Cite as: Keith M. Lundin, Lundin On Chapter 13, § 2.1, at ¶ ____, LundinOnChapter13.com (last visited __________).
This is not a history book. But consumer bankruptcy in the United States is such a creature of its times that you’ll miss the drift if you don’t know something about the context.
There have been five periods1 in the history of wage earner relief in United States bankruptcy law. Prior to 1931, there was the Era of Darkness. It’s not that there weren’t bankruptcy laws–there were, on and off, beginning with the 1800 enactment2 and, most famously, the Bankruptcy Act of 1898.3 Some of those laws included individual bankruptcy relief to one degree or another. But there was no bankruptcy law in America that specifically addressed wage earners until the twentieth century.
The Valentine Nesbit Era began in Birmingham, Alabama, in 1933, and ended with enactment of the Chandler Act in 1938.4 As explained below, Valentine Nesbit was the architect of what we call “Chapter 13,” but we are ahead of ourselves.
The four decades from 1938 to 1978 were controlled by the Chandler Act and the Chandler Act Era it is. The Chandler Act gave us Chapter XIII—the Roman numeral predecessor to the Chapter 13 that arrived in 1978.
The Bankruptcy Reform Act of 19785 ushered in the fourth period—the Chapter 13 Unbroken Era. No value judgment there. Writing history is different from most other composition—readers expect some author bias, and the clearer that message, the easier it is to read without fear of hidden meanings.6
This section starts with Valentine Nesbit (1931) and ends with Chapter 13 Unbroken (1978–2005). A warning repeated: This is not a history text. If you want details, if not the whole truth, check the notes below.
Valentine Nesbit Era
Wage earner rehabilitation in America began in Birmingham, Alabama, in April 1933. That kind of precision is only possible through the good works of others: Timothy W. Dixon and David G. Epstein best tell the story in Where Did Chapter 13 Come from and Where Should It Go?.9 You should find an hour to read this article. There is an important sense in which the history of wage earner relief in America is about heart and soul—and the loss thereof—and the authors of this article get that.
Before Birmingham in 1933, there was sporadic consumer relief in the bankruptcy laws in the United States10 but nothing you would recognize as wage earner payment of debt over time. For that you have to look to England or Canada, and a few important investigations of bankruptcy in America did just that as the Depression put pressure on the nascent consumer bankruptcy system under the Bankruptcy Act of 1898. The principal investigator for the 1930 Donovan Report on Bankruptcy in New York City was a U.S. district court judge named Thomas Thacher. As part of the Donovan investigation, Judge Thacher traveled to England and studied the English bankruptcy system with its “emphasis on rehabilitation rather than liquidation and its use of compositions and extensions of debtors under the supervision of the court.”11
Thacher became Solicitor General of the United States. He did further study of bankruptcy for President Herbert Hoover that resulted in legislation that would have added to U.S. bankruptcy law a “Section 75” to permit wage earners to pay debts from future earnings over two years with court protection. It didn’t pass.12 What was enacted in 1933—“Section 74”—dealt with business bankruptcy, inefficiently at that.
The condition of wage earners in Alabama in 1933 reflected the country as a whole. There was an increasing volume of personal bankruptcy by folks who had jobs but sought bankruptcy relief—in spite of the “stigma”—because garnishments were wrecking their jobs and their ability to provide for their families. A U.S. district court judge in Northern Alabama—W.I. Grubb—took much personal interest in the plight of wage earners and their families in the Birmingham area. One month after enactment of the new Section 74 legislation for business bankruptcies, Judge Grubb appointed a “wealthy and socially prominent”13 Birmingham lawyer, Valentine Nesbit, “special referee in bankruptcy” under Section 74.
Nesbit was a man with a mission. He recognized that Section 74 of the 1933 Act was intended to rehabilitate businesses. But his personal observations of debtors in Birmingham convinced him that the bankruptcy system had to provide relief to wage earners that would protect them from garnishments while they kept their jobs and paid their debts. For Nesbit it was about families: “I am not trying so much to protect the debtor, but his family. . . . That debtor owes a social obligation to society to provide for his family.”14
Section 74 of the 1933 Act was not suited to what Nesbit and Judge Grubb had in mind. They literally did it anyway. Here is how Dixon and Epstein describe what happened in Birmingham between 1933 and 1938:
Having committed to offering relief to wage earners, Nesbit devised procedures to carry out this commitment. When a petition for relief was filed under section 74, the court referred it to Special Referee Nesbit. A notice setting the time and date for a hearing was mailed to each creditor and to the debtor ten days in advance of the scheduled hearing. At the hearing the debtor was sworn and examined as to his earnings, expenses, debts, and family situation to determine what amount he and his family needed to live on each month and what amount might be paid against his indebtedness.
