extended from traders to other insolvents in both nations in the
mid 1800s, in the United States in 1841 and in Britain in 1861.79
•
In both nations, discharge is not available to certain “immoral” acts that lead to
bankruptcy. In England, gambling debts were so treated in the 1842 Act.80 In the United
71
Ibid. pp. 149-150.
Ibid. p. 200.
73
See Ian Domowitz and Elie Tamer, “Two Hundred Years of Bankruptcy: A Tale of Legislation and
Economic Fluctuations,” (1997) mimeo., Evanston, IL. Northwestern University.
74
Lester, Victorian Insolvency pp. 6, 10.
75
Ibid. p. 296.
76
Ibid., p. 36.
77
Warren, Bankruptcy in United States History.
78
Not surprisingly, the push for separate courts came from the business community and not the
established interests in the legal community. Lester, Victorian Insolvency. pp. 45, 55, 87.
79
Warren, Bankruptcy in United States History; Lester, Victorian Insolvency, p. 61.
72
24
States, to take one example, damage judgments from drunken driving are not
dischargeable.
•
In both nations, policy formation is subject to the influence of what might be termed
“non-economic” ideologies. In the United States, states rights, Jeffersonian ideals about a
nation of small farmers, and populism, all entered the debate. In Victorian England,
bankrupts were sometimes disciplined by their churches. Correspondingly, Brougham’s
1849 bill sought to classify discharged debtors into “virtuous”, “unfortunate” and “spendthrift, speculating, or fraudulent” types.81
•
Both nations provided for “composition” in private liquidations or “deeds of
arrangement” (“reorganization”) in continuations where creditors could privately contract
settlement with a debtor. Furthermore, an agreement between a requisite majority of
creditors and the debtor could bind minority creditors. In Britain, the majorities for
composition were set at 90% in 1826 and 60% in 1849. Indeed, the overwhelming
majority of business failures were handled privately in the 1840s and 1850s and even
more so in the 1860s. Private settlements increased further in the 1870s when the law
encouraged strategic liquidations where debtors and friendly creditors colluded.82
•
The automatic stay of actions against a bankrupt corporation, found in the United States,
was introduced in England in the Companies Act of 1862. This act provided for
involuntary liquidation under court supervision, voluntary liquidation without court
supervision approved by a 75% majority of creditors, or voluntary liquidation under court
supervision. However, in the Companies Act of 1890, corporate windups were placed
under the same BOT tutelage as were personal bankruptcies83
•
In both countries, changing the legal structure for bankruptcy promoted financial
innovation. In particular, giving government agencies (as against courts) a primary role
in bankruptcy appears to have led to substantial changes in debtor-creditor relations in
both nations. The English developed the “floating charge”, a contract that gives absolute
priority to a corporation’s senior debenture holders.84 The “floating charge” became
popular in England following the 1869 Bankruptcy Act that placed bankruptcy
proceedings under the Board of Trade. The “floating charge” allowed the debenture
holders to avoid discretion exercised by the BOT. Similarly, when the SEC was given a
80
Lester, Victorian Insolvency, p. 62.
Ibid. pp. 67-68.
82
Ibid. p. 78-80, 166, 180.
83
Ibid. pp. 226-228.
84
Julian Franks and Oren Sussman, “Financial Innovations and Corporate Insolvency”, manuscript,
London Business School, 1998; Carruthers and Halliday, Rescuing Business, pp. 194-203.
81
25
seat at the table in the 1930s, corporate bankruptcy filings vanished in the US.85 (On the
other hand, they flourished once the management friendly Chapter 11 appeared in 1978.)
•
A final insight from the historical experience of both countries is that much of legislation
is in the details. It is hard to forecast how these details will play out in practice. In
England, few anticipated that the move from bureaucratic to creditor management of
bankruptcies in 1869 would engender more problems than it solved. In the United States,
the SEC failed to notice a loophole in the law that would eventually cost it its authority
over bankruptcies of public firms.86 The lesson, even if obvious, is well worth stating.
Great care has to be taken in constructing bankruptcy reform.
Germany 1877 – Bankruptcy and the Unification of Legislation
The evolution of civil law in Germany in the 19th century is closely connected with the
process of national unification that led to the foundation of the (second) empire in 1871. Most
of modern German civil law codification, and most importantly the Civil Code (Bürgerliches
Gesetzbuch) of 1896, was carried out under the empire, but has its direct roots in legislation
passed before 1871 in various jurisdictions. It is therefore useful to briefly review the political
development in Germany in the 19th century.
