25 Mar Where Does Bankruptcy Law Come From? Part 2: State Law
As pointed out in the first installment in this series, U.S. bankruptcy law comes from many sources. Although the statute itself is part of the federal U.S. Code, a significant element of bankruptcy is actually drawn from state laws.
At the heart of bankruptcy are property rights. The right to be paid money — a debt, for example — is a property right owned by a creditor. And property rights are most commonly based in the law of our states. So your right to collect a debt is usually a state law right. To the extent that you have that right, you have a claim in bankruptcy.
And to the extent that the debtor or some other party can see there’s a defense or a legal defect to your claim in state law, it also can be enforced against you. So state law is often critical to a creditor’s interests in our courtrooms.
Property rights also define what things are at stake in many bankruptcy case. For example, in individual Chapter 7 cases, much of your property becomes property of the artificial thing called the “bankruptcy estate.” Often most everything you “own” is part of this, as discussed elsewhere on this site. This can include virtually anything your state’s laws recognize as a right to get paid on in some way, including the right to sue someone else for compensation like for personal injury. These are rights founded in the law of our states.
Similarly, in some parts of the country, what property you can protect — exemptions — may also be creatures of state law. But where you live matters! As part of a unique political compromise in the 1970s, the federal bankruptcy law allows the individual states to “opt-out” of a federal laundry list of exemptions consumers could use.
In such “opt-out” states, a debtor generally may only apply exemptions available under that state’s laws. In other states that did not opt-out, the debtor could pick from either the federal list or the state list. In other words, in some places you can pick the law that applies and in others, your state legislature picked for you…even though that pick applies to you for a federal court. (In fact, some states have even adopted a separate laundry list of protections exclusively for bankruptcy cases, a list which does not apply in state court collection cases.)
It should be noted that Congress did modify the “opt-out” rules in 2005 with BAPCPA when it moved to make clear that retirement assets — which were generally already protected — would be protected for debtors (even in opt-out states) in federal bankruptcy law.
This odd combination of federal and state law books to use makes it an exceeding complex area of law. And in future installments we’ll see where the rules and rulings come from that apply these laws that make up the thing we call “bankruptcy law.”
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