. . . Nesbit took into account the debtor’s social station in determining need, so the debtor could maintain appearances. The debtor would make a proposal for payment of both secured and unsecured creditors. The proposal would be calendared for a confirmation hearing. If the proposal was approved by a majority in amount and number of the creditors whose claims were filed and approved, the proposal would be confirmed and bind both the debtor and creditors. Nesbit estimated the length of time the court was involved in the matter to be four to seven minutes.
Occasionally there would be disagreements over the proposals. In those cases, Nesbit would dispense justice and equity “as he saw fit,” confirming proposals that he considered fair for all concerned. He resorted to “strong arm” tactics from time to time, particularly in reducing the claims of “loan sharks,” short-term moneylenders. He would tell an objecting creditor to appeal the issue to Judge Grubb who would then support Nesbit’s position in the matter.
At first, Nesbit’s procedures called for the debtors to remit payments directly to the creditors. This did not work well. . . .
Nesbit created the position of “supervisor.” A supervisor was appointed to collect and disburse all payments in accordance with the approved proposals.
. . . Two methods of payment to the supervisor were used. In the first, the debtor paid the agreed amount to the supervisor. In the second, the debtor’s employer deducted the agreed amount from his pay and remitted it to the supervisor’s office. If a debtor failed to make payments as provided in his proposal, Nesbit would issue an order on the debtor’s wages that required the employer either to make monthly deductions from the debtor’s pay, or remit the debtor’s entire earnings to the Debtor’s Court for division by the court. These procedures were used for all of Nesbit’s cases.
. . . After the debtor had paid in full the debts approved in the proposal, Nesbit closed the case by recommending to the Federal District Court judge that an order be entered dismissing the case. The order would state that the debts had been paid in full, and be a matter of record.15
Sound familiar? It does because the Valentine Nesbit Era in Birmingham birthed the wage earner provisions of the Chandler Act in 1938. Between April 1933 and 1938, Special Referee Nesbit administered 3,421 wage earner cases under Section 74 in Birmingham.16 More than 90 percent of total creditor claims were paid in those cases.17 It was later said that the credit community in Birmingham was “loud in their praise” of the “Debtor’s Court” run by Valentine Nesbit.18
Despite its success, the Birmingham Debtor’s Court did not spread to other parts of the country. Dixon and Epstein surmised that Valentine Nesbit’s special skills and personality had much to do with both the success in Birmingham and the difficulty of export to other districts.19
In any case, the Depression continued and Congress contemplated bankruptcy reform almost continuously from 1933 to 1938. The laboring oar fell to a junior congressman from Memphis, Tennessee, Walter Clift Chandler. Congressman Chandler had been City Attorney in Memphis and was personally familiar with the plight of city employees chased by garnishing creditors without court protection. Chandler heard about the Debtor’s Court in Birmingham and reached out to Nesbit. Nesbit responded generously with repeated drafts of wage earner bankruptcy legislation and with testimony at congressional hearings.
Valentine Nesbit literally authored several of the bills that became Chapter XIII of the Chandler Act of 1938.20 There is no mistaking that wage earner bankruptcy in America between 1938 and 1978 mirrored the Birmingham experience in many important aspects—its procedures, strengths and weaknesses.
Chandler Act Era
In his fine History of Bankruptcy Law in America, David Skeel, Jr., gives this account of consumer bankruptcy during the Chandler Act Era from 1938 to 1978:
[T]he Chandler Act had a relatively modest influence on general bankruptcy practice. It introduced consumer repayment plans—Chapter XIII—and expanded the scope of bankruptcy practice in some respects. . . .
