By FindLaw Staff | Legally reviewed by Renee Guolee, J.D. | Last reviewed July 29, 2022
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Bankruptcy is a legal proceeding for a person or business that cannot repay their debts. The Constitution grants power to Congress to enact laws creating a uniform system to cover the discharge of debts and distribution of the debtor's property.
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[The Congress shall have Power . . . ] To establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States; . . .
United States Library of Congress, The Constitution of the United States of America: Analysis and Interpretation
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."1 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.2 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.3
This interpretation has been ratified by the Supreme Court. In Hanover National Bank v. Moyses,4 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 a voluntary petition. The Court has given tacit approval to the extension of the bankruptcy laws to cover practically all classes of persons and corporations,5 including even municipal corporations6 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.7
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,8 as were later acts, which provided for the reorganization of corporations that are insolvent or unable to meet their debts as they mature,9 and for the composition and extension of debts in proceedings for the relief of individual farmer debtors.10
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.11 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.12
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.13 United States v. Speers,14 codified by an amendment to the Bankruptcy Act,15 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.16 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,17 that benefits under a nonparticipating annuity plan are not wages and are therefore not given priority,18 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.19 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.,20 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."21
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.22 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;23 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.24
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.25 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.26 Although it may not subject the fiscal affairs of a political subdivision of a state to the control of a federal bankruptcy court,27 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.28 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;29 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.30