The Bankruptcy Clause

The Congress shall have Power . . . To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States. . . .

—Todd J. Zywicki

Introduction

Today, bankruptcy law is thought of primarily as a device to provide debtors with relief from excessive debt. The overwhelming majority of bankruptcy cases are filed by individual debtors, not businesses. Historically, however, the purpose of bankruptcy law was to protect creditors from debtor fraud (such as concealing assets) and to require creditors to cooperate in distributing a debtor’s assets. Moreover, for centuries, “bankruptcy” relief was limited to merchants and traders, not consumers or farmers.

Congress’s power to “establish . . . uniform Laws on the subject of Bankruptcies throughout the United States” is consistent with this pro-creditor history. Through this provision, the Framers empowered Congress to knit together the nation into a uniform common market. Congress accomplished this goal in large part by overriding state discriminatory barriers that prevented creditors from collecting debts efficiently. Justice Joseph Story claimed that granting the bankruptcy power to the federal government was a necessary response to the tendency of a “mass of politicians, who will deem it more safe to consult their own temporary interests and popularity” to prefer local creditors over providing a “fair share of a ruined debtor” to “distant creditors.”¹ The Bankruptcy Act of 1800, which proved unpopular, was repealed in 1803, and Congress would enact several other bankruptcy codes throughout the nineteenth century. The present-day version traces its roots to the 1978 code. The U.S. Supreme Court has held that bankruptcy laws can apply to merchants and non-merchants alike but must be geographically uniform.

History Before 1787

Bankruptcy law in the United States finds its roots in English commercial law.² The primary purpose of English bankruptcy law was to assist creditors in their efforts to collect debts, not to protect debtors from creditors. Traditionally, a debtor’s insolvency, or failure to pay his debts, was seen as a form of fraud.

The first English bankruptcy law was enacted in 1542 during the reign of King Henry VIII.³ The law enabled creditors to seize and sell a debtor’s assets for purposes of distribution to creditors. The statute, however, did not provide for the debts to be discharged, or canceled. Only creditors could involuntarily commence a bankruptcy proceeding against a debtor.⁴

The Statute of Anne (1705) introduced the idea of enabling traders or merchants who cooperated with creditors to discharge their debts provided certain conditions were met. In the eighteenth century, English bankruptcy law began to focus less on the idea of the debtor’s culpability and fraudulent behavior and instead came to distinguish between “bankruptcies” on the one hand and “insolvency” on the other. Only merchants and traders could be declared “bankrupt,” which enabled them to have their debts discharged upon the satisfaction of certain requirements. Sir William Blackstone observed that “the laws of bankruptcy are considered as laws calculated for the benefit of trade, and founded on the principles of humanity as well as justice.”⁵ Blackstone explained that the laws of England “allow the benefit of the laws of bankruptcy to none but actual traders; since that set of men are, generally speaking, the only persons liable to accidental losses, and an inability of paying their debts, without any fault of their own.”⁶

By contrast, non-merchant debtors under English law were seen as fraudulent actors who had to seek refuge under so-called insolvency laws. These laws did little more than release a debtor from debtor’s prison; they did not discharge his debts. This dichotomy suggests that the Constitution’s grant of power to Congress to enact a “bankruptcies” law may have referred only to the power to adjust the debts of merchants, not individual debtors. On the other hand, some commentators have argued that by the end of the eighteenth century, the legal definition of “merchant” had expanded to the point that this traditional limitation on bankruptcy had largely disappeared, except as applied to farmers.⁷ English law, however, retained distinct insolvency and bankruptcy acts until the 1860s.

Bankruptcy law in the colonies followed English law in a somewhat haphazard fashion. Some colonies had bankruptcy laws, and others had insolvency laws with varying degrees of liberality.⁸ Under the Articles of Confederation, there was no national bankruptcy law. Thus, by 1787, the states had enacted a patchwork of different laws. Conflicts arose when one state purported to discharge a debt and then, when a debtor relocated to another state, a creditor tried to collect the same debt in the new state.⁹ Pro-debtor state laws—particularly those protecting farmers over out-of-state creditors by creating obstacles to foreclosure—interfered with the reliability of contracts. Moreover, courts in these pro-debtor states made it difficult for creditors to collect their judgments, especially when debtors absconded to other states to avoid collection.

The Constitutional Convention

During the Constitutional Convention, the subject of bankruptcy received minimal discussion. The most pressing goal was to establish a national bankruptcy law to address conflicting state laws that discriminated against out-of-state creditors.

