The U.S. Constitution makes bankruptcy a federal procedure. So how come it’s different in every state because of the property you can protect?
You might think that filing bankruptcy in Indiana is same as all other states. Even the Constitution says that Congress has the power “to establish… uniform Laws on the subject of Bankruptcies throughout the United States.”Article 1, Section 8, Clause 4.
But Indiana bankruptcies don’t sound like they are governed by “uniform Laws” if the residents of Indiana do not get to exempt (protect) the same amount of their property than residents of some other state. For example, you can exempt only $17,600 of value in your home if you live in Indiana (IND CODE 34-55-10-2) , but if you live in Florida, you can exempt an unlimited amount of value in your home (Art. X, Sect. 4, Fla. Const.).
How can the supposedly “uniform” bankruptcy laws be applied so differently in different states?
The reason is that the current law—created in the late 1970s—is a major political compromise involving the most basic tension in the Constitution– states’ rights versus federal power. (Remember, we fought the Civil War about this.)
The issue here is whether a federal set of property exemptions would be required for everyone throughout the country filing bankruptcy, or whether instead each state would be able to create its own separate exemptions to be applied to their residents filing bankruptcy. The compromise—quite firmly in favor of states’ rights—is that the Bankruptcy Code does contain a federal set of exemptions, but each state is allowed to “opt-out” of those federal exemptions and require its residents to use that state’s exemptions when filing bankruptcy.
So, if you live in one of 32 states like Indiana, you cannot use the federal exemptions. Instead you must use your state’s separate set of exemptions. In the remaining 18 states and the District of Columbia, you can use either the federal or local exemptions.
A Long Time Coming
Before this was settled, it was probably the most contentious issue in bankruptcy law. In fact, it’s a big part of why we didn’t even HAVE a bankruptcy law during most of the 1800s.
Throughout that century, an ongoing political and economic fight raged between bankers mostly in the Northeast against farmers and small merchants mostly in the South and West. Because of regular cycles of financial “panics,” the farmers and merchants endured a pattern of losing their homes and farms to out-of-state creditors. Because of this, the first law exempting certain property from creditors was adopted in 1839 in Texas even before it became a state. From this exemption, laws spread quickly through the South and the Midwest during the 1840s and 1850s.
Three different times during this same century, Congress passed a set of bankruptcy laws, each time to address the fallout from one of the reoccurring financial panics. But none of the bankruptcy laws stayed in force for long, expiring or being repealed as soon as the economy improved. With no federal bankruptcy law in effect most of the time, various kinds of state laws tried to fill the gap in various ways, including through property exemptions.
The first “permanent” bankruptcy law was passed in 1898, but it could only muster enough votes in Congress by letting states continue to use their own system of exemptions for bankruptcies filed by their residents.
So our last late-1970s compromise was a long time coming. Some members in Congress wanted to continue using state exemptions as in the 1898 law, while others wanted a mandatory uniform federal system. The compromise was that each state was given a choice: it could let its residents file bankruptcy using EITHER a new set of federal exemptions or the state’s exemptions, OR each state could require its residents to use the state’s exemptions.
The end result is that every state’s residents are either allowed or required to use their state’s exemptions, while in 18 states residents also have the option to use the federal exemptions. Between states’ rights and federal power, it sure looks like this favors states’ right. The result is that bankruptcies can look quite different from one state to another, in spite of the “uniform Laws” requirement in the Constitution. That is certainly true if you own a home with a large amount of equity in Indiana versus Florida.
If you have further questions, or would like to talk to a bankruptcy attorney in Lafayette, Indiana, call (765) 420-8900