Why is There Bankruptcy?

If you are thinking about filing a bankruptcy case, you might have also been pondering about just why there even is a bankruptcy process.  Shouldn’t people just pay their debts?  Why should Congress enact a law that allows you to avoid paying a debt?  This just seems too easy.  After all, you may have a lot of valid, legally enforceable debts, and it just doesn’t seem right that a court would wipe them out for you.  There must be a catch.

The answer to this “bankruptcy-seems-too-good-to-be-true” question is found in some basic principles that have little to do with you as an individual.  These principles are fundamental and have broad application in Western civilization.  To begin with, the right to debt forgiveness is mentioned in the Old Testament, Deuteronomy 15:2, and is to be granted every seven years.  That’s why Congress named it Chapter 7.  Although we live in a nominally secular society, in Western countries we are overwhelmingly Christian, or are familiar with the Judeo-Christian Bible.  This has been a powerful factor in shaping Western thought, and has historically exerted a powerful influence on Western legal thought and legal traditions.  Bankruptcy, or debt forgiveness, is something an individual is entitled to, periodically, as part of Western philosophy and our common shared value system.

Another fundamental reason there is a bankruptcy process is that we live in a capitalist economic system, which has evolved over several thousand years in the Western world.  For the most part, individuals are free to make a fortune or simply earn a living wage.  Some have become rich; some barely make ends meet; sadly, some cannot make it at all.  We accept these disparate results because of our commitment to human freedom, including economic freedom.  Individuals take risks in such a system, risks with money, risks with career choices, risks with investing, risks when starting or expanding businesses, risk that have serious financials consequences.  Sometimes an individual takes a risk, or incurs debts in doing so, which turn out later to have been unwise, and which leave a crushing burden of debt.

Think about what society’s response to such an individual, with an overwhelming debt burden, ought to be.  She she be consigned to debtor’s prison if she can’t pay?  Should she have her home taken to pay her creditors?  Should her children have to work off her debts in the salt mines?  Should she be sent to an area we reserve for people who can’t manage their affairs?  Maybe you can see that society’s possible reactions to an individual burdened with unmanageable debt can have a big impact on other individuals besides the debtor herself.  The welfare of her husband and children has to be considered.  Her neighbors and co-workers also have a large stake in how she is treated.  More importantly, maybe she incurred her debts in starting a business, which ultimately failed.  Other would-be entrepreneurs will certainly be watching to see what becomes of a failed business owner.  If the fate of the failed business owner is to be forever fiancially destroyed, this would be a powerful disincentive, a warning to others, and only the rich would be willing to take the risk of starting a business.

All of us benefit from allowing periodic debt forgiveness for individuals such as the woman in the above example.  This is we don’t have to go buy our lunch sandwiches at the only sandwich shop in town.  Numerous individuals have weighed the risks and have decided they should incur financing to start a sandwich shop.  This gives all of us a wide variety of choices when hunger strikes.  We all have benefited from the entrepreneur’s knowledge that if this sandwich shop doesn’t work out, there is at least debt forgiveness, if needed, in the form of bankruptcy.  It’s easy to see that this is why we have numerous competing business entities for automobiles, bakeries, computers, software, and everything else we consume or use in our society.

Likewise, a consumer would be much more reluctant to incur a debt to buy a car, take out a mortgage, or use a credit card, or incur any loans at all, if there was no bankruptcy.  Banks make serious money, in fact they make all their money, from the willingness of individuals to incur debts, even if the debt is incurred for household purposes.  Without bankruptcy much of this willingness to incur debt would disappear.  This is why all of us, especially those of us who never will file a bankruptcy, could not live as we do without bankruptcy being available.  Bankruptcy isn’t there for you; it’s there for every member of our society.  That’s why there’s a bankruptcy law.  None of us could live without it.