On September 3, 1787, the Convention briefly debated the Bankruptcy Clause. Roger Sherman of Connecticut observed that under English law, bankruptcies could be punishable by death in some cases, and he opposed granting such a power to Congress.¹⁰ Gouverneur Morris of Pennsylvania supported the proposal because “he saw no danger of abuse of the power” by Congress.¹¹ On September 3, 1787, the proposal to empower Congress “[t]o establish uniform laws on the subject of bankruptcies” passed the Convention by a vote of 9 to 1.¹² Only Sherman’s state of Connecticut voted in the negative.¹³

The Ratification Debates

During the ratification process, the bankruptcy power received minimal debate. In Federalist No. 42, James Madison observed that the “expediency” for uniform bankruptcy laws would “not likely . . . be drawn into question.” He explained that these laws “will prevent so many frauds where the parties or their property may lie or be removed into different States.” Madison added that federal court jurisdiction over bankruptcy mitigated the problems that arose from state court biases against out-of-state creditors. Madison further argued that the bankruptcy laws were “so intimately connected with the regulation of commerce” that they would not be controversial.

Unsurprisingly, some Anti-Federalists objected to this new federal power. Federal Farmer, for example, feared the bankruptcy power would “immediately and extensively interfere with the internal police of the separate states” and embody a massive transfer of power to the federal judiciary.¹⁴

The New York ratifying convention passed a resolution that the Constitution should be amended to limit the federal government’s power over bankruptcy. Under the proposal, “the power of Congress to pass uniform laws concerning bankruptcy” would “only extend to merchants and other traders,” and “the States respectively [might] pass laws for the relief of other insolvent debtors.”¹⁵ New York’s proposal was consistent with the historical dichotomy in England: Merchants and traders could use the bankruptcy laws; debtors could use the insolvency laws. On the other hand, contemporary dictionaries suggest that by the late-eighteenth century, the term “bankrupt” was commonly used in its broader sense to refer to any person who was unable to pay his debts and that the terms “bankruptcy” and “insolvency” were synonymous.¹⁶

Early Practice

Congress did not exercise its new power over bankruptcy immediately. In the absence of federal bankruptcy law, all debtor–creditor relations were governed by state law. Financial panics in 1792 and 1797, however, resulted in widespread ruin and the imprisonment of thousands of debtors.¹⁷ They also produced political pressure from merchant interests. The Federalist-controlled Congress narrowly passed the Bankruptcy Act of 1800,¹⁸ which was opposed by Anti-Federalist southerners and agricultural interests. The act was nearly identical to prevailing English law: Fraudulent bankruptcy was a criminal act but was not punishable by death.¹⁹

The 1800 Act was unpopular from the time of its enactment.²⁰ Debtors viewed the law as inefficient and subject to abuse by debtors, and farmers contended that it favored merchant interests. Moreover, involved parties were burdened by the obligation to travel to distant federal courts. In 1803, the Democratic-Republican-controlled Congress repealed the law.²¹

Other bankruptcy laws existed from 1841 to 1843 and from 1867 to 1878.²² The first permanent bankruptcy law was enacted in 1898 and remained in effect, with amendments, for nearly a century.²³ In 1978, Congress enacted a comprehensive new law, the essential structure of which remains in effect today.²⁴

Judicial Precedent

Sturges v. Crowninshield (1819) was an early Supreme Court decision that considered the line between the federal government’s power over bankruptcy and state laws.²⁵ New York State enacted a law that liberated the debtor from prison and also purported to discharge the debtor from his debts. Historically, such discharges were characteristic of bankruptcy laws, as insolvency laws did not provide for discharges. Chief Justice John Marshall held that to the extent the state law purported to discharge the debtor from his debts, it constituted a state impairment of contracts and was therefore unconstitutional. The creditor in the case did not seek confinement of the debtor to prison, so that issue was not relevant. But Marshall also explained that a state could not pass a bankruptcy law that discharged a debtor, but the term “bankruptcies” in the Constitution did not limit Congress to the regulation of merchant bankruptcies, the traditional scope of bankruptcy law. Rather, Congress’s authority could also reach individuals who were traditionally subject to state insolvency laws. As a result, Congress could legislate with respect to both merchants and non-merchants. Therefore, while the state law would be valid in protecting a debtor from confinement to prison for non-payment of debts (the traditional scope of a state insolvency law), the law was invalid to the extent that it purported to discharge the debtor’s debts.

Ogden v. Saunders (1827) further restricted the states’ concurrent power over bankruptcy.²⁶ A state’s law could not discharge debts owed to citizens of another state, but states could discharge debts owed to a citizen of that same state as long as the law operated prospectively so as not to impair existing contract obligations.

The Supreme Court also maintained that any federal bankruptcy law must be “uniform throughout the United States.”²⁷ The 1898 Bankruptcy Act recognized property exemptions under state law that vary widely from state to state. Hanover National Bank v. Moyses (1902) held that this “personal” nonuniformity in treatment among individuals was permissible as long as “geographical” uniformity was preserved.²⁸ Thus, debtors and creditors in different states may receive different treatment as long as the debtors and creditors within the same state are treated the same. The “uniformity” requirement, however, apparently does forbid “private” or “personal” bankruptcy laws that affect only particular debtors.²⁹

The separation of powers and the nature of the judicial power under Article III place certain restraints on bankruptcy courts, which are units of the U.S. district courts. The Supreme Court has also addressed the status of bankruptcy proceedings. Bankruptcy judges are so-called Article I judges. They are appointed for a term of years rather than for life during good behavior and lack many of the formal protections for judicial independence under Article III.

