Bankruptcy

Clause 4. The Congress shall have Power * * * To establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States.

Annotations

In an early case on circuit, Justice Livingston suggested that inasmuch as the English statutes on the subject of bankruptcy from the time of Henry VIII down had applied only to traders it might “well be doubted, whether an act of Congress subjecting to such a law every description of persons within the United States, would comport with the spirit of the powers vested in them in relation to this subject.”¹⁴²¹ Neither Congress nor the Supreme Court has ever accepted this limited view. The first bankruptcy law, passed in 1800, departed from the English practice to the extent of including bankers, brokers, factors, and underwriters as well as traders.¹⁴²² Asserting that the narrow scope of the English statutes was a mere matter of policy, which by no means entered into the nature of such laws, Justice Story defined bankruptcy legislation in the sense of the Constitution as a law making provisions for cases of persons failing to pay their debts.¹⁴²³

This interpretation has been ratified by the Supreme Court. In Hanover National Bank v. Moyses,¹⁴²⁴ it held valid the Bankruptcy Act of 1898, which provided that persons other than traders might become bankrupts and that this might be done on voluntary petition. The Court has given tacit approval to the extension of the bankruptcy laws to cover practically all classes of persons and corporations,¹⁴²⁵ including even municipal corporations¹⁴²⁶ and wage-earning individuals. The Bankruptcy Act has, in fact been amended to provide a wage-earners’ extension plan to deal with the unique problems of debtors who derive their livelihood primarily from salaries or commissions. In furthering the implementation of this plan, the Supreme Court has held that a wage earner may make use of it, notwithstanding the fact he has been previously discharged in bankruptcy within the last six years.¹⁴²⁷

As the coverage of the bankruptcy laws has been expanded, the scope of the relief afforded to debtors has been correspondingly enlarged. The act of 1800, like its English antecedents, was designed primarily for the benefit of creditors. Beginning with the act of 1841, which opened the door to voluntary petitions, rehabilitation of the debtor has become an object of increasing concern to Congress. An adjudication in bankruptcy is no longer requisite to the exercise of bankruptcy jurisdiction. In 1867, the debtor for the first time was permitted, either before or after adjudication of bankruptcy, to propose terms of composition that would become binding upon acceptance by a designated majority of his creditors and confirmation by a bankruptcy court. This measure was held constitutional,¹⁴²⁸ as were later acts, which provided for the reorganization of corporations that are insolvent or unable to meet their debts as they mature,¹⁴²⁹ and for the composition and extension of debts in proceedings for the relief of individual farmer debtors.¹⁴³⁰

Nor is the power of Congress limited to adjustment of the rights of creditors. The Supreme Court has also ruled that the rights of a purchaser at a judicial sale of the debtor’s property are within reach of the bankruptcy power, and may be modified by a reasonable extension of the period for redemption from such sale.¹⁴³¹ Moreover, the Court expanded the bankruptcy court’s power over the property of the estate by affording the trustee affirmative relief on counterclaim against a creditor filing a claim against the estate.¹⁴³²

Underlying most Court decisions and statutes in this area is the desire to achieve equity and fairness in the distribution of the bankrupt’s funds.¹⁴³³ United States v. Speers,¹⁴³⁴ codified by an amendment to the Bankruptcy Act,¹⁴³⁵ furthered this objective by strengthening the position of the trustee as regards the priority of a federal tax lien unrecorded at the time of bankruptcy.¹⁴³⁶ The Supreme Court has held, in other cases dealing with the priority of various creditors’ claims, that claims arising from the tort of the receiver is an “actual and necessary” cost of administration,¹⁴³⁷ that benefits under a nonparticipating annuity plan are not wages and are therefore not given priority,¹⁴³⁸ and that when taxes are allowed against a bankrupt’s estate, penalties due because of the trustee’s failure to pay the taxes incurred while operating a bankrupt business are also allowable.¹⁴³⁹ The Court’s attitude with regard to these and other developments is perhaps best summarized in the opinion in Continental Bank v. Rock Island Ry.,¹⁴⁴⁰ where Justice Sutherland wrote, on behalf of a unanimous court: “[T]hese acts, far-reaching though they may be, have not gone beyond the limit of Congressional power; but rather have constituted extensions into a field whose boundaries may not yet be fully revealed.”¹⁴⁴¹

In the exercise of its bankruptcy powers, Congress must not transgress the Fifth and Tenth Amendments. The Bankruptcy Act provides that use immunity may be granted “for persons required to submit to examination, to testify, or to provide information” in a bankruptcy case.¹⁴⁴² Congress may not take from a creditor specific property previously acquired from a debtor, nor circumscribe the creditor’s right to such an unreasonable extent as to deny him due process of law;¹⁴⁴³ this principle, however, is subject to the Supreme Court’s finding that a bankruptcy court has summary jurisdiction for ordering the surrender of voidable preferences when the trustee successfully counterclaims to a claim filed by the creditor receiving such preferences.¹⁴⁴⁴

