Bankruptcy Reform (1934-1938)

There were several legislative reforms of bankruptcy law during the New Deal, enacted as amendments to the Bankruptcy Act of 1898 and designed largely to address the economic problems of the 1930s. The most interesting of these reforms were the Municipal Bankruptcy Act, the Frazier-Lemke Farm Bankruptcy Act, and the Chandler Act.

The Municipal Bankruptcy Act (MBA) was signed into law by President Franklin Roosevelt on May 24, 1934; it allowed financially-troubled counties, cities, and towns to restructure (but not completely discharge) their debt [1]. The law was needed because the Great Depression had wrecked havoc with local government finances, leaving them unable to meet their day-to-day expenses or bond repayment obligations. Indeed, the U.S. municipal bond market had collapsed.

In 1936, the Supreme Court ruled the MBA unconstitutional “as an improper interference with the sovereignty of the states,” but a revision of the law was upheld in 1938 [2]. During the New Deal years, the MBA helped restore the nation’s municipal bond market [3]. Since then, it has been utilized several hundred times to rescue bankrupt local governments, as, for example, in the high-profile case of Orange County, California [4].

As part of a broad array of policies and programs to aid distressed farmers in the Depression, FDR signed the Frazier-Lemke Farm Bankruptcy Act (FBA) into law on June 28, 1934 [5]. The main purpose of the FBA was to delay foreclosures on troubled farms, in order to give indebted farmers time (up to five years) to get back on their feet. Creditors despised the law, considered it “socialism [6],” and challenged it in federal courts for many years. FDR was unmoved: “… it has been alleged that insurance companies and other mortgagees will suffer through the use of this law by farmers to evade the payments of debts that are within their capacity to meet. I do not subscribe to these fears. I have sufficient faith in the honesty of the overwhelming majority of farmers [to pay their] just debts” [7].

In 1935, the FBA was also ruled unconstitutional by the Supreme Court, but a revised version of the law was upheld in 1937. Even after the Supreme Court’s decision, however, many lower courts remained hostile to the law and biased against debtors. This made the FBA less successful than it might have been, and in most areas of the country it did little to curtail foreclosures. In that regard, higher prices from economic recovery and the effects of the Agricultural Adjustment Act of 1933 did more to help farmers. The FBA expired in 1949 [8].

Multiple types of bankruptcies, especially business bankruptcies, were dealt with by the Chandler Act (CA), which FDR signed into law on June 22, 1938 [9]. One bankruptcy scholar at the time described the CA as “the most extensive bankruptcy reform since…1898” [10]. Two important elements of the act were (a) greater court supervision and investor input during corporate bankruptcy and reorganization and (b) review of corporate reorganizations by the Securities & Exchange Commission. An important CA reform for personal bankruptcies was the creation of “chapter 13,” which today allows debtors to set up a repayment plan as an alternative to the more drastic “chapter 7” type of bankruptcy, which can involve the forced sale of the debtor’s property [11].

New Deal bankruptcy laws often exhibited a compassionate attitude towards debtors. In modern times that compassion has evaporated, as reforms—as well as the surrounding rhetoric, contractual behavior, and debt collection practices—have increasingly prioritized lenders and hurt, harassed, or shamed debtors. Modern laws, such as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, have rolled back several of the gains made during the New Deal [12].

SOURCES

(1) The full text of the law can be found at https://www.loc.gov/law/help/statutes-at-large/73rd-congress/session-2/c73s2ch345.pdf, Library of Congress (accessed January 24, 2021.  (2) “Chapter 9 – Bankruptcy Basics,” United States Courts (accessed January 24, 2021).  (3) “Municipal Bankruptcy Act of 1934,” in James S. Olson (ed.), Historical Dictionary of the New Deal: From Inauguration to Preparation for War, Westport, CT: Greenwood Press, 1985, pp. 341-342.  (4) See note 2, and also, “We’re out! Orange County pays final bankruptcy bill on July 1. The ride’s been wild.” The Orange County Register, June 30, 2017 (accessed January 24, 2021).  (5) The full text of the law can be found at https://www.loc.gov/law/help/statutes-at-large/73rd-congress/session-2/c73s2ch869.pdf, Library of Congress (accessed January 24, 2021).  (6) Ernest Feder, “Farm Debt Adjustments During the Depression: The Other Side of the Coin,” Agricultural History, Vol. 35, No. 2 (Apr., 1961), pp. 78-81.  (7) “Farm Mortgage Bill Signed By Roosevelt,” United Press, in Tulare Advance-Register (Tulare, California), July 2, 1934, p. 3.  (8) For a good general discussion of the law, its obstacles, and its impact, see, Ernest Feder, “What Kind of Bankruptcy Legislation for Farmers?Nebraska Law Review, 35 Neb. L. Rev. 39 (1955), on the website of the National Agricultural Law Center (accessed January 24, 2021).  (9) The full text of the law can be found at https://www.loc.gov/law/help/statutes-at-large/75th-congress/session-3/c75s3ch575.pdf, Library of Congress, January 24, 2021.  (10) David A. Skeel, Jr., Debt’s Dominion: A History of Bankruptcy Law in America, Princeton, NJ: Princeton University Press, 2001, p. 74.  (11) See, e.g., Herman M. Knoeller, “Reorganization Procedure Under the New Chandler Act,” Marquette Law Review, 24 Marq. Law Rev. 12 (1939), pp. 12-34 (accessed January 24, 2021).  (12) See, e.g., William W. Bratton and David A. Skeel, Jr., “Bankruptcy’s New and Old Frontiers,” University of Pennsylvania Law Review, Vol. 166, No. 7, June 2018, pp. 1571-1595 (accessed January 24, 2021); “Study: Law creates many too broke to file for bankruptcy,” Nasdaq, February 24, 2015 (accessed January 24, 2021); and “Debt shaming: Cruel and unusual or creative and effective?Yahoo! Finance, December 9, 2016 (accessed January 24, 2021).