Dealing with Economic Failure

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Preface

On 20/21 February 2014 the editors hosted an international and interdisciplinary conference on “Dealing with economic failures: extra-judicial and judicial conflict regulations”. Nine of the thirteen papers presented on that occasion are published in this volume; subsequently Jasper Kunstreich submitted his article. All papers were thoroughly revised before publication.

The editors met under the roof of the LOEWE Research Focus ‘Extrajudicial and Judicial Conflict Resolution’ (2012–2015), a project organized mainly by the Goethe-University Frankfurt a.M. and the Max Planck Institute for European Legal History. LOEWE is an ongoing programme of research funding by the state of Hesse, mainly focused on natural sciences, medicine and engineering; our research focus was among the few social science projects. Margrit Schulte Beerbühl was one of our research fellows, and Albrecht Cordes a member of the steering committee. While Albrecht Cordes is interested in the history of commercial law during the middle ages and early modern times in general, Margrit Schulte Beerbühl has done research on spectacular series of bankruptcies, namely the chain of collapses which originated in Hamburg in 1799 and subsequently shook the economy in Western Europe and even across the Atlantic Ocean. The crossroads of our interests and of the LOEWE subject were quickly identified: The ways medieval and modern societies dealt and deal with economic failure, concentrating on but not limited to the reaction on bankruptcies. Is the failure of an enterprise the ultimate defeat, a punishable crime and the terrible disaster? Or is it more like an incident, a bump in a mercantile career which can be overcome and possibly even leads to a welcomed opportunity to get rid of a suffocating amount of debts? The answers differ in space and time. The authors reflect on this subject from their respective economic or legal standpoints, some more with their individual case studies in mind, others from a more general angle.

The editors would like to thank the LOEWE research focus which funded the conference and the publication, to the whole LOEWE team under its managing director Andreas Karg, to the publishing house Peter Lang, to the Max Planck-Institute of European Legal History which hosted the conference, to the translator Sophie Costella, to the makers of the index Sonja Breustedt and Christina Voellinger, to Clemens Butzert who published the conference proceedings in ← 7 | 8 → H-soz-Kult to the chairs, discussants and other participants of the conference, and to all contributors of this joint enterprise between jurists and historians. We hope that our readers will not have to deal with too many failures within this book.

Albrecht Cordes

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Introduction

Writing in 1697 on bankrupts Daniel Defoe, the author of Robinson Crusoe, thought the English law on bankruptcy “has something in it of Barbarity”. He continues:

With these few words Defoe describes the hardships unfortunate traders faced in early modern England. Defoe suffered from the fate of a bankruptcy himself. After various unsuccessful ventures, among others in the wine trade with Portugal, and underwriting in insurance, he was declared bankrupt for more than £17,000 in 1692. Harassed by recalcitrant creditors he was committed to prison for several months, after a composition had failed, because four of his 140 creditors had refused to consent to an agreement. As the contemporary bankruptcy law contained no provisions for discharge Defoe remained liable with his future earnings. The harshness and cruelty of the law towards the debtor, he argues, “cast [him] out of Human Society, and expos’d [him] to Extremities worse than Death” Moreover, he thought that the bankruptcy laws were not only inhumane to the debtor but also of no advantage to the creditor.²

The bankruptcy laws of the early modern period treated the insolvent debtor as a criminal who had to be sanctioned severely. The perception of bankruptcy as a sort of theft or robbery of the creditor’s property was not only a central element in the European bankruptcy laws but also in nineteenth-century America.³ In Britain the insolvent debtor even had to face capital punishment until 1820.⁴

The shift from creditor-friendly towards more debtor-friendly legislation was a slow and uneven process lasting far into the twentieth century. The idea that ← 9 | 10 → prevails today, that bankruptcy law should be debtor-friendly, is a far cry from the creditor-friendly laws that dominated for centuries. Historically, according to Mike W. Peng, “entrepreneur-friendliness and bankruptcy laws are like an ‘oxymoron’, because bankruptcy laws used to be harsh and cruel”.5 Entrepreneur-friendly bankruptcy regimes are now advocated to make it easier to start afresh after a bankruptcy. Recent business literature highlights the role of entrepreneurs as agents of growth. As institutions decisively influence the level of entrepreneurial activity, business scholars pledge for entrepreneur-friendly institutional contexts that provide stimuli for innovation and risk-taking.⁶ Although the New Institutional Economics have long emphasized that institutions matter, the relationship between entrepreneurship and bankruptcy regimes has hardly been looked into. Only within the last few years, induced by the growing concern of governments around the world to facilitate the re-entry of bankrupts, have scholars begun to inquire into indices for entrepreneur-friendly bankruptcy laws.⁷ A strong interest in the question how bankruptcy laws impact on business activity resulted from various factors, the big financial crash in 2008, intensified global competition among business and states, the overall high number of failures even before 2008, and also from awareness that the percentage of firms that fail within the first five years is much higher than those that survive.⁸

