On Bankruptcy and Voluntaryism: “The Wicked Borrow But Do Not Pay Back”

By Carl Watner

I honestly cannot remember what sparked my recent interest in bankruptcy, but as I began researching the topic from a voluntaryist perspective I realized that bankruptcy, at least as we know it today, would not exist in a state-free world. “Why not?” you might ask.

Because bankruptcy, as Lawrence White described it, is a statist, third party, intervention in the financial arrangements between debtor and creditor. Twenty-first century American bankruptcy is a system of government laws which provides for the coercive elimination of contractual obligations. Creditors are compelled to reduce their claims against their common debtor and to adjust those competing claims to the fund created by the liquidation of the debtor’s assets. The debtor, who cannot meet his current obligations, surrenders his property to a legal entity created by fiat, i.e., the bankrupt estate, which then becomes title-holder to the moneys resulting from the sale of that property. Those funds are then first distributed to satisfy any outstanding debts owed to the government and secured creditors, and then usually paid out proportionally by court-approved order among the other outstanding creditors. In contemporary bankruptcy proceedings, the unpaid obligations of the debtor are eliminated, and the debtor is relieved or discharged from all further responsibility of paying those debts. Under the United States federal constitution, all contracts are written with bankruptcy laws as an implicit clause. [1] Bankruptcy laws are part of the rules of the game, specifying the government’s interpretation of property rights between debtor and creditor. In short, bankruptcy is entirely statutory: there was never any provision for bankruptcy under the common law. [2]

Despite the fact that Psalm 37:21 describes the person who does not repay his debts as an evil person (“the wicked borrow and does not pay back“), ancient Jewish law provided for the abrogation of debts and slavery on a 49 or 50 year cycle known as the Jubilee Year.  In Deuteronomy 15:1-2 the frequency of these debt forgiveness periods was imposed every seven years. [3]  Babylonian kings, going as far back as Hammurabi “occasionally issued decrees for the cancellation of debts.” [4] The problems of debt and servitude were faced in ancient Athens, as well as in Rome. Debt forgiveness in ancient Greece was unknown until Solon revised the Draconian Code in 594 B.C. by which “in exchange for the legal discharge of his debts, the bankrupt was to forfeit Greek citizenship for himself and his heirs.” [5] In Rome, the debtor was often seized and both the debtor and his family were made slaves of the creditors. As was said of the Romans: “He who cannot pay with his purse pays with his skin.” [6] “The history of western law since the Roman era has” generally treated the debtor as a criminal, who stole the property of his creditor when he could not repay it as promised. [7] The origin of the word ‘bankrupt” has been traced to medieval Italy where the table or bench of a banker was publicly broken “in a symbolic show of failure,” otherwise known in Italian as banco rotto or broken bank or ‘busted’ banker. [8]

In England the debtor was regarded as a thief, although the Magna Carta signed by King John, in 1215, decreed that a man’s body could not be taken for failure to pay a debt. [9] However, soon thereafter, “imprisonment for debt was instituted during the reign of Henry III.” [10] The first English statute establishing bankruptcy was passed in 1542, but it applied only to traders and merchants. Creditors were required to initiate the declaration of bankruptcy. A delinquent debtor was normally imprisoned at the behest of his creditors, even though this restraint often restricted his ability to repay them. Imprisonment for debt generally failed to coerce debtors into paying. Finally in 1869, Parliament passed the Debtor’s Act which “limited the ability of the courts to sentence debtors to prison, but it did not entirely prohibit them from doing so.” [11] Creditors often resorted to other means of enforcing payment, such as executing mortgages, writing conditional sales contracts, issuing collateralized loans, garnishing wages, and executing writs of attachment by which to seize the debtor’s property.