Granfinanciera, S.A. v. Nordberg (1989) held that Seventh Amendment jury trial rights are preserved in bankruptcy court.³⁰ Stern v. Marshall (2011) held that a bankruptcy judge lacked the power to enter a final judgment because such an order violated the right to have a particular state-law counterclaim heard by an Article III judge.³¹ Wellness International Network v. Sharif (2015) held that the right to an adjudication by an Article III tribunal is an individual right that can be waived (as in Granfinanciera), not a jurisdictional limit on the bankruptcy court.³² As a result, parties can consent to allowing a non–Article III tribunal to enter a final order or judgment otherwise requiring Article III adjudication. The Court further held that such consent need not be express but may be implied.

Harrington v. Purdue Pharma (2024) arose from the manufacture and sale of the notorious opioid prescription pain reliever OxyContin.³³ The Supreme Court held that the Bankruptcy Code does not authorize a court to issue a release and injunction that effectively discharges claims against a non-debtor party without the consent of affected plaintiffs.³⁴ The Court did not decide whether the Bankruptcy Clause would authorize a protective injunction for the benefit of third parties. But some scholars have argued that such injunctions are not authorized.³⁵ Rather, they claim that the Bankruptcy Clause only permits Congress to readjust relationships between debtors and credits, not third parties.

Open Questions

• The first three bankruptcy laws (1800, 1841, and 1867) required the debtor’s insolvency as a condition for filing bankruptcy. However, under the 1898 and 1978 Codes, proof of insolvency is not required as a jurisdictional condition for invoking bankruptcy protection, except in the case of municipal bankruptcies. As a matter of original meaning, does Congress’s bankruptcy power extend only to insolvent debtors?³⁶
• Does Congress’s power to adjust the relationship between debtors and creditors also extend to relations with third parties?³⁷

1. 3 Story’s Commentaries, § 1102. ↩︎
2. Charles Jordan Tabb, The History of the Bankruptcy Laws in the United States, 3 Am. Bankr. L. Inst. L. Rev. 5 (1995); Stephen J. Lubben, A New Understanding of the Bankruptcy Clause, 64 Case Western Res. L. Rev. 319 (2013). ↩︎
3. An Act Against Such Persons as Do Make Bankrupts, 34 & 35 Henry VIII, c. 4 (Eng. 1542). ↩︎
4. The Case of Bankrupts (Smith v. Mills), 2 Coke Report 25a, 76 ER 441–76 (1584). ↩︎
5. 2 Blackstone 471–72. ↩︎
6. Id. at 473 (emphasis in original). ↩︎
7. Thomas E. Plank, The Constitutional Limits of Bankruptcy, 63 Tenn. L. Rev. 487, 508–09 (1996). ↩︎
8. Tabb, at 12. ↩︎
9. Kurt H. Nadelman, On the Origin of the Bankruptcy Clause, 1 Am. J. Legal Hist. 215 (1957). ↩︎
10. 2 Farrand’s 441. ↩︎
11. Id. ↩︎
12. Id. at 488. ↩︎
13. Id. ↩︎
14. Storing 2.8.221. ↩︎
15. N.Y. Ratification Debates and Proceedings (July 25, 1788), https://perma.cc/F9M2-SCFP. ↩︎
16. Plank, supra at 529–30. ↩︎
17. Tabb, supra at 14. ↩︎
18. Act of Apr. 4, 1800, ch. 19, 2 Stat. 19 (repealed 1803). ↩︎
19. Tabb, at 14. ↩︎
20. Id. ↩︎
21. Act of Dec. 19, 1803, ch. 6, 2 Stat. 248 (repealed 1841). ↩︎
22. Act of Aug. 19, 1841, ch. 9, 5 Stat. 440 (repealed 1843); Act of Mar. 2, 1867, ch. 176, 14 Stat. 517 (repealed 1878). ↩︎
23. Act of July 1, 1898, ch. 541, 30 Stat. 544 (repealed 1978). ↩︎
24. Act of Nov. 6, 1978, Pub. L. 95-598, 92 Stat. 2549. ↩︎
25. 17 U.S. (4 Wheat.) 122 (1819). ↩︎
26. 25 U.S. (12 Wheat.) 213 (1827). ↩︎
27. 25 U.S. (12 Wheat.) at 313. ↩︎
28. 186 U.S. 181 (1902). ↩︎
29. Id. at 188. ↩︎
30. 492 U.S. 33 (1989). ↩︎
31. 564 U.S. 462 (2011). ↩︎
32. 575 U.S. 665 (2015). ↩︎
33. 603 U.S. 204 (2024). ↩︎
34. Id. at 226–27. ↩︎
35. Plank, supra at 560–62. ↩︎
36. Id. at 546–47. ↩︎
37. Id. at 560–62. ↩︎