Why does bankruptcy exist? I can tell you from more than 10 years of legal experience, that is the question most often asked by creditors who are baffled as to why they lose out when someone files bankruptcy against a debt that is owed to them. While it can be unfortunate for the creditor, for the person needing protection that bankruptcy offers, the choice is stark.
First, let’s look at a little bit of the history of bankruptcy. For hundred of years, if you couldn’t pay back your debts, your assets were often seized to satisfy those debts and if you didn’t have enough assets to cover the debts owed, you’d be thrown in jail. While this doesn’t make much sense, being that if you’re imprisoned you can’t exactly work to pay off your debts, it was the law in Great Britain and even in colonial times here in America. This all changed with the Financial Panic of 1837. This was the first time that debtors were able to file for bankruptcy protection voluntarily. Changes have occurred over the past 180 years that have made bankruptcy fairer for the debtor and the creditor.
At times, a person’s debts can become so overwhelming that they become paralyzing. Debts can feel like a type of financial bondage that steals a person’s hope for future prosperity and ability to take care of his or her family. From my ten years of experience, I have found that none of my clients actually want to file bankruptcy and all of them desperately want to have the financial capacity to repay their creditors. Unfortunately, they have reached a point in their life where they feel that this is simply impossible.
This is where bankruptcy becomes a type of safety net. The reasons for bankruptcy are numerous. First, bankruptcy serves to provide a debtor with a fresh start and renewed sense of hope. The Supreme Court has stated that this fresh start is the “essence of modern bankruptcy law” and that debtor is provided with special protections in bankruptcy called exemptions “to ensure that bankruptcy will provide a fresh start.” Local Loan Co. v. Hunt, 292 U.S. 244 (1934).
From the perspective of macroeconomics, bankruptcy is an essential part of capitalism. In an economy without bankruptcy protections if a business fails you’re out of luck but in our country bankruptcy can serve as a fail safe. Without this fail safe what business person would ever take a risk with his or her money? It is obvious that no one starts a business just to file bankruptcy, bankruptcy itself provides for an invaluable safety net that will allow a person to take the debts from the past and move forward into a brighter future.
Many creditors often ask, what about me? While it is not obvious why bankruptcy would benefit creditors, creditors are protected by the law as well. First of all, we assume that a person who is looking at filing bankruptcy has exhausted all other financial options. For the most part, debtors generally don’t have much more than their household goods and furniture, a car, and a home, if they’re lucky. The reality of the situation is, no one is going to get paid back in full. By assuming bankruptcy is unfair for creditors, must also acknowledge that the alternative probably wouldn’t be better either.
Understanding all this we realize that bankruptcy is an equalizing force among creditors. Creditors are broken up into roughly three different classifications: The first is secured creditors like your mortgage or car loans, the second is a priority creditor like alimony or child support, and the third is just unsecured like a credit card or medical bill. An example of this works would be a situation like this. A debt collection law firm is attempting to collect on a credit card issued by a bank and the debt collection law firm pursued a garnishment suit against the debtor in magistrate court. They won and got a judgment, and started garnishing the debtor’s paycheck to the fullest extent allowed by law. By doing this the debt collection law firm collected $1,500.00 in three months for the bank. The problem with this is that there is a section of the bankruptcy law that says that if an unsecured creditor is paid more than $600 within 90 days of the debtor filing bankruptcy (even if it’s court ordered), that creditor was given preferential treatment. This means that the bankruptcy trustee can force the bank to turn over the $1,500 so the trustee can distribute that money to the unsecured creditors in equal shares. So, from that perspective, even creditors may benefit by some equalization under the bankruptcy code.
With all this said, I hope I’ve answered the question, Why does bankruptcy exist. It exists for both the creditor and the debtor. It helps to ensure fair treatment of the creditors and to help the debtor get a fresh start. If you feel that you may be in need of a consultation with a bankruptcy attorney give the caring and compassionate attorneys at Harmon and Gorove a call to schedule a free, no obligation consultation with an experienced bankruptcy attorney. With our expertise you may be able to regain your financial freedom and start down the road to prosperity.