Encyclopedia of Sociology

BANKRUPTCY AND CREDIT

Dalkon Shield intrauterine device (a contracep-
tive) was judged the cause of many injuries and
some deaths among women who used it. As the
financial judgments against the company mount-
ed, its management sought the protection of the
bankruptcy courts. Bankruptcy allowed the com-
pany to hold its creditors at bay for a period of
time to allow the company to propose a financial
settlement.

THE ROLE OF THE STATES

Although bankruptcy is a federal matter, states
also have laws to govern debtor-creditor relations.
Each state’s debtor-creditor laws are affected by its
history and by the debt conventions that are part
of its history. Before becoming a state, for exam-
ple, Georgia was a debtor’s colony. Before the
Civil War, debtors in such southern states often
fled harsh debt-collection laws by going to Texas,
indicated by ‘‘G.T.T.’’ in sheriffs’ records. Texas
has traditionally retained pro-debtor statutory provi-
sions, especially its generous exemption.

An exemption is the property that a debtor
may keep despite bankruptcy or a judgment for
nonpayment. The federal bankruptcy statutes rec-
ognize the right of state law to prescribe exemp-
tions. There is also a federal exemption, but state
legislatures may require their citizens to claim only
the state exemption, which in some states is small-
er than the federal exemption. State exemption
laws vary widely, with some states allowing a sub-
stantial exemption and other states exempting
very little property. Even a generous exemption
law, however, is not a guarantee that a debtor will
keep a lot of property. A home is not exempt if
there is a mortgage on the home, and other goods
are similarly not protected from a secured creditor
if they have been used as collateral for a debt.

The states with a Spanish heritage often fol-
lowed the Spanish tradition that a bankrupt’s fami-
ly should have the means to continue to make a
living. Thus, the state laws of Florida, Texas, and
California, for example, have traditionally been
liberal in permitting debtors to keep their home-
steads and some other assets, such as the tools of
their trade and current wages. Other states ex-
empt items that are believed necessary for the
family’s well being, such as children’s school books,
certain farm equipment, sewing machines, and

funeral plots. There is a recent trend toward sub-

stituting dollar limitations for exemptions instead

of listing specific items of property.

The state exemption is the principal determi-

nant of the resources a bankrupt debtor will have

following the bankruptcy. The rest of the debtor’s

postbankruptcy status depends upon the type of

bankruptcy the debtor declares.

TYPES OF BANKRUPTCY

Bankruptcy may be entered either on a voluntary

or on an involuntary basis. U.S. bankruptcy law

arranges several ways by which debtors may volun-

tarily declare bankruptcy. Either individuals or

corporate actors, including incorporated and

unincorporated businesses, not-for-profit agencies,

and municipalities may declare bankruptcy. The

law makes special provision for the bankruptcies

of railroads and stockbrokers. Creditors may in

some circumstances initiate an involuntary bank-

ruptcy. Only a small proportion of all bankruptcies

is involuntary, and nearly all of those cases are

targeted toward a business.

The Clerk of the Bankruptcy Court classifies

each case filed as a business bankruptcy or a

nonbusiness bankruptcy. These distinctions are

not always clear-cut. As many as one in every five

‘‘nonbusiness’’ debtors reports currently owning a

business or having recently owned a business.

Moreover, many of the ‘‘business’’ bankruptcies

are small family-owned enterprises. Whether clas-

sified as business or nonbusiness, the bankruptcy

of a small business owner typically affects the

family’s welfare as well as that of the business.

Individual, noncorporate debtors typically have

two choices in bankruptcy: Chapter 7 liquidation or

a Chapter 13 repayment plan. In a Chapter 7 case,

the debtor’s assets over and above the exempt

property will be sold and the creditors will be paid

pro rata. Creditors with secured debts (those debts

with collateral) will be allowed to have the collater-

al. All remaining debt will be discharged, or wiped

away by the court. The debtor will not be able to

file a Chapter 7 bankruptcy again for six years.

The Chapter 13 repayment plan is available

only to individual debtors with a regular source of

income. There are also other legal limitations,