Following the assault by Napoleon, the old empire collapsed in 1806 when the southern and
western parts of the empire split off to form the "Rhine League", and the Habsburg emperor
resigned. The restoration in the years after 1815 did not restore the empire and, in fact,
created a relatively loose federation of independent monarchic states, the "German League",
with conservative rulers of little to no liberal inclinations. In the wake of the PrussianAustrian war, this federation was dissolved in 1866 by Prussia, which forced the Austrians to
accept the foundation of the "North German League" under the hegemony of Prussia, which
included the German states north of the Main River. The southern German states, but not
Austria, joined the North German League in 1871 to form the empire, when the Prussian king
became the German emperor.
Civil law evolved quite unevenly in this environment, but always in the shadow of the French
Code Civil of 1804.87 In some small parts of Germany the French Code Civil actually
85
Skeel, Debt’s Dominion.
Ibid.
87
These paragraphs draw, among others, on Uhlenbruck, Einhundert Jahre (an authoritative survey of
the history of German bankruptcy law up to the 19th century), Ernst Jaeger, Lehrbuch des Deutschen
Konkursrechts, Berlin, Leipzig 1932, and Kohler, Lehrbuch. A useful broad overview over the
86
26
survived the fall of the French occupation. In other parts, such as Austria, Prussia, and Baden,
a certain degree of new codification occurred before 1815, and in yet others, from Bavaria in
the south to Hanover in the north, Roman law dominated until the end of the 19th century.
Two main features in the development of civil law are noteworthy. First, the economic and
political liberalization that occurred in most German states during the 19th century brought
many special laws and rules governing economic activity into the realm of civil law ("the
commercialization of civil law"). The forerunner in this process was Prussia (beginning with
the freeing of the farm population in 1807 and the granting of freedom of commerce and
exchange in 1810), in an interesting combination of economic and administrative modernity
and political conservatism. Complementing this process, academic legal doctrine adapted
Roman law to the growing needs of a capitalist society, by developing the abstract notions of
contract, damages, claim, etc., without, however, striving for the completeness and
concreteness of the French Code Civil.
The second important development in the shaping of civil law in the pre-1871 period was the
emergence of a number of specialized pieces of legislation concerning commerce, often
influenced by the French Code de Commerce of 1807. Much of this happened independently
on the level of individual states, again usually with Prussia as the forerunner, such as with the
laws on joint stock companies (1843), on co-operatives (1867), and on bankruptcy (1855).
The most important example of legislation transcending state borders was the drafting of a
German Commercial Code (Allgemeines Deutsches Handelsgesetzbuch) by the German
League in 1861, unifying much of commercial and corporate law within the German League.
Civil law in the early days of the empire was far less homogenized than criminal law. The
empire's new Criminal Code (Strafgesetzbuch) was passed already in 1871, whereas it took
25 years to pass the Civil Code. Some special codes, however, were enacted more quickly,
mostly because of strong business interests,88 among them the bankruptcy code of 1877.
The 1877 bankruptcy code was a thoroughly new creation, and although it was inspired
directly and indirectly (through the Prussian bankruptcy code) by the French Code de
Commerce of 1807, it was widely perceived as an original, consistent, and well-crafted piece
of legislation. Despite a growing number of criticisms and modifications, it remained in force
until 1998, which means that it survived the state that enacted it by 80 years.
evolution of the law in general (with an emphasis on Germany) is Uwe Wesel, Geschichte des Rechts,
München 1996.
88
See, for example, Wesel, Geschichte and Thieme, Zur Entstehung.
27
The 1877 code differed in a number of important respects from earlier bankruptcy legislation
in Germany. Its most direct precursor, on which the 1877 code draws extensively, had been
the Prussian bankruptcy code of 1855, which is widely viewed as the first modern bankruptcy
code in Germany (and which influenced the American code of 186789). This code marked the
departure from simple common law codifications in Germany. Among its many innovations,
the distinction between personal and commercial bankruptcy with separate procedures for
both is perhaps the most important one, and reflected the interests and influence of business
interests in the project on the one hand, and the increasing "pro-business" stance by the
Prussian state in economic matters on the other. An important motive for the creation of the
Prussian code has undoubtedly been the wish to pre-empt pan-German legislation in an area
in which business interests in the course of the nation-wide industrialization became more and
more important and vocal.
