The Bankruptcy Clause of the Constitution was one of Congress's several delegated powers in Article I, Section 8, that were designed to encourage the development of a commercial republic and to temper the excesses of pro-debtor state legislation that proliferated under the Articles of Confederation. Both state legislation and state courts tended to use debtor-creditor laws to redistribute money from out-of-state and urban creditors to rural agricultural interests. Under the Articles of Confederation, the states alone governed debtor-creditor relations, and that led to diverse and contradictory state laws. It was unclear, for instance, whether a state law that purported to discharge a debtor of a debt prohibited the creditor from trying to collect the debt in another state. Pro-debtor state laws also interfered with the reliability of contracts, and creditors confronted still further obstructions in trying to use state courts to collect their judgments, especially when debtors absconded to other states to avoid collection.

A coherent and consistent bankruptcy regime for merchants was also required for the United States to flourish as a commercial republic. The Bankruptcy Clause helped to further the goals of uniformity and predictability within the federalist system. As James Madison observed in The Federalist No. 42, "The power of establishing uniform laws of bankruptcy is so intimately connected with the regulation of commerce, and will prevent so many frauds where the parties or their property may lie or be removed into different States that the expediency of it [i.e., Congress's power to regulate bankruptcy] seems not likely to be drawn into question." The Framers were so convinced of the need for a national power over bankruptcy that, as Madison suggests, there was little debate over the issue and little opposition to the Bankruptcy Clause at the Constitutional Convention. Although state law continued to govern most routine debtor-creditor relations, Congress had the authority to override state laws dealing with insolvency.

Following ratification of the Constitution, the mercantile northeastern states spearheaded the movement for a national bankruptcy law. The first bankruptcy law was passed under the Federalists in 1800, but it lasted only until 1803. Other bankruptcy laws existed from 1841 to 1843 and from 1867 to 1878. The first permanent bankruptcy law was enacted in 1898 and remained in effect, with amendments, until being replaced with a comprehensive new law in 1978, the essential structure of which continues today.

Subsequent to the ratification of the Constitution, it remained unclear where the line between the state and federal power should be drawn. English law relied upon a traditional distinction between "bankruptcies" on one hand and "insolvency" on the other. Under English law, only merchants and traders could be declared "bankrupt," which enabled them to have their debts discharged upon the satisfaction of certain requirements. By contrast, nonmerchants had to seek refuge under "insolvency" laws, which did little more than to release a debtor from debtor's prison but did not discharge the debtor from his indebtedness. Thus, many understood the Constitution’s grant of power to Congress to regulate “bankruptcies” as creating federal power to regulate only with respect to merchants and traders and not with respect to those individuals traditionally subject to “insolvency” laws, which remained under state control. Others argued that this traditional distinction had disappeared by the mid-eighteenth century, such that by the time of the Constitution, the terms became interchangeable so as to give Congress the power to regulate all insolvent debtors. In 1819, the Supreme Court held in Sturges v. Crowninshield that the use of the term bankruptcy in the Constitution did not limit Congress’s jurisdiction, thereby permitting Congress to regulate both of these realms. In Ogden v. Saunders (1827), the Court further restricted the states’ concurrent power, prohibiting discharge of debts owed to citizens of another state, but permitting discharge of debts owed to a citizen of the same state so long as the law operated prospectively so as not to impair contract obligations.

Still, the original understanding of the Bankruptcy Clause placed several clear constraints on Congress’s authority to regulate on the subject of debtor-creditor relations. First, Congress’s power under the Bankruptcy Clause is limited to the adjustment of the debts of insolvent debtors and their creditors and does not extend to the general regulation of debtor-creditor law. Previous bankruptcy laws required that the debtor be insolvent as a condition for bankruptcy, but the current Bankruptcy Code contains no such limitation. Second, Congress’s bankruptcy power was limited to the adjustment of relations between a debtor and its creditors and does not extend to the protection or benefit of third parties, except to the extent that such protection is ancillary to the adjustment of the debts of an insolvent debtor. This original limitation is also ineffective today.

The Bankruptcy Code thus represents a tenuous accommodation between federal and state law. Most of the nonbankruptcy law that governs debtor-creditor relations remains state law, and federal bankruptcy law honors these state-law substantive entitlements, unless federal law and policy expressly preempt them. Moreover, the Bankruptcy Code expressly incorporates some elements of state law into the Code itself, such as in the treatment of a debtor’s property exemptions. This interaction between state and federal law guarantees that creditors and debtors will be treated differently depending on the state that determines their rights.

At the same time, any bankruptcy legislation enacted by Congress must also be “uniform . . . throughout the United States.” In Hanover National Bank v. Moyses (1902), the Supreme Court held that this “personal” nonuniformity in treatment among individuals was permissible, so long as “geographical” uniformity was preserved. Thus, debtors and creditors in different states may receive different treatment, so long as the debtors and creditors within the same state are treated the same. The “uniformity” requirement does, how-ever, forbid “private” bankruptcy laws that affect only particular debtors.

Courts have also had to consider the contours of this power to make uniform bankruptcy legislation in light of the Eleventh Amendment’s protection of states against private suit. In Central Virginia Community College v. Katz (2006), the Supreme Court found that a bankruptcy trustee’s proceeding to set aside the debtor’s preferential transfers to state agencies is not barred by sovereign immunity. This implies that the power of Congress to enact bankruptcy legislation gives them the power to abrogate state sovereign immunity protected by the Eleventh Amendment. In dissent, Justice Clarence Thomas argued this was inconsistent with the Constitution’s “text, structure, or history.”

In administering the bankruptcy system there are additional restraints placed on bankruptcy courts by the separation of powers and the nature of the judicial power under Article III. As currently designed, bankruptcy courts are units of the United States District Court and bankruptcy judges are so-called “Article I” judges, appointed for a term of years rather than for good behavior and lacking many of the formal protections for judicial independence under Article III. In Granfinanciera, S. A. v. Nordberg (1989), the Supreme Court held that Seventh Amendment jury trial rights are preserved in bankruptcy. In Stern v. Marshall (2011), the Court addressed the related question of when a party is entitled to have its case heard by an Article III district court judge rather than a bankruptcy judge. The case involved a state law counterclaim to a proof of claim filed in a bankruptcy case. That counterclaim was a “core” proceeding under the Bankruptcy Code, which authorized the bankruptcy court to render a final judgment. However, that statutory grant was unconstitutional, the Court found, and a bankruptcy judge lacked the power to enter a final judgment because it violated the right to have the claim heard by an Article III judge.