The following papers are the outcome of an international conference that focused on the norms and practice of dealing with economic failure within and outside the courts from a long-term, international and interdisciplinary perspective. The papers cover the period from the early sixteenth century until today. Without ← 10 | 11 → claiming to give a comprehensive overview, the papers presented here – by addressing some central issues – should give an impression of the protracted process of modernization and adaptation. They focus on Europe’s leading commercial centres, for it was here that the impact of economic change was first experienced. Here we find information on the earliest examples of alternative conflict regulations and efforts by the town councils to search for more viable ways of dealing with bankruptcies. The volume concludes with a paper on today’s bankruptcy law in Germany to show where we are now.

The contributors to this volume are from various disciplines, social and economic as well as legal history and contemporary law. In Germany – perhaps more so than in Anglo-American countries – social and economic historians on the one side and legal historians on the other have for a long time approached the history of bankruptcies from diverging angles. Social and economic historians have used legal records like bankruptcy files predominantly for analyzing social and economic developments, or more recently turned their attention to cultural factors such as reputation, trust and the impact of social relations such as family, kin, or co-religionists on firms and companies.9 Vice versa, legal historians have focussed on the law, paying only secondary attention to economic and social aspects.¹⁰ Only within the last few years are some tendencies towards a broader approach visible in both disciplines. One of the aims of the conference was to intensify the dialogue between the disciplines.

A word needs to be said about the terms used: failure is a broader term that includes, but is not limited to, bankruptcy. A business may fail for lack of assets without undergoing a formal procedure before the courts. The term bankruptcy goes back to the Italian “banca rotta” meaning the break-up of a trader’s business, when he was not able to pay his debts. “Bankrupt” or “banqueroute” or “Bankrotteur” frequently used to have a negative connotation applying to a fraudulent failure,¹¹ the term failure or the outdated continental version of “falliment”, “fallissement” ← 11 | 12 → for bankruptcy or “fallit” for the debtor did not carry the negative implication of bankruptcy. In the past “insolvency” was applied to small traders and non-trading groups in Britain, who had to undergo a different court procedure than a bankrupt.12 Some of the papers in the volume are written by lawyers or legal historians. The character of the German legal language tradition may have connotations that are not to be found in the same English term. To open the German quotations in the articles to a non-German reading public, terms were adapted to the language used in the contemporary U.S. Bankruptcy Code.

Since the discovery of the Americas the world has changed fundamentally. The expansion of trade to distant non-European shores produced the financial revolution of the late seventeenth century followed by the industrial revolution.¹³ The rise of the European commercial empires was not, however, a history of continuous growth but was also accompanied by birth pangs and setbacks. Trade with the non-European world offered surprising economic opportunities and profit prospects, but traders had also to cope with new and unpredictable risks. Although we do not have comprehensive and reliable figures on failures, those we do have suggest that the number began to rise with long-distance trade and first became an accompaniment to commercial life in the early modern commercial centres such as Antwerp, Augsburg or Nürnberg. For Augsburg, for example, Mark Häberlein counted 62 bankruptcies between 1529 and 1580 and a further 57 between 1580 and 1620. Even large firms such as Höchstetter in 1529 failed along with middling and small merchants.¹⁴ A similar rise in bankruptcies can also be noticed in England during the sixteenth century.¹⁵ Compared to the eighteenth ← 12 | 13 → century the numbers were low. Two centuries later the numbers were several times higher in the leading commercial centres and jumped with the advent of industrialisation. In England they rose from an average of between 172 and 278 per year in the first half of the century to an average of 762 yearly in its last decade. A similar trend, although much lower in absolute numbers, can be perceived in Amsterdam and even in Stockholm.16

Given the economic change on the one side and the harshness of bankruptcy laws on the other, the question arises to what extent the laws were enforced and to what extent alternative solutions were sought. Researchers should not only study the provisions of the bankruptcy laws, but look at the practice of handling failures by the parties concerned.¹⁷

The penalizing treatment of the unfortunate trader had a more than thousand year old tradition dating back to the Roman times. As well as imprisonment, the bankrupt had to endure bondage and corporal punishment. The Romans already distinguished between the honest and the fraudulent debtor. While the fraudulent debtor faced bondage, incarceration and death, the honest debtor, whose misfortune was caused by external accidents, was granted a cessio bonorum and did not suffer the disgrace of losing his citizen’s rights, if he surrendered his property voluntarily.¹⁸ This distinction and the institution of cessio bonorum was lost with the decline of the Roman Empire and only slowly re-discovered in the early modern period. In some countries it took even longer before it was written down.¹⁹

