Bankruptcy gives debtors a reprieve from their creditors by allowing an orderly liquidation of assets or a restructuring, often alongside a reduction or complete discharge of remaining debts. Usually a sign of financial defeat, it can be easy to forget that bankruptcy is a protection largely provided to the borrower and not the creditor. Before bankruptcy was among a debtor’s rights, financial ruin could have meant the endless torment of wage garnishment or asset seizures. For a long time, it could have also meant being held in a debtors’ prison for an unlimited amount of time.
Debtors’ Prisons in America
In England, laws allowing imprisonment of debtors had dated back to 1285; they were hardened in the early 17th century. Soon after, the practice was exported to America. Britain and America would oscillate between periods of leniency and severity towards fallen debtors but until the mid-19th century, the rules were usually much tougher than those of today. Often, debtors were imprisoned at their own expense until their debts were either repaid or forgiven. To the truly destitute, the law offered little hope of release; unlike criminals, they had no fixed sentence.
A few British colonies in America established more lenient rules, some even designed to explicitly attract debtors fleeing their Old World debts by coming to the New World. Virginia and North Carolina protected arriving debtors from the law, effectively ensuring that one’s bad debts did not transfer with them to America. The colony of Georgia was founded by James Oglethorpe, a Member of Parliament who, looking for an alternative to debtors’ prisons, settled on shipping them to the American South.
If anything, laws in America became less friendly towards debtors over the 18th century and debtors’ prisons were established even there. After American Independence, debtors’ prisons were still common. They were not insignificant, even if some of the debts that could land someone there were. Of the 1,162 debtors imprisoned in New York City alone in 1787 and 1788, some 716 of them owed less than one pound. It would remain a phenomenon of debtors’ prisons that many were held there for being delinquent on small loans.
Though even wealthy bankrupts, like early American financiers Robert Morris, Blair McClenachan, and Richard Plat, found themselves in debtors’ prison. So too did James Wilson, a sitting member of the U.S. Supreme Court and a signer of both the Declaration of Independence and the American Constitution. They were just some of the many wealthy or powerful people imprisoned for their debts.
Another, William Paulding, led a rebel government of New York during the War of Independence. He incurred personal debts to raise a militia to fight in the war; when the Continental Congress refused to reimburse him, he was ruined and sent to debtors’ prison. Debtors were a large portion of the prisoner population. As an example, in 1821, they made up 20% of the incarcerated population of New York City.
Some regarded failing to repay debts to be a moral failure but the prisons could hardly be justified on utilitarian grounds. Some tried, suggesting that without them people would simply disregard their debts. However, a poor debtor could not possibly repay debts while in prison and being charged for his own sustenance while there. Often, the cost of keeping someone in debtors’ prison exceeded the value of the debts they were held for. Donating food to imprisoned debtors was a common charitable cause of the day. Meanwhile, wealthy debtors could buy better conditions for themselves even while their creditors awaited repayment.
The beginning of the end for the debtors’ prison came not long after American Independence. In 1798, the state of New Jersey shifted some of the cost of imprisoning debtors to their creditors. If the creditors failed to make payment, the debtor could be freed. By this time, North Carolina and Pennsylvania had already enacted post-independence constitutions with some protections against incarceration for unpaid debts. Georgia, itself founded as an alternative to debtors’ prison, was also relatively quick to ban the practice by a constitutional provision in 1798.
After the thirteen original colonies, new entrants to the union adopted state constitutions that largely banned debtors’ prison. Many followed Pennsylvania’s example, even adopting the same language in their own constitutions. Still, some bankrupts preferred the loss of liberty to the loss of property, so it was not uncommon for people to voluntarily accept prison if it meant not revealing the existence of concealed property that would go to their creditors.
Popular opposition to imprisoning debtors grew, often on the grounds of bad conditions for inmates, lack of due process, or their simple ineffectiveness. Where the practice still existed, debtors could be imprisoned without any investigation of the validity of their debts. By now though, states were strengthening protections for debtors and those with the toughest laws reversed course. New York released prisoners owing less than $25 in 1818, doubled this threshold in 1825, and abolished imprisonment for debt in 1831. The practice was partially abolished federally in 1839 though states could still impose prison time under their own laws. Nonetheless, most holdouts abolished debtors’ prison soon thereafter.