The most remarkable, and most widely noted, characteristic distinguishing the 1877 code
from earlier legislation was its relative debtor friendliness. Several features of the code are
noteworthy in this respect. First, conceptually the code is based on the premise that
bankruptcy is typically a consequence of adverse or unforeseen circumstances, not of moral
hazard on the side of the debtor. Already the code’s early critics, in the 1870s, criticized that
lack of liquidity could not be the sole foundation of bankruptcy law, and that excessive
leverage or lack of due care were conceptually equally important.
A second debtor friendly feature of the 1877 code, derived from this principle of presumed
innocence, was an early form of a debtor-in-possession provision (“Eigentumsvorbehalt”): the
debtor remained owner of his property in bankruptcy, and only lost his right to manage it
freely. A third, related point was the exemption of newly acquired property by the debtor
from inclusion within the bankruptcy estate. Fourthly, the code allowed for a debtor-initiated
and court-imposed settlement (“Zwangsvergleich”), which had the potential to speed up the
bankruptcy procedure at the expense of the creditors.
These and other features of the 1877 code made it, compared to its predecessors, relatively
debtor-friendly. In fact, the main criticism leveled against the code at the time of its
enactment was that it was “a child of Manchesterian ideas” and tailored to the needs of big
business. Until the code’s repeal in 1998, the extremely low recovery rates in German
bankruptcies were often blamed on its debtor-friendliness.
89
See Ulrich Kramer, "Das anglo-amerikanische Sonderverfahren zur Reorganisation von
Kapitalgesellschaften nach Abschnitt X des Bankruptcy Acts", Prozessrechtliche Abhandlungen 45,
1977
28
The code had other important features that, although not primarily viewed as disadvantaging
creditors, contributed to its reputation as debtor-friendly. Most importantly, several of its
provisions - such as the powers attributed to the bankruptcy court and to the bankruptcy
trustee ("Konkursverwalter") who was responsible to creditors and debtor alike - entailed a
clear curtailing of creditors’ autonomy. This was in the tradition of German bankruptcy law of
the 18th and early 19th century, which in turn was influenced by the Spanish “administrative”
bankruptcy school in the spirit of Salgado de Samoza (1663). The restrictions of creditor
autonomy in the Prussian and the German codes, however, were by no means an automatic
result of historic development, as the example of the Austrian code of 1868 shows. This code,
in the Italian statuary right tradition that also influenced the French code, strived to minimize
the influence of courts on the bankruptcy procedure and to maximize creditor autonomy. It is
interesting to note in passing that the code provoked serious complaints about collusion and
gaming by creditors ever since its enactment (not unlike the complaints collected by Balleisen
about the American court administered procedure after the 1841 act).90
A second important feature of the 1877 code concerning creditors' rights, and conceptually
perhaps its most important and radical one, was the abandoning of a fundamental principle of
bankruptcy in the old German legal tradition, the "vis attractiva". This principle held that all
claims and cases related to the debtor's estate were "attracted" by a bankruptcy proceeding. In
practice this often meant that bankruptcy cases could not be closed before all creditors had
exhausted all litigation concerning the debtor and therefore lasted forever (a regional statute
in 1718 (!) complained that bankruptcy procedures were "almost immortal"). The 1877 code
cut through this web and stated that the bankruptcy court was not competent to settle legal
disputes concerning the estate. Claimants could only register their claims, which then had to
be processed by other courts, and the bankruptcy case proceeded without their being settled.
The end of the "vis attractiva" - together with the "par condicio creditorum" (equal treatment
of creditors), the cornerstone of traditional German bankruptcy rules - may be interpreted as
an instance of weakened creditor rights, because it limited creditors' legal recourse rights in
bankruptcy. On the other hand, it also marked a strengthening of creditors' rights in the sense
of speeding up the procedure and potentially preventing the degradation of the debtor's estate,
which, after all, was to be distributed to the creditors.
90
Balleisen, “Vulture Capitalism”.
29
Perhaps the most important shortcoming of the 1877 code was the lack of a settlement
procedure that allowed the parties to avoid the liquidation-oriented bankruptcy process.
