Available at: https://ssrn.com/abstract=5253527 or http://dx.doi.org/10.2139/ssrn.5253527
Abstract:
This article determines the historiographical problem of municipal bankruptcy law, 1933-1979. First, it identifies the problem. So far, the story has belonged to scholars of the law-and-economics school, but economic theorizing is unhelpful, and the L&E authors' version is inadequately researched and factually incorrect. Instead this article submits the historical method as superior methodology for unearthing and understanding the genesis of municipal bankruptcy.
Second, the article solves the problem by providing the first archivally researched history of that origin and early development. Congressman Hatton Sumners, Judiciary Committee chair, was the key actor. The legislative process was a laboratory for new forms of relief under the Constitution's Bankruptcy Clause, seeking to relieve the insolvency experienced during the Depression by irrigation districts in Texas, new towns in Florida, and across the nation all types of political subdivisions that could not collect their taxes and pay their municipal bonds. State governments were helpless. The Constitution’s Contract Clause forbade “impairing the Obligation of Contracts,” and voluntary restructuring agreements were frustrated by the “holdout problem.”
From multiple models, it was the device of composition with creditors that succeeded. 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 a freshman Florida congressman, Mark Wilcox, who worked in conjunction with a bondholders’ group. But it was Sumners who determined that the composition model was not only constitutional but also politically most feasible.
Sumners navigated through opposition that insisted “bankruptcy” required turnover of the debtor’s assets in exchange for a discharge of debt and that such legislation would destroy the municipal credit market. Municipal bankruptcy did leave all properties in the debtor’s hands and beyond bankruptcy court jurisdiction, and it did grant a discharge. The credit market survived. Further, relevantly to an issue in mass-tort chapter 11 bankruptcy today, Sumners crafted the first, and still the only, statutory injunctive relief applicable in the bankruptcy case of a non-individual entity for the protection of nondebtor third parties—here, all officers and inhabitants of a municipal debtor—against collection efforts by a debtor's claimants.
Once municipal bankruptcy became a New Deal agenda item, Franklin Roosevelt helped push the legislation to enactment in spring 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 restructurings, 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
Summary:
This paper, by Josiah M. Daniels, III, is a deeply researched legal history of the enactment and evolution of municipal bankruptcy—originally Chapter IX (1933–1979), now Chapter 9—arguing that its origins have been misunderstood by modern “law and economics” scholars. Drawing on archival sources rather than abstract theory, the author shows that municipal bankruptcy was born out of the Great Depression’s wave of local-government insolvencies, particularly special taxing districts and small municipalities overwhelmed by bond debt and crippled by the holdout problem. Congress, led principally by Texas Congressman Hatton Sumners, crafted municipal bankruptcy not as a creditor-control regime, but as a constitutionally sensitive, debtor-protective composition process designed to preserve local sovereignty while enabling realistic debt adjustment. The Supreme Court’s initial rejection (Ashton) and later approval (Bekins) reflect this careful balance between federal bankruptcy power and state sovereignty. The paper sharply criticizes later scholarship that retrofits creditor-bargain theory onto Chapter 9 by misreading or oversimplifying this history, calling that approach “forensic” rather than historical.
Commentary (ncbankruptcyexpert.com style)
This is one of those articles that quietly—but firmly—reminds us that bankruptcy law did not drop from the sky fully formed by economic theorists with spreadsheets and utility curves. It was built, piece by piece, by legislators confronting human, institutional, and political failure.
The most important lesson for consumer bankruptcy reform is this: bankruptcy succeeds when it is designed as a pressure-release valve, not a moral judgment or a collection enhancement tool. Chapter IX was not created to maximize creditor recoveries. It was created to solve collective action problems, stop destructive litigation, and allow insolvent debtors—here, municipalities—to continue functioning. That same DNA runs through the best parts of modern consumer bankruptcy.
There are several takeaways worth underscoring:
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History matters more than theory. Just as Chapter 9 was never meant to be a creditor-control regime, consumer bankruptcy was never meant to be a pure debt-collection device. Efforts to “reform” consumer bankruptcy by importing creditor-bargain logic or market-discipline rhetoric repeat the same category error this article exposes in the municipal context.
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The holdout problem is the real villain. Whether it’s bondholders in the 1930s or aggressive unsecured creditors, servicers, or debt buyers today, bankruptcy law exists because individual enforcement breaks systems. Any consumer bankruptcy reform that strengthens individual creditor leverage while weakening collective relief is moving backwards.
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Debtor dignity and institutional survival matter. Municipal bankruptcy was structured to preserve democratic governance and local autonomy. Consumer bankruptcy, at its best, preserves similarly preserves autonomy and also household stability, employment, housing, and family systems. Reforms that treat consumer debtors as failed market actors rather than citizens facing systemic stress miss the point entirely.
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Constitutional humility is a feature, not a bug. Sumners’ careful navigation of federalism constraints should be a model for modern reformers. Over-aggressive tinkering—whether by courts or Congress—often reflects impatience with limits that are actually doing important work.
If there is a cautionary note here for today’s consumer-bankruptcy reform movement, it is this: do not let elegant theories overwrite messy reality. The system works best when it is grounded in lived experience, political feasibility, and a clear-eyed understanding of why bankruptcy law exists in the first place—not to punish failure, but to manage it humanely and efficiently.
In short, if we want to reform consumer bankruptcy, we should spend less time asking what creditors would have bargained for in a hypothetical world, and more time asking what history teaches us about what actually works when real people, real institutions, and real crises collide.
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