In the United States, a bankruptcy clause was written into the federal Constitution of 1789, even though various colonies and states had  previously established their own systems of insolvency, stay or delayed payment, and bankruptcy law. When the first official federal bankruptcy law was written in 1800, there was some discussion about whether the legislature had the right to interfere between a debtor and creditor, “in respect to transactions which took place before the passage of” such a law. Would it not “partake in the nature of an expost facto law, which is prohibited by the Constitution?”  [12] The bankruptcy law of 1800 was repealed in 1803. Subsequent legislation has been passed and revised numerous times, until today “billions of dollars of debt are discharged annually, releasing” millions of  households and businesses from their legal financial obligations. [13]

Historically, there have been several different systems of settling debts when the debtor had insufficient assets to satisfy all the claims against him. Under ancient Jewish law “nearly all creditors were paid in the order of time in which their claims were created. … In the [old] Germanic system, creditors were ranked according to the time in which their executions were levied  … .” In [early] France “the creditors were satisfied in the order of the date the debts were contracted.” ]14] In England, at least until the time of the first bankruptcy laws, “the first creditor to get wind of trouble and take legal action under the common law” received payment, while less diligent creditors “were left with a large bad debt loss.” [15] Thus, depending on the time and place where a creditor lived, the satisfaction of an unpaid debt could depend upon one of two interpretations of the priority principle. Priority could either be based on (1) the date on which the debt was contracted; or (2) the date on which an attachment or execution of property was made.

A few libertarian writers, most notably Lysander Spooner, in the mid-19th century, and Murray Rothbard and Lawrence White, in the late 20th century, have dealt with the subject of bankruptcy. Spooner devoted the whole of his book, POVERTY: ITS ILLEGAL CAUSES AND LEGAL CURE (1846), to elaborating his ideas about the nature of credit and debt repayment. He returned to that topic without having changed his mind, forty years later in his A LETTER TO GROVER CLEVELAND. [16]  Spooner believed that “a debt should be a lien upon the property that a man has before, and when the debt becomes due; and not upon his earnings after the debt is due. If, therefore, a man be able to pay a debt when it becomes due, he should pay it in full; if unable to pay it in full, he should pay to the extent of his ability; and that payment should be the end of that transaction. The debt should be no lien upon his future acquisitions.” [17]

Murray Rothbard, on the other hand, believed that “The prime consideration in the treatment of the debtor would be his continuing and primary responsibility to redeem the property of the creditor. The only way” which the debt obligation “could be eliminated would be for the debtor and creditor to agree, as part of the original contract, that if the debtor makes certain investments and fails to have the property at the date due, the creditor will forgive the debt; … .” [18] According to Rothbard, bankruptcy laws violate the ownership rights of the creditor.  If voluntary forgiveness is not included in the original loan agreement, then forgiveness might be granted  after a default occurs. If a creditor decides to forget about the debt he in effect grants a gift of his property to the debtor. [19]

Writing after Spooner and Rothbard, Larry White summarized how those in a state-free society might deal with the problem, “which bankruptcy attempts to deal with, namely, the inability [of an individual] to repay contracted debts.”

According to the title-transfer view of a loan contract [which White and Rothbard endorse], the creditor first transfers title to his money (in the amount of the loan) to the debtor. At a contractually agreed-upon later date (or dates, if repayment is in installments), the creditor gains title to the debtor’s money in the agreed amount (loan plus interest and other charges). The debtor who fails to honor fully the creditor’s claim is at that point in illegitimate possession of the creditor’s property. The creditor’s claim is part of his [the creditor‘s] property and is not, unless the loan contract so stipulates, contingent upon the ability of debtor to pay at that time. The creditor has a right to payment which is not eliminated by any fact of adverse circumstances surrounding the debtor. Only forgiveness of the debt can eliminate the creditor’s unsettled claim by transferring title to the debtor.

There is therefore no warrant for the legal discharge of debtors from the payment of their debts for as long as they continue to live or their estates continue to exist. To put it another way, the debtor is not entitled to the legal elimination of his debt. On the contrary, the creditor is entitled to (properly has a lien against) the future earnings of the insolvent debtor. Thus the feature of contemporary bankruptcy law which most differentiates it from … [that] which would prevail in an unhampered market system is its provision for the extra-contractual dissolution of debts. [20]

White’s discussion highlights the differences between Spooner and Rothbard, and also raises the question as to how a contract of debt is to be interpreted in the absence of explicit provisions regarding failure to pay the debt when due. Should it be assumed that a debtor’s obligation ends at the time the debt is due or should the debtor be held perpetually liable (until such time as he dies or his estate is settled)? Is a debt a personal obligation that attaches to the body of the debtor, or is a debt a mortgage upon certain property? What becomes of such a mortgage if that property no longer exists?