Given the increase of risk and failure from the sixteenth century onwards, the question arises how debtors and creditors as well as the lawmakers and courts responded to the changing economic environment. Imprisonment for debt robbed the bankrupts of the opportunity to pay back their debts. For the creditor, imprisonment, death or flight of the debtor to some unknown place could mean that ← 13 | 14 → he would have to write off losses and in the worst case be drawn into the failure, possibly facing bankruptcy himself. Given the laws, the questions will be: What opportunities did debtors, creditors and the court have for alternative instruments of conflict regulation and conflict reduction? What changes can be perceived in the level of imprisonment?

Law sources provide us with interpretations of what was considered right or wrong at a given time. These provisions vary in time and space as they are embedded in cultural values and responsive to social change. As Lawrence Friedman and, more recently, Jérôme Sgard have pointed out economic and social developments do not only have an impact on legal and judicial structures, but vice versa as well; the two spheres shape each other.20 Reciprocal influences do not imply that changes correlate immediately. Legal norms may react much more slowly to changes, because lasting cultural perceptions, such as the criminal perception of economic failure for example, retarded change in the law. Furthermore, the early bankruptcy laws were often attempts to solve immediate problems and thus were vague and had defects.²¹ By looking at judicial and non-judicial practices in dealing with bankrupts the impact of social relations on the outcome of a procedure should be taken into account.

The inability to repay debts opens up a Pandora’s box of conflicts not only between debtor and creditor, but also between the creditors. It was conflict-prone on many issues, economic, social, cultural and legal, which had to be solved quickly and individually. Given the penalizing character of the pre-modern laws, bankruptcy was something to be avoided at nearly any price. Thus conflict reduction and prevention for the benefit of good governance have been the guiding principles throughout the centuries.

Powerful trading enterprises with trade links extending to the New World already existed in the first half of the sixteenth century. Well-known examples are the Fuggers and Höchstetters of Augsburg or the Imhoffs of Nuremberg. These firms had invested not only in long-distance trade but in mines and other early modern industrial enterprises. They were, moreover, money-lenders to the crowns and nobility of Europe. Although they were family firms, capital did not exclusively come from family members or dowries but also from non-related shareholders. ← 14 | 15 → To prevent internal litigation and conflict among the active and silent partners that could end in bankruptcy, the Höchstetters, Imhoffs and other large family enterprises had concluded company agreements detailing the rights and duties of the governing members and providing instruments to deal with existing or threatened conflicts. Three measures proved particularly effective to prevent litigation, as Mechthild Isenmann explains in detail in her contribution; firstly they institutionalized regular and obligatory shareholder meetings that provided a platform for regulating internal conflicts. In case of unforeseen and imminent disputes the contract provided for extraordinary shareholder meetings. Secondly, if these could not be settled at the meetings the articles prescribed mediation either internally by a family member and kin, or if the matter could not be settled internally, they were to call in external mediators. Litigation was the last resort and only started when all other forms of conflict regulations had failed. Isenmann comes to the conclusion that mediation practices were generally preferred for several reasons. One was that information on internal business habits should not be laid open to the public, and a mutual agreement or mediation could be more advantageous to the parties concerned.

Another preventive measure to evade the threat of social death that accompanied bankruptcy in the early modern period is described by Wolfgang Forster. The commercial developments after the discovery of the New World began to shake the social and economic foundations of the traditional social elite in Spain by the new wealth of the mercantile middle classes. Traditionally, social status was based on landownership that needed to be displayed by a conspicuous and elaborate dress code and consumption rituals. The obligation to demonstrate noble status through a luxurious lifestyle and extravagant dowries for daughters was a financial strain. Unlike the mercantile classes they faced falling revenues from a declining population. Various instruments existed to prevent or delay bankruptcy of a noble family: creditors could grant a respite, a partial remission of debt was another option or the crown could intervene and hustle creditors and debtor into an agreement. When all of these possibilities failed only a “cession bonorum”, i.e. relinquishing all assets to the creditors, remained in order to avoid imprisonment and disgrace. Surrendering all assets, however, implied losing noble status which was inalienably bound to the memoria of entailed estates in Spain. Faced with this problem the Spanish lawyer Salgado de Somoza developed a legal solution by separating administration from possession which allowed the over-indebted nobility to retain its social status.