Interestingly, earlier drafts, including a prominent 1873 proposal, had included such a
procedure, in fact, had suggested it as a mandatory first step of the whole bankruptcy process.
This shortcoming proved to be more and more disturbing and got on the political agenda
regularly in times of economic downturns. It was finally tackled following the hyperinflation
of the early 1920s, leading to the "settlement code" ("Vergleichsordnung") of 1927, revised
following the Great Depression in 1935, an independent code that complemented the
bankruptcy code.
Despite the growing awareness of the code's insufficiencies after the Second World War,91 it
proved remarkably resilient. In fact, only after more than 20 years of hearings, commissions,
and drafts was a new code passed in 1994. This code united the bankruptcy code and the
settlement code into one insolvency code, whose main features can be summarized in the
following six points:92 (i) procedural unification and simplification, (ii) facilitation of
restructuring following default, (iii) increase of the recovery rate in bankruptcy, (iv)
improving creditor autonomy, (v) increasing distributional justice among creditors, and (vi)
improving personal bankruptcy.
Sweden 1862 – Reluctant Reformer in the Wake of Crisis
Sweden also got its first modern bankruptcy law in the second half of the 19th century, more
precisely in 1862.93 The law introduced French influence into Swedish bankruptcy legislation
previously dominated by German legal thinking. The first laws of bankruptcy are found in
some city statutes from the 14th century with strong influence from the commercial law of the
Hanseatic cities. The first national reforms came in the late 17th century. In 1687 debtor prison
was abolished and complete write-offs made possible when the cause of insolvency was
beyond the debtor’s control.94 The first comprehensive bankruptcy law came in 1734. From
then on bankruptcy is a feature of the law. In fact, the mercantilism thinking at the time
attached great importance to the bankruptcy institution. The legal works of the time
91
See, among many others, Hans Hanisch, Rechtszuständigkeit der Konkursmasse, Frankfurt 1973.
This discussion is taken from Reinhard Bork, Einführung, in Insolvenzordnung, Beck-Texte, 1998,
IX-XXII. For international perspectives on the new insolvency code, see Ihle, M. (1989),
"Administrative Receivership in W. Germany", Revue de droit des affaires Internationales 3, 267-289.
93
I. Agge, 1934, “Några drag av det svenska konkursförfarandets utveckling,” Minnesskrift ägnad
1734 års lag, Stockholm, 1934. K. Olivecrona, 1862, Bidrag till den svenska concurslagstiftningens
historia, Upsala.
94
But debtor prison as such remained a feature of bankruptcy well into the 19th century. The law of
1830 (IV: §§ 49-50) contain rules for debtor prison.
92
30
frequently mentions the connection between these procedures and the general economic well
being of the country.95
The influence in the 1734 law was distinctly German in the sense that bankruptcy procedure
is dealt with as a regular civil law case. The approach was further refined in reforms of 1773
and 1798. The focus of the law was not the procedural and execution aspects of bankruptcy,
but rather the rights of the bankrupt debtor to keep certain assets and his general treatment
when the reasons for his bankruptcy was beyond his control and he voluntarily gave up
control over his assets. This concern for unfortunate debtors was an inheritance from late
Roman law and was pervasive in much of European law at the time. Complete write-offs
were possible, but the scope was reduced in revisions of 1818 and 1830. Instead exemptions
were introduced. Once the ideas of exemptions of certain assets had been introduced into the
law this discussion died out.96
The early 1820s also saw the embryo of the Swedish financial system with a number of
commercial banks being formed. In the 1840s a wave of liberal reforms swept through
commercial life in Sweden.97 The guild system was largely dismantled in 1846, and
competition increased. A company act was enacted in 1842. The political unrest of 1848 was
followed by a conservative backlash. The King became more conservative, and protectionism
grew stronger. In the parliament of 1850/51 the conservative groups controlled three out of
four chambers (the burgers were still liberal). The influence of the commercial code of the
Code Napoleon had been strong all over Europe and influenced Swedish legislation. A new
company law was adopted in 1864.
But the French influence, and its emphasis on the procedural aspects, came later into
bankruptcy law than other areas of commercial law. In 1854 a first draft of a revised
bankruptcy code was discussed in parliament, but no law was passed. In 1857 a new
economic crisis renewed the interest in bankruptcy reform and the parliament asks the King to
appoint a bankruptcy committee. A law was eventually passed in 1862.