. . . Probably the most lasting change to personal bankruptcy was the introduction of consumer repayment plans under Chapter XIII. When Chapter XIII was enacted, lawmakers believed that many debtors would choose this option in order to minimize the stigma of their bankruptcy filing. In reality, most did not, and the percentage of Chapter XIII plans, as compared to immediate discharges, varied dramatically from district to district. Debtors “use Chapter XIII,” according to an influential 1971 Brookings Institution study, “only if it is favored by local usage or if it is the preference of their lawyers.” In Alabama, whose referees had pioneered the approach, a substantial majority of debtors used Chapter XIII. Elsewhere, the reverse was true, as most debtors sought an immediate discharge. . . .
* * * *
With the 1960s came increasingly vocal calls for Congress to undertake its first global reconsideration of the bankruptcy laws since the Chandler Act. The reason for the sudden interest in bankruptcy was simple: bankruptcy filings had risen to previously unheard-of levels, and each year seemed to bring a new record. After hovering around 10,000 per year in the mid-1940s, the number of personal bankruptcies had begun a steady climb thereafter. In 1960, the filings reached 97,750; and they surged over 100,000 the following year, to 131,402—more than a tenfold increase in a period of just fifteen years . . . . These numbers seem almost quaint now, in an era that has seen over a million filings in each of the past several years. But at the time, most observers saw the numbers as real cause for alarm.
Nearly everyone suspected the record number of bankruptcy filings was somehow related to the rise of consumer credit. This was the dawn of credit cards, and an era when consumers incurred more installment credit than ever before. . . . [C]onsumer debt expanded from $30 billion in 1945 to $569 billion in 1974. . . . [T]here was a rough consensus that bankruptcy and consumer credit went hand in hand.21
In 1970, there were 178,202 personal bankruptcy filings under the Chandler Act. Of that number, 30,51022 were filed under Chapter XIII. As Skeel details, there were problems with the Chandler Act. There was the perception that a tight-knit “ring” of professionals controlled bankruptcy practice. The status of bankruptcy “judges”23 was uncertain, and there were jurisdictional problems with the extent of property of the bankruptcy estate. “Summary” versus “plenary” proceedings bedeviled everyone. The definition of “claims” was convoluted, and there was widespread dissatisfaction with state variations in exemptions in bankruptcy cases.
Specific to Chapter XIII cases, there were huge regional variations in use of the chapter and no consistency of outcome from district to district. Secured creditors could not be forced to participate in a Chapter XIII plan, giving rise to the oxymoronic practice of providing for secured creditors “outside” the Chapter XIII plan. Real estate-secured loans were out of reach altogether in a Chapter XIII case.
In 1970, Congress authorized a National Bankruptcy Review Commission with a broad mandate to study existing bankruptcy law. The Commission reported in 1973.24 In the meantime, an influential Brookings Institution study was published in 1971.25 Skeel describes the 1973 Commission Report and the legislative considerations that led to the Bankruptcy Reform Act of 1978:
[The 1971 Brookings Institution study] criticized the wide variations from one region to the next on issues such as the percentage of debtors who proposed rehabilitation plans rather than seeking an immediate discharge.
The Brookings report called for Congress to completely rethink the bankruptcy process. . . .
The National Bankruptcy Review Commission . . . relied heavily on the [Brookings] report's empirical work . . . . “The Commission’s investigations have convinced it that the average consumer bankrupt today has no understanding of the options available to him under the Bankruptcy Act,” the commissioners wrote, and “probably no ability to calculate unassisted which option [as between immediate discharge or an individual rehabilitation plan] may be feasible or desirable for him.” . . .
* * * *
In addition to exemptions, the most important consumer bankruptcy issues involved the nature and scope of the bankruptcy discharge. Starting in the 1960s, the consumer credit industry had repeatedly urged lawmakers to adopt variations on what would now be called a “means test”— that is, a provision that forces debtors to use Chapter 13 rather than Chapter 7 if they are capable of repaying at least some of their debts. A crucial question for the 1970 commission was whether to develop a means-testing proposal.
. . . [T]he commission rejected creditors['] calls for restrictions on Chapter 7. After noting that lawmakers had rejected means testing in the past and that groups such as the ABA continued to oppose this approach, the commission concluded that “forced participation in a [Chapter 13 plan] has so little prospect for success that it should not be adopted as a feature of the bankruptcy system.”