Some jurisdictions went further. New Jersey not only included a ban on debtors’ prison in its 1844 constitutional overhaul but also forbid imprisonment for “any judgment upon contract” and not only debts. It was also the first state not to require that a debtor surrender his assets to creditors in order to avoid prison. New entrants to the union, like Iowa and Texas, followed this example.
The abolition of debtors’ prison may seem overdue, but the United States was ahead of its time on this matter. The concept was still quite common in Europe. In Britain, debtors’ prison wasn’t abolished until 1869 when the attention of Victorian reformers fixated on abuses of the law and conditions in the prisons.
The first bankruptcy law in the United States was introduced in 1800. It was only narrowly passed into law despite following English precedent. It applied only to traders and not consumers or other types of businesspeople. Unless two-thirds of creditors agreed, the law did not allow for a complete release of a debtor from his past obligations. Under the law, bankruptcy cases had to be initiated by creditors; there was no option for a merchant to voluntarily enter bankruptcy. Still, it was believed that debtors would commonly ask a friendly creditor for relief by initiating a bankruptcy of his behalf. The act, repealed in 1803, was short lived.
In time, the United States developed far broader and more debtor-friendly bankruptcy laws. However, public interest in bankruptcy would oscillate with the economy. So, reforms of the system in a more bankrupt-friendly direction generally came after financial crises or depressions and these were often reversed as conditions improved. A permanent bankruptcy law would have to wait.
For example, a new federal bankruptcy law was passed in 1841 as the Panic of 1839 caused economic distress. It was more lenient and accessible than the 1800 law. It allowed for a complete discharge of a bankrupt’s debts and bankruptcy could now be initiated by the debtor himself. Some 41,000 took advantage of the law within a two-year span, before this bankruptcy act was itself repealed. Yet another new bankruptcy law was introduced in 1867 but this one again was repealed after just a few years.
Bankruptcy Act of 1898
Starting in the 1880s, businessmen began lobbying for a new bankruptcy act. The first long lasting reform came in 1898, with the Act to Establish a Uniform System of Bankruptcy. This was considered a pro-debtor law by the standards of the time, with relatively broad ability to discharge debts. Few countries were taking as lenient an approach. Discharged bankrupts in France were still barred from certain business activities.
Over the 20th century, bankruptcy increasingly became the commonly resorted to solution for overindebted consumers, with consumer bankruptcy cases growing in proportion of total cases. American bankruptcy law generally continued to become more lenient towards borrowers with time, and more frequently resorted to, at least until 2005, when means testing was introduced to prevent abuse of the bankruptcy process. Just before that reform, bankruptcy filings in the United States reached two million in a single year.
In America, the law has gone from favoring creditors to forgiving debtors. In doing so, it has generally been ahead of other countries which have also done the same. At the time of American Independence, financial ruin could have meant imprisonment and there was little hope for debt forgiveness. The 19th century opened with the gradual abolition of debtors’ prison and closed with the creation of the first broad and lasting bankruptcy law. No doubt critical was the gradual loss of a moral phobia towards debt. For better or worse, this probably has something to do with the change, and has been a feature of financial life in America for generations.
More from the Tontine Coffee-House
1. Federal Judicial Center. The Evolution of U.S. Bankruptcy Law | A Time Line, Federal Judicial Center, Washington, D.C.
2. Hansen, Bradley. “Bankruptcy Law in the United States.” EHnet, Economic History Association, 14 Aug. 2001.
3. Lepore, Jill. “I.O.U.” The New Yorker, 6 Apr. 2009.
4. Monea, Nino C. “A Constitutional History of Debtors’ Prisons.” Drexel Law Review, vol. 14, no. 1, 2022, pp. 1–67.
5. Trieman, Israel. “The Law and the Insolvent Debtor.” St. Louis Law Review, Jan. 1927, pp. 189–195.