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Understanding Bankruptcy

Why Bankruptcy Is Important

When a debt is eliminated as part of a bankruptcy process, we say that the debt is DISCHARGED.

Once a debt has been discharged, the debtor is relieved of the obligation to pay the creditors, and the creditors are prohibited by law from taking any further action to recover the debt. In this way, an individual can continue to live his life free from the burden of oppressive debts. (This is often referred to as a FRESH START.) Similarly, a company can stay in business, while reorganizing itself around a more favorable debt structure; and a government can return to providing essential services to its citizens.

The chance to discharge debt legally is a unique and crucial part of our economic system. To understand why, we only need to consider the alternative. That is, let us consider what happened to debtors who were unable to pay their debts before bankruptcy was invented.

Before bankruptcy, debtors who could not meet their obligations were subject to severe penalties. For example, in the ancient Greek city states and the early Roman Empire, a person who could not pay his debts would often be forced to become a slave to his creditor. (This is called DEBT BONDAGE.)

A thousand years later, the treatment of debtors was still harsh. For example, in England, the first official laws regarding insolvency were passed in 1542 during the reign of King Henry VIII. These laws treated insolvent debtors as criminals, with penalties such as imprisonment and even death.

Even in more modern times, well into the 1800s, people who were unable to pay their debt could still be imprisoned. They were sent to DEBTOR'S PRISONS, where they would be confined, often in a brutal and inhumane manner.

As an example, in 19th-century England, a debtor could be accused by any of his creditors. Once this happened, the debtor would be given a short time to raise the money to pay off the debt. If the money was not forthcoming, the debtor would be imprisoned until the debt was paid.

If you are a fan of the novels of Charles Dickens, you may remember that several of his characters were sent to debtor's prisons: Mr. Pickwick (Pickwick Papers, published in 1836), Micawber (David Copperfield, 1849), and William Dorrit (Little Dorrit, 1855). In fact, in 1824, when Dickens was 12 years old, his own father was sent to a debtor's prison.

In the United States, federal imprisonment for unpaid debts was abolished in 1833, and around the same time for most of the states. In England, imprisonment for debt was not abolished until 1869.

By the late 1860s, the attitude towards indebtedness was beginning to change generally. For a long time, it had been recognized — for two important reasons — that a better system was needed to deal with debtors. The first reason was that imprisoning debtors, or forcing them into involuntary servitude, is an extremely severe punishment. For centuries, such punishments were considered appropriate because defaulting on one's debts was seen as a serious moral failing. In modern times, however, it began to be recognized that it is common for people to acquire overwhelming debts because of circumstances beyond their control. In such cases, it is more appropriate to offer a compassionate solution to the problem.

An even more important reason for avoiding involuntary servitude or imprisonment for debtors is based on a practical observation: people who cannot work freely are unproductive. When such debtors are liberated from the burdensome demands of their debts, many of them will, once again, become useful and productive.

This is why, in the long run, it is more practical to allow people who are overwhelmed with debt to discharge their obligations and get back to work than it is to punish them. To be sure, there will always be those who are dishonest and take advantage of the system. However, in the aggregate, allowing overwhelmed debtors to go bankrupt is now recognized to be beneficial for the economy as a whole.

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