Although it rejected means testing, the commission did agree that not enough debtors invoked Chapter 13 and attempted to repay some of their obligations. Rather than mandating Chapter 13, the commission concluded that the best way to increase the percentage of Chapter 13 cases would be to make the repayment option more enticing—that is, to sweeten the Chapter 13 pot. The commission therefore proposed to give Chapter 13 debtors a variety of powers that would not be available if the debtor sought an immediate discharge—including the right to cure any defaults on the debtor’s home mortgage and an injunction—referred to as a co-debtor stay—that required creditors to halt any collection efforts against anyone who was jointly responsible for any of the debtor’s obligations. . . .
By the end of the hearings, the list of benefits that would be available in Chapter 13 but not Chapter 7 had grown still larger. A particularly important addition involved one of the oldest limitations on a debtor’s discharge—the denial of a discharge for any debt that was based on a fraudulent financial statement. . . . The commission agreed with the consumer advocates’ concerns noting, “Substantial evidence of the abuses of this exception by creditors has come to the attention of the Commission,” and the commission concluded that the exceptions should no longer apply to consumer debtors. . . . In the end, the creditors and prodebtor advocates reached a compromise. Although the fraud exception would be retained in Chapter 7, even fraudulently incurred obligations could be discharged as part of Chapter 13’s so-called superdischarge.26
For political reasons, there were several versions of the bankruptcy legislation that became the Bankruptcy Reform Act of 1978. Fundamental disputes about state versus federal exemptions, the status of bankruptcy judges and the creation of an independent bankruptcy administrative agency were resolved by compromises—some of which, especially with respect to bankruptcy court jurisdiction, sentenced the bankruptcy community to decades of strident but worthless litigation.
In contrast, the wage earner chapter that emerged in 1978—Chapter 13—sported clean and powerful new provisions favoring the rehabilitation of wage earners. Prophetically, the 1978 law rejected “means testing” in favor of making Chapter 13 more attractive to debtors.27 The Chapter 13 carrots in the 1978 Act included the power to modify secured debt28 other than debt secured by a debtor’s principal residence; a new power to cure default and maintain payments on long-term debt;29 a new codebtor stay;30 and the broadest “superdischarge”31 available to individuals under any chapter of the Bankruptcy Code. The Bankruptcy Reform Act of 1978 began the era of Chapter 13 Unbroken.
Chapter 13 Unbroken Era
Those of us who began consumer bankruptcy practice in the late 1970s remember these messages about the Bankruptcy Reform Act of 1978:
|1.||The 1978 Act removed bankruptcy judges from day-to-day administration of bankruptcy cases. The 1978 Act introduced what became the U.S. Trustee Program housed in the Justice Department, to appoint trustees and to manage some aspects of bankruptcy administration.|
|2.||The 1978 Act expanded bankruptcy court jurisdiction to its constitutional limits to include all property wherever located, all claims of all kinds from all creditors, and all causes of action. “Nationwide jurisdiction” was the buzz, and centralization of the collection of estate assets was realized.|
|3.||Secured creditors could be managed without consent in Chapter 13 cases. Even home mortgages could be rehabilitated by curing default and maintaining payments during the plan. No more “outside” the plan—all creditors would be dealt with through the plan with payment through the standing Chapter 13 trustee in all cases and with respect to all claim holders.|
|4.||Codebtors were protected without separately filing a bankruptcy case to the extent the debtor paid a cosigned claim through a Chapter 13 plan.|
|5.||The superdischarge was a reality. Fraud claims could be discharged in a Chapter 13 case at the completion of payments under the plan.|
In 1979, there were 196,976 nonbusiness bankruptcy filings in the United States; in 1980, that number was 314,886. The consumer credit industry blamed that sudden increase on the Bankruptcy Reform Act of 1978 and almost immediately began lobbying for amendments. Congress reacted in 1984 with two important changes to consumer bankruptcy law: the addition of a “substantial abuse” ground for dismissal of a Chapter 7 case;32 and the addition to the confirmation requirements in a Chapter 13 case that on proper objection, the debtor must commit all “disposable income” to the plan for at least three years.33 It is noteworthy that in 1984, Congress considered but again rejected the concept of a “means test” for admission to Chapter 7. By 1994, nonbusiness bankruptcy filings had risen to 780,455.
