Capital Markets

Finance in History: Bankruptcy

Chapter 11 may be tough, but it beats death, dismemberment, slavery, exile, prison, and other insolvency solutions.
R.G. VoorheesAugust 8, 2007

“Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” (Charles Dickens, David Copperfield)

Misery indeed. Bankruptcy is no picnic even today, but through the ages it has been the source of much literal pain. The word “bankruptcy” comes from an Italian practice of the Middle Ages — “banca rotta” — which means “bench-breaking.” The term describes the punishment administered to businesses that failed: local fiscal authorities came to the market and smashed the bankrupt business’s table.

Through the ages, people or businesses have gone bankrupt in two ways, either running out of money and thus being unable to repay debts, or being forced to close as a result of fiscal mismanagement. Either way, bankruptcy has often carried a punitive dimension.

Death, dismemberment, slavery (for the debtor and family members), indentured servitude, exile, and debtors’ prison have all been used as punishment. Dickens did not use the word “misery” lightly.

And yet the first known effort to regulate bankruptcy was surprisingly modern in its approach. Appearing in the Code of Hammurabi, which dates to Babylon around the 18th century B.C., the law stipulated that a bankrupt’s possessions were to be divided among creditors in proportion to the amount of money each was owed.

Alas, those would soon come to be seen as the good old days, because by 621 B.C., when Draco ruled Athens, the punishment meted out to “deadbeats” (literally, one who is “completely exhausted”) was death. Or they and their families might be sold into slavery, with the proceeds going to creditors. If that strikes you as Draconian, well, consider the source.

A generation later the Athenian statesman and poet Solon decided this was perhaps a bit too severe. Under his legal reforms the bankrupt and his family had to give up their citizenship but not their freedom — or their lives.

The Romans, however, soon turned back the sundial. Under the Twelve Tables of Rome, promulgated in 451 B.C., maiming became the appropriate sanction. Instead of getting his money back, the creditor was given a pound of flesh — or perhaps more, depending on how much was owed. Debtors were cut up and their parts distributed among creditors on a pro rata basis. (The Roman writer Petronius would later satirize this practice in The Satyricon, a portion of which describes a plutocrat whose will decrees that any friend, parasite, or hanger-on who wants to collect his inheritance must eat a piece of the dead man’s corpse.)

Fast-forward to Renaissance England, where Henry III established the practice of imprisoning debtors in the 13th century. By the time of Henry VIII, in the mid-16th century, the first bankruptcy statute (as opposed to insolvency law) was enacted. It applied only to merchants and traders, since they were considered the only people who had a legitimate reason to borrow money, and provided a way for their debts to be addressed (sans death, torture, or even prison) in the event that a storm at sea sank their boats and thus their fortunes, or similar circumstances beyond their control led to bankruptcy.

That statute did not get the common man off the hook, however. And once someone landed in debtors’ prison it was often nearly impossible to get out. Family or friends might come forward to pay the prisoner’s debts; if not, debtors had to rot, presumably coming to appreciate, as they did, the error of their ways.

The absurdity of debtor’s prison, of course, is that a bankrupt’s ability to repay his creditor from prison is precisely nil. That may be why, in some countries, creditors were required to pay the costs of incarcerating their debtors. The open-ended prison sentence could be cut short, therefore, should the creditor tire of throwing good money after bad.

If you were lucky you might end up a “peon,” a term that originally described a bankrupt person condemned to work without pay for a creditor until the debt was paid off.

While bankruptcy was generally a bigger problem for the debtor than for the creditor, that wasn’t true in every case. In the 14th century, Italian bankers unhappily discovered that England’s Edward III was an unreliable credit risk, but couldn’t do much about it. And in the 18th century, English goldsmiths, the principal bankers of the era, slid into bankruptcy after the Stuart kings found it inconvenient to pay back their loans. Worse, if the bankers were deemed to be charging too much interest their fingers would be burned.

Today bankruptcy still entails pain, if only in the form of many, many meetings with lawyers. And Dickens’s lesson still rings true: having slightly more than you need is infinitely better than having even slightly less. Unless, of course, your credit card offers rewards points and a low introductory rate.