The new law dealt with the problem of multiple creditors, in particular that the rights of
individual creditors might be in conflict with the creditors as a collective. The law gave
creditors, rather than the debtor, control over the estate during the bankruptcy procedure.98
95
I. Agge, 1934, “Några drag av det svenska konkursförfarandets utveckling,” p. 917.
Agge, “Några drag av det svenska konkursförfarandets utveckling,” p 921.
97
Schön, Lennart: En modern svensk ekonomisk historia - Tillväxt och omvandling under två sekel,
SNS 2000, pp. 109-116
98
In the law of 1862 (4, § 39 –68).
96
31
But to mitigate the problem of individual creditors pursuing claims to the detriment of the rest
of the creditors a court-appointed administrator was supposed to run the business on behalf of
the creditors. The law also imposed stricter time limits on the different phases of the
bankruptcy procedure in order to reduce value destruction during the court procedure. The
1862 law gave creditors the right to pursue assets even after the formal filing period was over.
However, late filers could not claim assets that had been distributed by the court.
An examination of the records from the parliamentary debates at the time reveals that the
major concern was the slowness of the process under the old German-inspired law. One
member of the aristocratic chamber even refers to a saying that you “will have died before
you see any distribution of assets from a bankruptcy procedure in Sweden”.99 The problem
allegedly was that each claim was treated independently and without concern for the overall
value of the estate. Frequent reference was made to earlier reforms elsewhere in Europe, but
also to the peculiar circumstances of Swedish business life. One speaker also suggested that
the slowness of the existing procedure was beneficial during the 1857 crisis.100 He also
mentioned a debt moratorium during the crisis. Another concern of the opposition to the
reform is that the proposed law, unlike its French antecedent, would extend beyond commerce
to encompass every citizen.101
The parliamentary debate made several references to local bias in courts.102 Several speakers
raised concern that the stricter time limits will benefit well-informed local creditors at the
expense of other creditors.
The legal commentators emphasize that the 1862 law was not a complete break with the
previous tradition.103 The adjustments in 1818 and 1830 had mitigated some of the problems
of the 1734 law, and the hand-over of control to the creditors was less complete than in the
French tradition. The court maintained more than a mere control function, e.g., by retaining
the right to decide on conflicting claims, and by the fact that the whole process took place
before the court. As in civil law cases, the judge also convened and chaired a meeting of the
creditors where they filed claims and could challenge each other’s claims. This practice was
99
Count Sparre in the minutes from 1860 debate in the chamber of the gentry, p. 39.
100
Sparre, 1860, p.54.
Ibid, p.39.
102
Ibid, p. 54-55, but local bias is also mentioned by Johan Johansson in the farmer chamber in 1856 (
p. 163, in the minutes).
103
Olivecrona, 1862, Agge, 1934, and Welamsson, L, Om konkursrätt.
101
32
abolished in 1821 since it was viewed as adversarial and damaging to loyal creditors
interested in the continuation of the debtor’s business.104
The bankruptcy law of 1862 came in the last years of the class-based four-chamber
parliament abolished in 1866. The farmer chamber had in 1848 demanded that certain
privileges of the gentry, in particular the right to be tried by the appeal court directly, be
revoked.105 They repeat this demand in 1851, but in the final debate of 1860 farmers show
limited interest in the reform. The discussion was much more intense in the chambers of the
gentry and burgers with many votes and changes in the original text. But when the law
eventually passes all chambers support the text.
Minor revisions followed in 1877,1891 and 1912. In 1906 a committee was appointed to
reform the law. The following deficiencies were noted in the instructions to the committee:
(1) difficulties to get the debtor into bankruptcy; (2) more effective control, better
administration (more professional); lower cost of control and administration; (3) the “posting
time” (anslagstiden) unnecessarily long and short be shortened like other time periods
mentioned in the law; (4) creditors must get better information about some critical data
through the administrator; and (5) the prosecutor’s possibilities to indict must be expanded.106
A new law was adopted after the recession of 1921.