In 1994, Congress created another commission to study the bankruptcy laws and recommend changes. This Bankruptcy Review Commission is discussed elsewhere.34 For current purposes, the 1994 Commission began the process that ended with BAPCPA.35
By 2004, nonbusiness bankruptcy filings in the United States had risen to 1,563,145. The percentage of Chapter 13 cases approached 30 percent in many years between 1979 and 2004 but stalled within a percentage or two of that level in most years. The overall size of the Chapter 13 program grew dramatically during the Era of Chapter 13 Unbroken. The sheer number of cases and the three- to five-year life expectancy of each case produced a huge Chapter 13 industry. By 2004, the Chapter 13 trustees were distributing to creditors close to $5 billion each year. There were 449,129 Chapter 13 cases filed in 2004. Distributions to unsecured creditors in Chapter 13 cases in 2004 totaled $1 billion.
In 2005, Congress passed BAPCPA and the Chapter 13 Unbroken Era came to an abrupt end.36
1 David Skeel, Jr., Debt’s Dominion, A History of Bankruptcy Law in America (2001), says there were three eras of United States bankruptcy law. David is a fine legal historian and should be believed.
2 Bankruptcy Act of 1800, 2 Stat. 19 (repealed 1803).
3 Bankruptcy Act of 1898, 30 Stat. 544 (repealed 1978).
4 Pub. L. No. 75-696, 52 Stat. 840 (1938).
5 Pub. L. No. 95-598, 92 Stat. 2549 (1978).
6 My rationalization and I’m sticking with it.
7 Pub. L. No. 109-8, 119 Stat. 23 (2005).
9 Timothy W. Dixon & David G. Epstein, Where Did Chapter 13 Come from and Where Should It Go?, 10 Am. Bankr. Inst. L. Rev. 741 (2002) [hereinafter Dixon & Epstein].
10 See David Skeel, Jr., Debt’s Dominion, A History of Bankruptcy Law in America (2001) [hereinafter Skeel].
11 Dixon & Epstein, at 744.
12 Except with respect to compositions and extensions for farmers. See Dixon & Epstein, at 745–46.
13 Dixon & Epstein, at 747.
14 Dixon & Epstein, at 748.
15 Dixon & Epstein, at 750–52 (internal footnotes omitted).
16 Dixon & Epstein, at 752.
17 Dixon & Epstein, at 753.
18 Dixon & Epstein, at 753.
19 Dixon & Epstein, at 753–55.
20 Dixon & Epstein, at 757–59. Nesbit received important encouragement from the National Retail Credit Association.
21 Skeel, at 131–36.
22 Christopher M. McHugh, The 2002 Bankruptcy Yearbook & Almanac 9 (New Generation Research 2002).
23 So renamed from “referees” in 1973.
24 Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. No. 93-137 (1973).
25 David T. Stanley & Marjorie Girth, Bankruptcy: Problem, Process, Reform (Washington, D.C.: Brookings Inst., 1971).
26 Skeel, at 142–55 (internal footnotes omitted).
27 Contrast the overtly anti-debtor ideology that led to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. See § 2.2 Brief History, Including “Legislative History,” of BAPCPA.
28 See 11 U.S.C. § 1322(b)(2), discussed in § 74.11 The Power to Modify.
29 See 11 U.S.C. § 1322(b)(5), discussed in § 78.4 Curing Default, Waiving Default, Maintaining Payments and Combinations and § 81.1 Overview: General Rules for Saving Debtor’s Home.
30 See 11 U.S.C. § 1301, discussed in § 65.1 Cosigners and Joint Obligors Are Protected, § 65.2 Consumer Debts Only, § 65.3 Codebtor Heaven after BAPCPA, § 65.4 Can Plan Enlarge Codebtor Stay?, § 65.5 Expiration of Codebtor Stay, § 66.1 Motion Practice, § 66.2 Automatic Relief under § 1301(d), § 66.3 Timing of Request for Relief, § 66.4 Burden of Proof, § 67.1 Codebtor Received the Consideration, § 67.2 Plan Does Not Pay Debt in Full, § 67.3 Postpetition Interest, Attorneys’ Fees, Costs and Other Charges, § 67.4 Can Creditor Collect Original Contract Payment from Codebtor?, § 67.5 Irreparable Harm and § 67.6 Annulment of Codebtor Stay.
31 See 11 U.S.C. § 1328(a), discussed in § 157.1 Broadest Discharge Available.
32 See 11 U.S.C. § 707(b).
33 See 11 U.S.C. § 1325(b).
35 Pub. L. No. 109-8, 119 Stat. 23 (2005). See § 2.2 Brief History, Including “Legislative History,” of BAPCPA.