It's Time to Return to Our Roots: The Bankruptcy Common Law That Governs Insolvent Estates.

• Author: Haines, Randolph J.

Most of us probably remember that the first task in answering a bar exam question is to identify the body of law that provides the relevant analysis. And even most non-bankruptcy lawyers would probably identify insolvency law, more commonly known as bankruptcy law, as the relevant body of law to determine what comprises an insolvent estate or how it should be distributed. Yet in the past three decades, the United States Supreme Court (the "Supreme Court") and many circuit courts have fumbled or failed to follow this simple rule of legal analysis. And this failure to begin by identifying the appropriate body of law has been exacerbated by another first year law school mistake--reliance on headnotes or isolated quotes without first under' standing the facts and context of an apparent precedential opinion. Most recently, the Supreme Court held that the fact that a question of corporate property rights happens to arise "in the context of a federal bankruptcy" "doesn't change much," (1) without first identifying the appropriate body of law and without considering the factual contexts of its cited authorities. These failures not only resulted in an irrelevant opinion but also drove the Supreme Court to the type of constitutional analysis (2) that it ordinarily seeks to avoid when the case can be resolved on non-constitutional grounds.

Such analytical failures are of purely modern origin. Since at least 1571 insolvency law has been recognized as the unique analytical framework for the ultimate determination of the asset side of an insolvent estate. This was made most evident in 1601 when Lord Coke held that the Statute of 13 Elizabeth c. 5 (1571) trumped two-party contract rights and property rights. (3)

On the liability side the overriding relevance of insolvency law was recognized as early as 1584 when the concept of avoidable preferences became part of the common law of insolvency. (4) As recently as 1970 the Supreme Court unequivocally stated that the common law of bankruptcy and the "basic purpose of the Bankruptcy Act" superseded any other body of law that might otherwise identify what must be included in an insolvent estate. (5)

Yet even before the Supreme Court's recent pronouncement that "the context of a federal bankruptcy" "doesn't change much" the Ninth Circuit had held that characterization of claims and interests in a bankruptcy estate should be determined by "reference to state law" rather than by the federal common law governing insolvent estates. (6) And the Fifth Circuit had held that determination of property of estate hinges on the existence of a "pre' petition legal interest" such as a property right or cause of action defined by non-bankruptcy law, (7) purportedly distinguishing the Supreme Court precedent holding that the "purposes" of the bankruptcy law "must ultimately govern." (8)

How in the relatively short time of three decades could four centuries of insolvency common law be supplanted? And how could this change in focus become so complete that insolvency law is no longer recognized as being the appropriate body of law to begin the analysis? The goals of this Article are to explore (1) why the body of insolvency law must ultimately govern both the assets and the priority of liabilities of an insolvent estate, (2) how this principle was understood and applied for most of the previous four centuries, and (3) what has led many courts astray over the past 30 years, including recently the Supreme Court.

1. PROPERTY OF THE ESTATE IS DEFINED BY BANKRUPTCY LAW, NOT "PROPERTY" LAW

   1. PROPERTY OF THE ESTATE IS NOT LIMITED BY OTHER LAW

      The first English bankruptcy law was the act of 34 Hen. VIII c. 4, adopted in 1542 and entitled "an act against such persons as do make bankrupts." (9) It was extensively amended by the Statute of 13 Eliz. c.7 in 1571. Together they established basic English bankruptcy law for more than one hundred fifty years until the adoption of the discharge in the Statute of Anne in 1705. (10)

      Because there was no discharge, the sole purpose of the first English bankruptcy law was to collect all of the debtor's assets and distribute their proceeds to the creditors. One might ask why the central government felt it necessary to create this novel collective remedy rather than simply allowing the creditors to exercise their own legal remedies. Perhaps one reason is that creditors' remedies were otherwise incapable of seizing many if not most of an insolvent entrepreneur's (11) most valuable assets, particularly those that were created by the recent expansion of commerce and business. (12)