Spooner answered this last question by arguing that a contract of debt was a bailment and that the debt should be extinguished if the property entrusted to the debtor no longer existed. Under the common law a bailment is the delivery or surrender of goods “in trust for a specified purpose.“ [21] Thus, Spooner held that since the creditor was entrusting his property to the debtor (for a certain length of time) a bailment was created. Under the accepted law of bailment, so long as the debtor or bailee (the person to whom the property was entrusted) did nothing fraudulent or contrary to the contract of bailment, his responsibility ended if he were not able to return the property when promised. In his book, POVERTY, from which I have previously quoted, Spooner devoted two whole chapters to “The Legal Nature of Debt.” It is difficult to compress his argument in a few lines, but it can be summed up by quoting a few brief comments:

If debt be but a bailment, the value bailed is at the risk of the owner, (that is, of the creditor) from the time he buys and pays for it, and leaves it in the hands of the seller, or debtor, until the time agreed on for delivery to himself. If  it be lost during this time, without any fault or culpable neglect on the part of the bailee, or debtor, the loss falls on the owner, or creditor. All the obligations of the … debtor are fulfilled, when he has used such care and diligence, in the preservation of the value bailed, as the law requires of other bailees, and has delivered to the creditor … at the time agreed upon the value bailed, or such part thereof, if any, as may then be remaining in his hands.

If such be not the natural limit to the obligation of the contract of debt, then there is no natural limit to it in any case, short of the absolute delivery of the amount mentioned; a limit, that requires a debtor to make good any loss that may befall the property of the creditor in his hands, … .

If such be not the natural limit to the legal obligation of debt – that is, if debts be naturally binding beyond the debtor’s means of payment when the debt becomes due, then all insolvent and bankrupt laws are palpable violations of the true and natural obligation of debts, and, consequently, of the rights of creditors; … .

On the other hand, if such be the natural limit to the legal obligation of debt, then we have no need of insolvent or bankrupt laws at all, for every contract of debt involves, within itself, the only honest bankrupt law, that the case admits of. [22]

Rothbard dismissed the idea of debt as a bailment, but never elaborated why he thought Spooner‘s interpretation was wrong. Rothbard simply asserted that creditors should “have a lien on the debtor’s future assets if the [debtor] had no money to pay at the time of default.” [23] However, neither Rothbard nor White explained why this should be the case. Spooner’s position has a certain degree of elegance and simplicity because it eliminates the need for externally-imposed Jubilee Years or other forms of debt abrogation. The Rothbard-White position has no way of eliminating perpetual debt slavery (other than by relying on the voluntary forgiveness of  creditors). Spooner makes an interesting aside, noting that a creditor who has been so negligent as to entrust his property to an incompetent – but non-fraudulent – debtor, should shoulder responsibility for his own poor judgment. If the debtor (through no fault of his own) can’t repay the debt then the creditor should bear the loss, rather than impose it upon the defaulting debtor. [24]

The answer to the problem of debt repayment in a free society is not “neither a lender nor a borrower be,” because sometimes the extension of credit is necessary to achieve one’s goals in life. However, voluntaryist thinking is in line with the efforts of Robert LeFevre, who once declared personal bankruptcy, but then proceeded later in life to repay or compromise with his creditors. The discharge of liabilities enacted by the state does not relieve the responsible individual of his moral duty to repay what he owes, even if there is no legal obligation to do so. [25] This outlook was described by H. L. Mencken in his book, HAPPY DAYS 1880-1892. Mencken’s father, August, had a unique outlook on lending and borrowing.

[H]e never borrowed a nickel. Indeed, he regarded all borrowing as somehow shameful, and looked confidently for the bankruptcy and probable jailing of any business man who practiced it regularly. His moral system, as I try to piece it together after so many years, seems to have been predominantly Chinese. All mankind, in his sight, was divided into two great races; those who paid their bills, and those who didn’t. The former were virtuous despite any evidence that could be adduced to the contrary; the latter were unanimously and incurably scoundrels. [26]

That pretty much sums up the voluntaryist position. Before you borrow, try to establish what your liability might be, if any, in the event of an unforeseen default. If you borrow money, try to be in a position to pay it back. If you can’t, seek forgiveness from your lender or make arrangements to pay it back little by little. The man of integrity attempts to pay his bills, even if late, because he is a man of his word.


