The famous novel Robinson Crusoe tells the story of a man who is shipwrecked on a desert island, where he spends 28 years building shelters, hunting goats and passing the time with a dog and cat that he rescued from the shipwreck.
But few know the author of Robinson Crusoe, Daniel Defoe, was an entrepreneur who, as many do, eventually found himself unable to pay his creditors. In 1692 and again in 1706, Mr Defoe went bankrupt. In Defoe’s day this did not mean that your assets were transferred to the Official Assignee and sold to pay your creditors pari passu. No, Daniel Defoe went to debtor’s prison.
Debtors’ prisons were cruel and often deadly places. Food was not provided and had to be paid for by bankrupts who were short on funds. Many died of starvation. Defoe was an advocate for bankruptcy reform, though he did not live to see any established. Instead, he passed away in London hiding from his creditors.
There are two competing policy concerns that contribute to the law of insolvency. A strong economy thrives on new ideas and forms of organisation. To innovate people must be able to take risks. On the other hand, a strong economy requires credit. To convince creditors to supply that credit, the risks of providing it must be mitigated by the state maintaining a process for regaining some amount of the credit provided when an investment goes wrong.
The earliest ancestor of modern bankruptcy law was the Act Against Such Persons As Do Make Bankrupts 1542. This early act simply enabled creditors to begin selling off the assets of the bankrupt, during which time the debtor was often sent to prison to ensure that he did not attempt to flee or hide. There were no provisions enabling a fresh start for the bankrupt, the debtor remained burdened until he was able to repay his creditors which might never happen. This was difficult to achieve from prison, and the burden of repayment usually fell upon the debtor’s family.
By the early 1800s, there were so many people in debtor’s prisons that parliament had to make a change. With the Bankruptcy Act 1813, the idea of a discharge from debt was established. This allowed some bankrupt individuals to be released from their debts if certain requirements were fulfilled but the cases where such a discharge was available was limited. Bankruptcy law remained concerned primarily with punishing the debtor and making sure they did not escape or hid from their debtors.
The personal and corporate insolvency regime are very similar. This has been so since The English Joint Stock Companies Winding Up Act 1844, which mandated that the personal bankruptcy regime would be imposed on an insolvent company. The Act also extended the concept of incorporation to public companies, where it had previously only been available to entities formed by the state. But the concept of the limited liability company was not established until 1855, with the Limited Liability Act. Suddenly, investors were able to pool their capital without rendering themselves personally liable should the venture fail, that is unless guarantees are offered.
This limit on the liability of investors encouraged reasonable risk taking. The British parliament eventually realised the positive effect this had on the economy, when at last in 1869, they passed the Bankruptcy Act. This Act established a new regime that reflects that of today. Bankrupts were no longer to be imprisoned and, once the process of bankruptcy was completed, the bankrupt was given a fresh start, a new economic life.
That is not to say that modern bankruptcy law is not punitive at all. Some of the results of bankruptcy are tough and provisions still exist that mean to keep the bankrupt in country and repaying their debts. After disclosing to the Official Assignee all their assets and debts, and after providing all accounting and other relevant documents, certain obligations are imposed on the bankrupt individual. They may not: be a director, manage a business without the consent of the Official Assignee, leave New Zealand without the consent of the Official Assignee, obtain more than $1000 of credit without disclosing that they are a bankrupt, and they may be required to make payments from their earnings according to the direction of the Official Assignee. A bankruptcy will usually remain in place for three years, but following this, the bankrupt individual is given another chance.
Tough or not, modern bankruptcy law serves an economic purpose without being needlessly punitive. In 2023, 628 people went bankrupt, sadly none of them (as far as I’m aware) wrote a groundbreaking novel, but thankfully none went to debtor’s prison either.