In 1975 some important substantive changes were made, and the 1979 reform introduced a
new organization of bankruptcy and a special procedure for small bankruptcies. In 1986 a
restructuring component was added to the law, but during the crisis of the early 1990’s it
became clear that a revision of the priority structure was required for the new procedure to
work satisfactory. The protection of the claims of government, employees and banks were
perceived to be too strong for successful restructuring. A government commission was
appointed. The (social-democratic) government and the labor unions accepted a weakening of
the standing of government tax claims and employee protection if the banks also agreed to
lower priority. Interestingly, besides banks, the associations of small businesses, for whom
bank finance is the main source, were strongly against the proposed change. In the final
compromise proposal the floating charge, the main instrument used by the banks, was
extended to cover a broader range of assets, but its priority in bankruptcy was lowered. The
proposal, made in the wake of the deep crisis, has not become a bill since the interest in
104
Agge, 1934, p. 929.
In the parliamentary debate in 1860 (July, 11) Printzensköld points out that the farmers have tried to
have the privilege of the gentry revoked in 1848 and then again in 1851.
106
K. Gratzer och H. Sjögren, ”Introduktion” i Konkursinstitutets betydelse i svensk ekonomi, red
Gratzer och Sjögren, Stockholm 1999.
105
33
bankruptcy reform has more or less disappeared in the boom of the second half of the 1990’s.
The remaining concern is primarily with the use of bankruptcy in various forms of economic
criminality.
Germany and Sweden – Some Common Themes
While Swedish bankruptcy law has unique roots in early local practices, the influence from
Germany has been strong since Hanseatic times. This influence carried over into the 19th
century and it still remains despite the reforms of 1862. Both countries somewhat reluctantly
integrated French bankruptcy law in the second half of the 19th century, significantly later
than many other countries on the European continent. In the late 20th century both Germany
and Sweden have introduced reorganization procedures in response to a perceived liquidation
bias in their debtor-creditor laws.
Despite these common influences and similarities in the legal text it is interesting to note that
legal commentators seem to view the effects of the, at least superficially, rather similar
reforms very differently. The 1877 German bankruptcy law has generally been viewed as prodebtor whereas the Swedish law of 1862 is typically portrayed as strengthening creditors as a
collective at the expense of individual creditors and the debtor. Understanding these
differences in interpretation of the two laws requires a deeper analysis not only of the legal
text but also on the implementation and enforcement.
34
Conclusions
The legislative histories of these four countries provide a wide range of experience. All four
countries adopted their basic modern bankruptcy law during the second half of the 19th
century and had substantial reforms a century later. In this final section we summarize some
important observations from our study.
•
There is a tremendous variation in bankruptcy institutions across countries and
over time in individual jurisdictions. While legal origin plays some role in explaining
the current institutions, it is striking how much bankruptcy law changed over time and the
extent of variation in outcomes with families of countries with the same broad legal
origin.
•
Changes of bankruptcy law come in international waves, with the possible exception
of the United States. The second half of the 19th century and the 1970s and 1980s saw
such waves in Europe and the United States. In the 1970s, both the United Kingdom and
the United States governments convened “blue ribbon “ panels to consider bankruptcy
reforms. The process resulted in major legislation in the US in 1978 and in the UK in
1985.
•
Politics played a crucial role in the development of bankruptcy law. Fundamental
technological changes combine with incentives for international harmonization, in
particular for smaller trade-dependent countries, and broad political movements to create
the underlying pressures for bankruptcy reform. But politicians and interest groups were
critical in shaping the outcome of these reform movements. With the possible exception
of the United States judges played a secondary role in this regard.
•
Major changes in institutions typically come in severe economic downturns. In the
United States all initiatives for instituting a national bankruptcy law came after deep
economy-wide crises, and Sweden had to experience a severe crisis in 1857 before the
bankruptcy proposal of 1854 could be adopted (in 1862). The only major German reforms
of its 1877 act occurred after the economic crisis in the early 1920 and in the great
depression.
•
Legislative activity often coincided with moratoria and bailouts of failing debtors.
All US bankruptcy acts of the 19th century had elements of economy-wide debt relief. A
35
moratorium also preceded the Swedish law of 1862. One interpretation is that the political
process solves a coordination problem among creditors by taking into account
macroeconomic signals. In another view the government, or the politicians, simply
accommodates to the impossibility of enforcing these debt contracts.
•
Political majorities were often important for the success of reform initiatives. In 19th
century United States it was a necessary condition for reform proposal to be passed into
bankruptcy acts that both houses of Congress and the presidency were controlled by the
right wing. In Sweden the reform proposal in the 1850s came in the conservative backlash
to the liberalization and political unrest of the late 1840s.
