The Historiographical Problem of Municipal Bankruptcy Law

Abstract

This is the first archivally researched history of the genesis of municipal bankruptcy law, 1933-1938. It also compares the historical method with law and economics (L&E) for finding and telling the story. 

Congressman Hatton Sumners, Judiciary Committee chair, was the key actor. The legislative process was a laboratory for new forms of relief under the Bankruptcy Clause of the Constitution, seeking to relieve the insolvency experienced during the Depression by irrigation districts in “the Valley” of Texas, new towns in Florida, and elsewhere across the nation that could not collect taxes and pay their municipal bonds. State governments were helpless; the Constitution’s Contract Clause forbade “impairing the Obligation of Contracts,” and voluntary, private restructuring agreements were frustrated by the “holdout problem.”

From a variety of models, it was composition with creditors that succeeded politically. Congress from 1933 to 1937 amended the Bankruptcy Act of 1898 by enacting the First and Second Municipal Bankruptcy Acts—known as Chapter IX—based on composition. L&E scholars credit this to freshman Florida congressman Mark Wilcox who worked in conjunction with a bondholders’ group. But it was Sumners who determined that the composition model was constitutional and politically most feasible. He navigated through opposition that insisted “bankruptcy” required turnover of the debtor’s assets in exchange for a discharge and that such legislation would destroy the municipal credit market. Municipal bankruptcy did leave all assets in the debtor’s hands and granted a discharge, and the credit market survived. And relevantly to a key issue in reorganizational bankruptcy today, Sumners crafted the first, and still the only, statutory injunctive relief applicable in the bankruptcy case of an artificial entity for the protection of nondebtor third parties—here, all officers and inhabitants of a municipal debtor—against creditors’ collection efforts.

Municipal bankruptcy became a New Deal agenda item, and Franklin Roosevelt helped push the legislation to enactment in the spring of 1934. The Supreme Court invalidated the first act in the 1936 Ashton case, but Justice Cardozo dissented and outlined small changes that Sumners and Congress utilized in enacting the second act in 1937. Then Sumners led the oral arguments in 1938’s Bekins case that sustained it.

Municipal bankruptcy law succeeded in effectuating municipal-bond restructuring agreements, and its essence lives in today’s Bankruptcy Code as Chapter 9, providing discharge of unpayable debt and more commonly furnishing the platform upon which towns and taxing districts negotiate such deals. Chapter IX worked in the past, and Chapter 9 works today. Sumners, not Wilcox, was primarily responsible for the legislation. Nothing was assured; the story demonstrates change over time, with Sumners the key actor. And the project of finding and interpreting the genesis of municipal bankruptcy is one for legal history, not for L&E, the author argues. 

Keywords: municipal bankruptcy history