Because Congress may not supersede the power of a state to determine how a corporation shall be formed, supervised, and dissolved, a corporation that has been dissolved by a decree of a state court may not file a petition for reorganization under the Bankruptcy Act.¹⁴⁴⁵ But Congress may impair the obligation of a contract and may extend the provisions of the bankruptcy laws to contracts already entered into at the time of their passage.¹⁴⁴⁶ Although it may not subject the fiscal affairs of a political subdivision of a state to the control of a federal bankruptcy court,¹⁴⁴⁷ Congress may empower such courts to entertain petitions by taxing agencies or instrumentalities for a composition of their indebtedness where the state has consented to the proceeding and the federal court is not authorized to interfere with the fiscal or governmental affairs of such petitioners.¹⁴⁴⁸ Congress may recognize the laws of the state relating to dower, exemption, the validity of mortgages, priorities of payment and similar matters, even though such recognition leads to different results from state to state;¹⁴⁴⁹ for, although bankruptcy legislation must be uniform, the uniformity required is geographic, not personal.

The power of Congress to vest the adjudication of bankruptcy claims in entities not having the constitutional status of Article III federal courts is unsettled. At least, it may not give to non-Article III courts the authority to hear state law claims made subject to federal jurisdiction only because of their relevance to a bankruptcy proceeding.¹⁴⁵⁰

Prior to 1898, Congress exercised the power to establish “uniform laws on the subject of bankruptcy” only intermittently. The first national bankruptcy law was not enacted until 1800 and was repealed in 1803; the second was passed in 1841 and was repealed two years later; a third was enacted in 1867 and repealed in 1878.¹⁴⁵¹ Thus, during the first eighty-nine years under the Constitution, a national bankruptcy law was in existence only sixteen years altogether. Consequently, the most important issue of interpretation that arose during that period concerned the effect of the clause on state law.

The Supreme Court ruled at an early date that, in the absence of congressional action, the states may enact insolvency laws, because it is not the mere existence of the power but rather its exercise that is incompatible with the exercise of the same power by the states.¹⁴⁵² Later cases settled further that the enactment of a national bankruptcy law does not invalidate state laws in conflict therewith but serves only to relegate them to a state of suspended animation with the result that upon repeal of the national statute they again come into operation without re-enactment.¹⁴⁵³

A state, of course, has no power to enforce any law governing bankruptcies that impairs the obligation of contracts,¹⁴⁵⁴ extends to persons or property outside its jurisdiction,¹⁴⁵⁵ or conflicts with the national bankruptcy laws.¹⁴⁵⁶ Giving effect to the policy of the federal statute, the Court has held that a state statute regulating this distribution of property of an insolvent was suspended by that law,¹⁴⁵⁷ and that a state court was without power to proceed with pending foreclosure proceedings after a farmer-debtor had filed a petition in federal bankruptcy court for a composition or extension of time to pay his debts.¹⁴⁵⁸ A state court injunction ordering a defendant to clean up a waste-disposal site was held to be a “liability on a claim” subject to discharge under the bankruptcy law, after the state had appointed a receiver to take charge of the defendant’s property and comply with the injunction.¹⁴⁵⁹ A state law governing fraudulent transfers was found to be compatible with the federal law.¹⁴⁶⁰

Substantial disagreement has marked the actions of the Justices in one area, however, resulting in three five-to-four decisions first upholding and then voiding state laws providing that a discharge in bankruptcy was not to relieve a judgment arising out of an automobile accident upon pain of suffering suspension of his driver’s license.¹⁴⁶¹ The state statutes were all similar enactments of the Uniform Motor Vehicle Safety Responsibility Act, which authorizes the suspension of the license of any driver who fails to satisfy a judgment against himself growing out of a traffic accident; a section of the law specifically provides that a discharge in bankruptcy will not relieve the debtor of the obligation to pay and the consequence of license suspension for failure to pay. In the first two decisions, the Court majorities decided that the object of the state law was not to see that such judgments were paid but was rather a device to protect the public against irresponsible driving.¹⁴⁶² The last case rejected this view and held that the Act’s sole emphasis was one of providing leverage for the collection of damages from drivers and as such was in fact intended to and did frustrate the purpose of the federal bankruptcy law, the giving of a fresh start unhampered by debt.¹⁴⁶³

If a state desires to participate in the assets of a bankruptcy, it must submit to the appropriate requirements of the bankruptcy court with respect to the filing of claims by a designated date. It cannot assert a claim for taxes by filing a demand at a later date.¹⁴⁶⁴