Why We Need Bankruptcy, and How It Developed

Driving the Ambulance, Not the Hearse: The idea that bankruptcy is useful and important was something I learned as a child in Canada. I grew up with bankruptcy because my father, Murray Hahn, was an accountant who specialized in insolvency. (In Canada, the role of bankruptcy trustee is often filled by an accountant.) As I got older I would, from time to time, help out in my father’s office, where I learned about insolvency and bankruptcy.

My grandfather Irving Hahn often worked for my father. My grandfather’s job was to process the assets when a small business needed to be liquidated. After taking a full inventory, he would organize whatever he found to ensure that what remained of the business could be accounted for and sold efficiently. As a teenager, I sometimes helped my grandfather, and I have many memories of counting, lifting, moving, and organizing.

My father was an innovator in his field, and I grew up watching him assist many, many people. Murray Hahn saw his job as being more than a businessman: He taught me that the role of the bankruptcy trustee was to give the honest debtor a second chance, a task he carried out for many years. In February 1997, his professional contributions were honored when he was made a life member of the Canadian Insolvency Practitioners Association.

Over the years, my father handled a great many bankruptcies, sometimes for high-profile companies. However, he also helped individuals, including many small-business owners. His favorite saying was that his job was to “drive the ambulance, not the hearse.”

As such, my father devoted much of his time to counseling people who were down on their luck. He taught his clients how to reorganize their obligations and how to budget their money, making it possible for them to continue to earn a living and, thus, maintain their dignity.

When my father talked about his work, he would tell me that he considered himself to be as much a social worker as an accountant. Over the years, as I watched him help so many clients and their families, I realized just how important his job was — what he did made a positive difference.

As a result, I learned a lot about why businesses fail (the biggest reason being poor management) and how important bankruptcy could be to both individuals and businesses, small businesses in particular. What I didn’t understand until I was older is that bankruptcy itself is one of the most important tools of modern economics.

The Story of Robert Morris: In the early days of the United States, the most prominent American to become insolvent was Robert Morris, a highly accomplished statesman and businessman. His story illustrates how difficult life could be for insolvent debtors before it was possible to go bankrupt.

Robert Morris was born in Liverpool, England, in 1734 and emigrated to the U.S. when he was 13 years old. As an adult, Morris held a large variety of important public offices. He was, at various times, a member of the Pennsylvania Assembly, a delegate to the Second Continental Congress, and the U.S. Superintendent of Finance. In addition, he was one of Pennsylvania’s two original U.S. senators. During his tenure as the powerful U.S. Superintendent of Finance (1781-1784), Morris was charged with managing the economy of the brand new United States of America. As such, he was considered to be the second most powerful person in the country, after George Washington.

(Historical footnote: Robert Morris was one of only two people to sign the three most important documents in early U.S. history: the Declaration of Independence, the Articles of Confederation, and the United States Constitution. The only other triple-signer was Roger Sherman, a Connecticut lawyer and politician.)

Over time, Morris became extremely wealthy by buying and selling land. So much so that, eventually, he became the largest single landowner in the country. Nevertheless, in spite of all his wealth, experience, acumen, and political connections, Morris ended up in serious financial trouble. By the late 1790s, his land speculation businesses were over-leveraged and losing money. In 1796, a real estate bubble burst, which led to a severe recession referred to as the Panic of 1796-1797. The resulting deflation devastated many businesses, and within a short time, Morris found himself owing large sums of money.

Once deflation devalued his holdings, Morris found he didn’t have enough cash to pay his creditors. They sued him, and in February 1798, at age 64, Morris was found guilty and sent to debtors’ prison in Philadelphia, where he was to remain for three and a half years, until August 1801. After his release, Morris suffered from poor health. He retired permanently to a modest home in Philadelphia where he died five years later, in 1806.

As you will see in a moment, the U.S. government passed the very first federal bankruptcy law in 1800. In fact, one reason the law was passed at that particular time was to provide a way for Morris to be released from captivity. Once people saw that such a distinguished individual as Robert Morris could be sent to debtor’s prison, they realized that there was a clear need to find better ways to deal with insolvency.

Early Bankruptcy Law in the United States: For a long time, bankruptcy in Europe and in North America has been considered so important as to be placed under federal jurisdiction. In the United States, for instance, even though individual states are allowed to make their own bankruptcy rules, they must be based on U.S. federal law. Article 1, Section 8, Clause 4 of the U.S. Constitution mandates that Congress shall have power to establish “uniform laws on the subject of bankruptcies throughout the United States.”

In Canada, similar powers were given to the federal government by the British North America Act of 1867. Two years later, the Canadian government passed the first bankruptcy law, the Insolvent Act of 1869. In England, modern bankruptcy dates from the same time, with the Debtor’s Act of 1869.

In the United States, although constitutional authority was established in 1789, it took 11 years for the first American bankruptcy law to be passed, the Bankruptcy Act of 1800, which was modeled after the British laws in effect at the time. (As I mentioned above, one of the prime motivations for this law was to provide a way to release Robert Morris from debtors prison.)

The Bankruptcy Act of 1800 made it possible, for the first time, for U.S. citizens to be declared legally insolvent. However, this right lasted only three years, as the law was repealed in 1803. The reason was that, at first, all U.S. bankruptcy laws were temporary. They were passed only in response to dire financial conditions and were repealed once the economy recovered.

Here are the highlights:

1800: Bankruptcy was introduced in the United States in response to the Panic of 1796-1797 (a severe recession). This law was biased in favor of creditors and applied only to individuals, not to companies.

1803: The Bankruptcy Act of 1800 was repealed after only three years.

1841: A second bankruptcy law was passed in response to another recession, the Panic of 1837.

1843: The Bankruptcy Act of 1841 was repealed after only two years.

1867: A third bankruptcy law was passed in the aftermath of the financial chaos caused by the Civil War. For the first time, bankruptcy protection was extended to companies as well as individuals.

1878: The Bankruptcy Act of 1867 was repealed after 11 years.

Author’s Note: “Understanding Bankruptcy” is a series of seven columns to help you understand our modern bankruptcy system and how it works. I suggest that you start with the first column and read them in order, if you have not already done so. As a reference aid, I have created a comprehensive glossary of bankruptcy-related terms. You can find it in the “Money and Economics” section of my website.