Some factors allow the sixteenth century to be seen as a first turning point in the history of bankruptcy: around the turn to the sixteenth century a more systematic bankruptcy system began to emerge in Europe resulting from the expansion ← 15 | 16 → of trade and credit relations, the frequent wars and rising number of bankruptcies. Suitable solutions for handling bankruptcy had to be found. In medieval cities creditors could take debtors to prison without the intervention of a court, and the old instruments for dealing with insolvent debtors led to tensions and discontent. The inadequacy of the old bankruptcy regulations was first felt in the commercial centre of Antwerp, whose mercantile community had grown considerably and become more international.

In response to rising litigation the Antwerp City council, as Dave De ruysscher elaborates, issued an ordinance in 1516 that for the first time introduced collective bankruptcy proceedings. Up to that time creditors who first made a claim to the assets of a bankrupt were prioritized over those who claimed compensation before the courts at a later stage. The new law imposed restraint on the individual creditor who sought full repayment at the expense of others. Besides the introduction of collective bankruptcy proceedings a second important measure was introduced in the 1520s and 1530s. During these decades de Ruyscher notices a certain shift from creditor-oriented to more debtor-oriented legislation that to some extent alleviated the debtor’s fate, although its aim was primarily to encourage him to come forward and forfeit all his property. This development resulted from the economic and financial crises between the Frisian war of 1517 and the Italian wars of 1521 and went along with further changes, such as a distinction between unfortunate and fraudulent debtors, and the introduction of voluntary bankruptcy.

Furthermore, the council of Brabant and the urban government took an active role in hustling the parties into compromise, allowing the debtor to apply to the council of Brabant to commission the Antwerp aldermen to mediate a compromise, encouraging the creditors to consent to postponement of payments, and allowing a debtor to continue business at least during the negotiations. Although, as De ruysscher points out, the number of arrangements increased considerably in the 1530s. The new regulations were clearly adapted to the needs of a commercial hub, but the city authorities lacked effective instruments to force all creditors into a lasting compromise.

The eighteenth century marks a step up in the history of bankruptcy. It saw the evolution of a commercial bankruptcy regime adapted to the needs of a commercial society. The bankruptcy system of Antwerp was a local regulation, but during the eighteenth century commercial opportunities and risk extended beyond the few city centres. After the fall of Antwerp in 1585 trade shifted to the north, to Amsterdam, later on to London. Besides the two leading financial hubs many larger and smaller trading and commercial centres had emerged by the eighteenth century. Non-European regions had become interconnected forming an early modern global trade by European trade companies, adventurers and individual ← 16 | 17 → merchants, who had established far-reaching trade networks.22 New financial institutions had been created during the course of the seventeenth century such as the Wisselbank in Amsterdam as early as 1609, the Hamburg Bank in 1619 or the Bank of England in 1694 along with insurance companies and other financial instruments to meet the rapidly growing credit demand of private businessmen and governments.

Although bankruptcy laws had been amended to some extent during the early seventeenth century they had become inadequate to meet the requirements of the commercialized economies at the end of the century. That did not only hold true for Britain. The laws had been suited, as Daniel Defoe remarked, for “the Circumstances and Time of the Evil they were made against”, but were “now a Public Grievance to the Nation”²³ and their “severity served neither the creditor nor the debtor”.²⁴ Suffering himself from the dreadful fate of a bankrupt, Defoe began to advocate a reform of the bankruptcy law that would allow a ‘full and free discharge’ of debts. His struggle for a reform resulted in the new bankruptcy law of 1706 (4 & 5 Anne c. 17). It can be seen as a turning point in the history of bankruptcy legislation as it introduced for the first time the possibility of a discharge from debt and a debt-free fresh start for the honest traders.²⁵ The law of 1706 alleviated the fate of at least some honest traders, but it neither abolished the traditional penalizing provisions (on the contrary, it even exacerbated punishment for fraudulent debtors by introducing the death penalty), nor did it introduce voluntary bankruptcy.²⁶

Given the long period of wars between 1689 and 1714 (the Nine Years’ War and the War of Succession) and a marked increase in failures, the perception that reforms were necessary induced many lawmakers across Europe to consider them. Besides Britain, Denmark passed a new bankruptcy law in 1706, Bremen followed a few years later in 1711. Further towns and countries followed during the next ← 17 | 18 → few decades. The new laws, however, only reflect a minor part of the reform efforts and changes in dealing with bankrupts. In the case of the free City of Hamburg, for example, discussions on a reform of the bankruptcy law already started before the end of the seventeenth century. Several attempts at new legislation followed, and discussions continued throughout the next fifty years, before the new law was finally passed in 1753. Even the new law did not stop further discussions.27 Similarly in Britain discussions continued throughout the century, only a few amendments were passed, but all in all legislation became more lenient during the course of the century.²⁸