End Notes

[1] Ian Domowitz and Elie Tamer, TWO HUNDRED YEARS OF BANKRUPTCY: A TALE OF LEGISLATION AND ECONOMIC FLUCTUATIONS, Evanston: Institute for Policy Research, Northwestern University (July 1997), p. 1.

[2] Lawrence H. White, “Bankruptcy As an Economic Intervention,” 1 JOURNAL OF LIBERTARIAN STUDIES (1977), pp. 281-288 at p. 281. Also see Philip Schuchman, “An Attempt at a ‘Philosophy of Bankruptcy’.” 21 UCLA LAW REVIEW (1973), pp. 403-476 at pp. 419-420.

[3] Larry Burkett, BUSINESS BY THE BOOK, Nashville: Thomas Nelson Publishers (1990), pp. 158-159.  Also see “A Brief History of Bankruptcy,” at www.bankruptcydata.com/Ch11History.htm.

[4] “Jubliee (biblical),” at https://en.wikipedia.org/ wiki/Jubilee_(biblical).

[5] White, op. cit., p. 281

[6] Louis Edward Levinthal, “The Early History of Bankruptcy Law,”  66 U. Pa. L. Rev. (1918), pp. 223-250 at p. 231.

[7] Schuchman, op. cit. p. 455.

[8] “A Brief History of Bankruptcy,” op. cit. in End Note 3.

[9] Hugh Barty-King, THE WORST POVERTY: A HISTORY OF DEBT AND DEBTORS, Wolfeboro Falls: Alan Sutton (1991), p. 3.

[10] White, op. cit., p. 281.

[11] “Debtors‘ prison,” at https://en.wikipedia.org/ wiki/Debtors%27_prison.

[12] Charles Warren, BANKRUPTCY IN UNITED STATES HISTORY, Cambridge: Harvard University Press, 1935, p. 14.

[13] Domowity and Tamer, op. cit., p 1.

[14] Levinthal, op. cit., pp. 233 and 244-245.

[15] Alexander J. Field, “Bankruptcy, Debt, and the Macroeconomy: 1919-1946, 20 RESEARCH IN ECONOMIC HISTORY (2001), pp. 99-133 at p. 101.

[16] Lysander Spooner, A LETTER TO GROVER CLEVELAND, Boston: Benj. R. Tucker (1886). See Section XIX, p. 62.

[17] Lysander Spooner, POVERTY: ITS ILLEGAL CAUSES AND LEGAL CURE, Boston: Bela Marsh, 1846, pp. 17-18.

[18] Murray N. Rothbard, MAN, ECONOMY, AND STATE, D. Van Nostrand Company, Inc.: New York, 1962, p. 155.

[19] ibid. Also see Murray N. Rothbard, THE ETHICS OF LIBERTY, Atlantic Highlands: Humanities Press, 1982, Chapter 19, “Property Rights and the Theory of Contracts,” p. 143.

[20] White, op. cit., p. 283.

[21] “bail,” Lesley Brown (ed.), THE NEW SHORTER OXFORD ENGLISH DICTIONARY, Oxford: Clarendon Press, 1993, p. 170.

[22] Spooner, POVERTY, op. cit., pp. 72-73.

[23] Rothbard, THE ETHICS OF LIBERTY, op. cit., p. 147, Footnote 19, Paragraph 3.

[24] Spooner, POVERTY, op. cit., p. 72, first footnote.

[25] Larry Burkett distinguishes between the Biblical principles of a) “Don’t borrow needlessly;” b) Don’t sign surety;” and c) Don’t take on long-term debt” and the scriptural commandment: “Repay what you owe. There is no option for the Christian when it comes to repaying a debt. … [T]he Scripture is very clear when it equates the breaking of a promise (vow) with sinning.” Burkett, op. cit., p. 158.

[26] H. L. Mencken, HAPPY DAYS 1880-1892, New York: Alfred A. Knopf, 1968, p. 251.