•
Institutional rules also affected how reform initiatives faired. Several initiatives in the
United States only passed one of the houses; the disproportionate representation of the
agrarian Southern and Western states in the Senate blocked initiatives to strengthen
creditors’ rights to possess failing debtors’ land. In the Swedish four-chamber parliament
three chambers were inherently conservative whereas one chamber (the burgers) was
more change-oriented. Since three out of four chambers were necessary for passage, and
the farmers were against bankruptcy reform, the aristocratic and the clergy chambers
(they typically voted together) became pivotal. The federal nature of both German and US
nationhood is likely to have influenced the outcome of the reform process, but local bias
was also mentioned in the Swedish debate.
•
The visibility of the issue shaped the legislative process. When bankruptcy reform was
high on the political agenda, like in the 19th century United States and Europe, ideology
played an important role in shaping the outcome. However, as the reform process moved
towards fine-tuning and the issue failed to generate public interest, strong lobby groups
became increasingly important.
•
Bankruptcy reform created its own constituencies. In the United States lawyers
developed into a strong pressure group shaping the legislative agenda in the second half
of the 20th century. In the United Kingdom accountants came to determine the outcome of
the reform efforts during the same period.
•
Original rationales for bankruptcy reform may not be visible later. The predominant
force behind the movement for bankruptcy reform in 19th century United States was the
desire by financial interests in the banking interests in the east to fight local bias of state
36
courts. While issues of local bias remain, the debate over bankruptcy law in the United
States is fundamentally centered on the incentives that influence debtors and creditors
irrespective of place of residence or incorporation. Similarly in Sweden, most of the
reforms during the century preceding the 1862 law were about finding the appropriate
level of punishment of a failing debtor. With the introduction of exemptions for basic
needs and the concern for the viability of the credit system as a whole the individual
debtor became a secondary issue, at least in corporate bankruptcy law.
•
Legal origins were by no means absolute. Swedish bankruptcy law initially had strong
idiosyncratic features but with considerable German influence. The 1734 act was
essentially a German-inspired act, but in 1862 the French civil code was the model.
Sediments were left from previous laws, but the thinking was radically different in the
new law. The British and the Germans themselves were also heavily influenced by the
French tradition. In late 20th century reforms US bankruptcy law was very influential.
•
When implementation and enforcement are poor, it may be more productive to rely
on private, non-governmental mechanisms of enforcement of contracts. Pre-packaged
bankruptcy has been an important element of finance in the United States since the 19th
century. Some features were later incorporated into the law. The development of AngloAmerican investment banks such as Drexel Morgan and Brown Shipley may have been
stimulated by the lack of credibility of debts incurred by U.S. governments and the
inefficiency of the court system for dealing with private debt.107
•
Bankruptcy law should perhaps not be written in a manner that removes all
flexibility for the government to recognize macroeconomic circumstances as well as
the circumstances of the firm. U.S. law is not written in this manner, but the political
system does intervene, ex post, in debt contracts during crises. It might pay to consider
mechanisms that make such intervention more predictable and systematic, an “indexing”
if you will, of bankruptcy law.
•
Special courts or administrative agencies with expertise in bankruptcy are
appropriate institutions for bankruptcy proceedings. Many developed nations,
including the United States and the United Kingdom, either have special courts or special
administrative agencies to handle bankruptcies. In many parts of the world, certainly
throughout almost all of Latin America, debt collection is just thrown into the standard
37
court system. The expertise, if imperfect, embodied in the institutions of developed
nations is worth copying.
•
Debtors should not be permitted to shop jurisdictions. A persistent problem in
American bankruptcy is that the wealthy can shift liquid assets to states with high
exemption levels. The persistence of non-uniform procedures across the states is political
in origin and not drive by considerations of economic efficiency. Similar problems exist
in Argentina, where national law is enforced to different degrees across the provinces.
Both law and enforcement need to be harmonized. While it is perhaps less important to
harmonize law concerning physical assets than cannot be readily shifted across borders,
international capital mobility creates new problems for liquid assets. Defaulting debtors
in the twenty-first century should not be allowed to use international borders to undertake
the same type of fraudulent conveyance that local courts may have condoned in the
nineteenth.
107
Lance Davis and Robert Gallman make the point for the lack of credibility of public borrowing, in
“Lessons from the Past”.
38