      Then, as now, the principal remedy for individual creditors was execution of judgment by the writ of fieri facias, more commonly known today as a writ of execution. (13) But that writ was effective only to "seize the defendant's chattels." (14) It did not extend to land, which could only be executed on after 1285 by an alternative procedure called elegit, which did not transfer ownership of the land but only the rents it generated until the debt was paid. (15) "The writ of execution could not touch anything but that which the common law court could recognize as property." (16) So although the writ of fi. fa. could reach a trader's inventory it could not reach what might constitute most of the trader's wealth that might be tied up in contracts, receivables and other collection rights, other kinds of choses in action, or investments in partnerships or joint ventures, or trust estates. Such assets could not be reached by any legal process because they were not recognized by "law," as distinct from equity, as being any kind of "property." (17) "At common law judgments could not be levied upon estates merely equitable, because courts of law did not recognize any such titles and could not deal with them." (18)

      All of those non-legal equitable assets could only be reached by a creditor's bill. After the creditor had obtained a judgment and had "failed to obtain seizure of his debtor's property under execution" the creditor could file a bill requesting the Court of Chancery to order the judgment debtor to turn over to the receiver any interest in any "equitable asset." But this process was cumbersome in requiring an action at law, a judgment, a writ of execution and finally a bill in equity. And it benefited only those judgment creditors who were made party to the bill in equity, and even as to them a creditor's bill gave full priority to the creditor who first filed the bill rather than sharing them equally or equitably among all creditors. (19)

      So the solution was the bankruptcy act of 1542 (20) as amended in 1571. (21) It dispensed entirely with the necessity of judgments and writs and the narrow legal definition of leviable "property." Instead, upon proof that the debtor was a trader who had committed an act of bankruptcy, the debtor was required to "make a full discovery of all his estate and effects, as well in expectancy as possession." (22) Then by operation of law "all the personal estate and effects of the bankrupt are considered vested, by the act of bankruptcy, in the future assignees of the commissioners, whether they be goods in actual possession, or debts, contracts, and other choses in action ...." (23) "The property vested in the assignees is the whole that the bankruptcy had in himself at the time he committed the first act of bankruptcy, or that has been vested in him since, before his debts are satisfied or agreed to." (24)

      Therefore since the origin of bankruptcy law the property of the estate has never been limited to "property," or even to any rights that were recognized by the law. No legal requirement or technicality could limit the estate, which even included expectancies in existence at the time of the first act of bankruptcy and anything else that might be of benefit to the debtor at any time thereafter until all the debts were satisfied, even if not an expectancy at the time of bankruptcy.

      This history, which has been incorporated into America's common law and was understood by the Framers when they adopted the Bankruptcy Clause, is one unequivocal reason why insolvency common law (25) must supersede all other law in the analysis of either the assets or the priority of liabilities of an insolvent estate. That has been the primary intent of this body of Anglo-American common law since before 1542.

      And if that primacy of insolvency common law were not clear enough from the historical evolution and the manifest statutory intent of the acts of 1542 and 1571, it also became part of the common law just a very few years later, in Twyne's Case. (26) Twyne's Case is usually analyzed for the purpose of understanding one relatively narrow branch of insolvency law, actual fraudulent transfer law and the "badges of fraud." But for present purposes its more significant function is to establish that on appropriate facts insolvency common law is the governing body of law despite a party's otherwise compelling argument that contract rights or property rights should prevail.

      The actual facts are critical to an appreciation of the broader significance of Twyne's Case. Pierce was the debtor, who owed at least two creditors, 400 [pounds sterling] to Twyne and 200 [pounds sterling] to C. C. obtained judgment and a writ of fieri facias. When the Sheriff executed the writ he sought to levy it upon sheep on Pierce's pasture and bearing Pierce's brand. (27) But Twyne had his allies forcibly resist the sheriffs levy.

      Twyne was prosecuted in the Star Chamber. His defense was that the sheep were his, not Pierce's, because they had been deeded to him, along with all of Pierce's other goods and chattels that had a value not exceeding 300 [pounds sterling], which Twyne had accepted in full satisfaction of his 400 [pounds sterling] debt. He even produced in evidence a written deed, executed by Pierce. Yet Twyne and Pierce were convicted of "rebellious riot" by the Star Chamber. (28)

      For future...