Janice A. Oser, Esq.

“Unfair!" cried a group of Chrysler bondholders in the press and on TV about an agreement that might or might not have averted bankruptcy for Chrysler. Now we’ll see what the bankruptcy judge says.

After learning about contract law from the press in connection with the AIG bonus fracas, we can now turn our attention to learning about bankruptcy law from the media in connection with Chrysler and GM. Or maybe not.

The bankruptcy cases coming down the pike these days are a challenge even for those who are most expert in bankruptcy law. The cases are so enormous and so complex that the supply of experienced bankruptcy lawyers may even run out (see “Bankruptcy for G.M. Would Tax the Experts,” by Micheline Maynard and Michael J. de la Merced in the May 26, 2009 New York Times).

In the Chrysler case, a group of bondholders claimed that the proposed plan was unfair to them, and that it bent the bankruptcy law and violated longtime practice in the application of that law. They got a lot of attention in the media.

The bondholders are what is known in the legal trade as “secured lenders.” That is, they hold loans, in the form of bonds, against which specific assets are pledged as security, much as in the case of consumer loans, a house is pledged as security for a mortgage loan and a car is pledged as security for a car loan. If the borrower goes bust, the creditor gets the property securing the loan. Or so the script goes.

The U.S. Constitution empowers Congress to enact uniform bankruptcy laws. States may not regulate bankruptcy, though they may enact laws that govern other aspects of the debtor-creditor relationship. In a bankruptcy case, anyone with a claim against the assets of the bankrupt has to get in line when these assets are to be parceled out, and the order of the line is determined according to the bankruptcy law.

Ordinarily, secured lenders stand in the line ahead of unsecured creditors, and only if and when the secured creditors get compensated in full do the unsecured creditors get anything. The protesting Chrysler bondholders had accepted the idea of getting less than the full amount of their claims, but not the idea of getting less than unsecured creditors.

The protesting bondholders also argued that in pressuring them to accept the agreement and in using it as a bankruptcy plan, the government risked overturning the rule of law in this country.

The Chrysler situation is a bit more complex than that and it involves certain provisions of the bankruptcy law little used until now. While the experts examine the intricacies of the Chrysler situation and while the bankruptcy judge judges, most of us would do better simply to try to get a sense of the relation between our bankruptcy law and fairness as it concerns ordinary folk and and ordinary-sized businesses.

A bankruptcy filing starts a process that is usually described these days as one that is designed to enable a borrower with more debts than he or she or it can pay to wipe the slate clean and get a fresh start. This is a far cry from the manner in which debtors who were in over their heads were treated in the early days.

Two co-existing English traditions concerning debtors who couldn't pay traveled to America. There was English bankruptcy law that applied only to “traders” (stockbrokers, bankers and merchants), on the theory that this kind of debt needed to be forgiven, for the sake of commerce. Other debt needed to be enforced rather than forgiven, for the sake of creditors, contracts, and public morality. Hence, the debtors’ prison, key to the plot of the Masterpiece Theater dramatization of Charles Dickens’ novel, Little Dorrit shown on public television.

The medieval tradition of locking up people other than “traders” if they couldn’t pay their debts came to the American colonies in the seventeenth century by way of the English common law, that is, law that is made by judges in deciding cases, as distinguished from laws enacted by legislatures.

Debtors’ prisons were horrendous, hopeless places for people without relatives or friends on the outside who could give them money for the bare necessities of life inside, and help them to get their creditors to forgive their debts to get the debtors outside. Debtors’ prisons served to terrify people into paying their debts to avoid such prisons. Imprisonment for debt was abolished in New York in 1831 and in the rest of this country soon afterward.

In enacting the first federal bankruptcy act in 1800, Congress followed the precedent of English bankruptcy law in applying it only to “traders.” The law was repealed not very long afterward, as were two bankruptcy laws enacted subsequently. Congress kept changing its mind, with a tug of war between proponents of creditor protections, of bankruptcy as a creditors’ sword, and proponents of debtor protections, of bankruptcy as a debtors’ shield.

The bankruptcy law enacted by Congress in 1841 included protections that were revolutionary at the time that applied to debtors who were not "traders." Opposition to these debtor protections resulted in the repeal of this bankruptcy act and passage in 1867 of a law that was more favorable to creditors. This was also subsequently repealed. Finally, Congress enacted in 1898 the first bankruptcy act that stuck. Some subsequent amendments to the Bankruptcy Act of 1898 have favored creditors, others debtors, but, in contrast to European bankruptcy law, American bankruptcy law continues to protect all debtors, not just “traders.”

The tug of war over bankruptcy law between those on the side of expanding the category of debts that cannot be forgiven, that is, the creditors' side, and those on the side of narrowing this category, that is, the debtors' side, will always be with us. How you see the bankruptcy law itself as fair or unfair at any given time pretty much depends on where you're standing.

The question in the case was whether the provision could be used by prosecutors against illegal immigrants who knowingly used a fake Social Security card but did not know that the number on the card belonged to a real person.

The answer, says the Supreme Court, is no. Accordingly, under the statute, to knowingly use a false Social Security number, for example, means to use it in the knowledge that it is the number of a real person. The reasoning of the Justices is summarized in an article in The New York Times, "Court Bars Identity-Theft Law As Tool in Immigration Cases," by Adam Liptak and Julia Preston (May 5, 2009).