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Calvinism Reborn: Bankruptcy 2.0

“Back during Christmas, CitiBank was calling me on the phone. The Rep was telling me that he was going to find me and get me if I did not pay my bills. I was actually getting very scared. He would call me three or four times a day and say, ‘Your time is running out.’” Tina, Female, 37, Single, Caucasian, Beautician. Earlier this week, Elizabeth Warren introduced the Consumer Bankruptcy Reform Act of 2020, a culmination of bankruptcy reforms she’s been talking about for over twenty years. What’s on her wish list? Student loans, cheaper filing fees, no more mandatory rehabilitation classes, and a single chapter that streamlines consumer bankruptcy practice. The legislation would roll back many of the provisions of the 2005 “No Creditors Left Behind” law, a modern peasant thrift manual that cut the number of consumer filers by half. In our first article on bankruptcy, we traced the development of early bankruptcy protection from debtors’s prison to the celebrated equity receivership practice in the early 20th century. Now, as we await the latest upheaval to modern bankruptcy practice, we outline how American bankruptcy law swung from one of the most progressive systems in the world to the Calvinist morality tale that it is today.

The Casino and The Alms House

The 1930s Depression era was a time of ill repute for corporate law. After the House of Morgan toppled from grace in 1929, populist ire turned against Wall Street and its fleet of attorneys who became regarded as little more than hired guns that lent their craft to a gambling den. William Douglas, the celebrity Supreme Court justice who catapulted his career by hunting down investment banks, described the New York Stock Exchange as a “private club with elements of a casino.” Three decades after the Bankruptcy Act of 1898, corporate reorganization had dovetailed into two distinct groups. The first was an elite Wall Street receivership bar whose fingerprints were left on nearly every large reorganization case. Its members could easily be identified by their illustrious Anglo-Saxon surnames and a pair of casually scuffed buckskin shoes. The second was a decidedly less glamorous (and less profitable) bankruptcy bar whose small-time operations were left to those excluded from the white-shoe firm crowd: namely, Catholics and Jews. One attorney divided the New York bar along clear racial lines: “Cromwells and Cravaths rose to the top; ‘Hebrews’ sank to the bottom.” Jewish lawyers, barred from law firms, discovered that their practice — relegated to personal injury, family law, and insolvency — had become “a dignified road to starvation” not unlike the impoverished country lawyers of Abe Lincoln’s era.

“Wild Bill” Hires A Nanny State

This power imbalance was completely overturned by the efforts of William “Wild Bill” Douglas, a man described by a contemporary as “one of the most unwholesome figures in modern American political history.” Douglas, a natural contrarian who preferred the quiet presence of nature to his more troubling human counterparts, survived more marriages (4), divorces (3), and impeachment attempts (4) than any other supreme court justice. Convinced by his mother from a young age that he was destined for the presidency, Douglas had no interest in currying favor with Wall Street. He spent a mere four months at Cravath, Swaine, and Moore before abandoning it for the less slavish crowds of academia. “I saw just enough of the horrors of Wall Street,” he said, “to know that adequate control of those [corrupt securities] practices must be uncompromising.” In 1934, FDR recruited Douglas from his prestigious position at Yale to join the newly minted SEC, the New Deal reformers’ showcase federal agency. There, Douglas was tasked with investigating the equity receivership practice dominated by Wall Street. One of the first individuals Douglas questioned was his former boss, Robert Swaine, the nation’s most celebrated reorganization lawyer, who he claimed felt as though he had been held upside down and shaken “until all of his fillings fell out.” The investigation shocked its audience. It listed a litany of abuses, among them corruption and nepotism, fleecing investors, and overlooking blatant cases of fraud or mismanagement. “Managements and bankers seek perpetuation of [their] control for the business patronage it commands,” the report complained, “which they take for themselves or allot to others, as they will.” Disciplinary action culminated in the Chandler Act of 1938, which effectively installed a nanny state for any bankruptcy with over $250,000 in liabilities. Bankers and their attorneys were banned from serving as trustee (or advising the trustee) and replaced with an independent party installed by the government. Swaine urged caution, warning that this would leave the process in the hands of ignorant outsiders, but his pleas were ignored: Wall Street elites largely disappeared from bankruptcy practice until the next major reform in 1978.

The Dark Ages of Bankruptcy

Douglas continued his anti-Wall Street crusade on the Supreme Court when he was appointed in 1939. Most notably, he strengthened the absolute priority rule, which prevented senior creditors and shareholders from squeezing out junior creditors. At first, colleagues were relieved at the presence of a corporate bankruptcy expert. “That guy can look at a corporate statement and tell you in a minute if there’s any fornicating going on in the back room,” said one. But the relief was short-lived. Bored with what he publicly called a “4-day-a-week” job, Douglas often dashed off opinions in twenty minutes or less, and used his remaining free time to pen increasingly mythical autobiographies (Go East, Young Man and Of Men and Mountains are among a few of the many titles). His secretaries and law clerks referred to him as “Old Shithead” behind his back, particularly after he told one exhausted woman, “If you hadn’t stopped working, you wouldn’t be tired. Work is energizing.”

The SEC’s new restrictions were nearly as unappealing as their author. Large companies, rather than cede control from management, simply stopped declaring bankruptcy. More than five hundred corporations filed for Chapter X in 1938. That number dropped to sixty-eight in 1944 and hovered around a hundred per year until the mid-1960s. Clever parties side-stepped the issue entirely by filing under a loophole in the cozier waters of Chapter XI (originally designed for small corporate debtors), where managers remained in control, absolute priority was not required, and the SEC was nowhere in sight.

The Modern Bankruptcy Code

By the late 1960s, the quilted bankruptcy law of 1898 had passed its sell-by date years earlier. Consumer filings were on the rise, Chapter X had proven itself an ineffective disaster, and Congress felt primed for reform again. After eight years of Congressional investigation, the SEC had few fans remaining and was quickly relieved of its babysitting responsibilities. Chapter X was scrapped in favor of an updated Chapter XI. Support for keeping managers in place was nearly unanimous, even among creditors. “If management is competent and honest and the debtor’s financial plight is due to circumstances beyond management’s control, bringing in an outsider may not solve anything,” testified one creditor. “Instead, it may only slow the reorganization, add expense and restrict flexibility while the new trustee learns the business.” The sweeping generosity of the Bankruptcy Code of 1978 — for both corporate and consumer filers — made filing and reorganizing a viable business strategy that could be applied to a large number of corporate situations, including failed leveraged buyouts and mass tort cases. Bankruptcy courts were established in each district, and “bankruptcy professionals experienced a meteoric rise in their professional identity, their market position, and the rewards accompanying both.” Moral judgement was minimized by designating each petitioner as a “debtor” rather than a “bankrupt.”

Leave No Creditor Behind

“Really, if the lower orders don’t set us a good example, what on earth is the use of them? They seem, as a class, to have absolutely no sense of moral responsibility.” –Oscar Wilde, The Importance of Being Earnest The flowering of U.S. bankruptcy law didn’t last long. Almost as soon as the Code was enacted, consumer bankruptcy filings skyrocketed from 196,976 in 1979 to 314,886 in 1980. That number topped 2 million a few years into the new millennium, prompting a Congressional identity crisis among Republicans. Bankruptcy was quickly repackaged as a moral rather than economic issue. Consider the comments of former House Majority Leader Richard Armey, when proposing the Bankruptcy Abuse Prevention and Consumer Protection Act: “Bankruptcy laws in America have put a lie to one of the most important lessons we teach our children. Bankruptcy laws in America have said to our children, you are a fool if you do not file. That is not right. … It is not about the money. Anybody who thinks this bill is about who gets the money is missing the point. … This bill is about the character of a Nation and will the Nation’s laws have a character of the Nation’s people.” Others were more explicit in their desire for punishment. Alan Greenspan, then Chairman of the Federal Reserve, remarked, “[p]ersonal bankruptcies are soaring because Americans have lost their sense of shame.” Many were convinced that abuse was pervasive, with savvy bankrupts taking joy rides at Disneyland and the casino just days before requesting a discharge.

Subsequent studies found that debtors, if anything, were far poorer than their predecessors: From 1981 to 2001, the ratio of total debts to annual income rose from 30% of income to 63%. But the damage was done. A “bread and water” means test was installed to determine if a petitioner was worthy of a full discharge, bankruptcy became more cumbersome and expensive to file, and the number of filings was permanently halved. Afterwards, one prominent east coast judge joked to an audience in 2006, “I call this new law the ‘leave no creditor behind law.’”

Calvinism Once More?

Perhaps the most significant cultural legacy of BAPCPA is that each debtor is presumed dishonest until proven otherwise. Debt has a strong moral stranglehold when it can reverse the most basic tenants of our justice system in the name of “personal responsibility.” Still, every economic downturn promises newfound forgiveness towards debtors, and perhaps the Warren coalition, after twenty years of warm-up, can move us away from the infantilizing phone calls and smug disciplinary measures of yesteryear. We already suffered through one reading of Poor Richard’s Almanack in grade school: let’s spare debtors the pithy homily and grant them some relief.

About Colbeck: Colbeck is a strategic lender that partners with companies during periods of transition, providing creative capital solutions to meet their evolving needs. You can reach the team at


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