When the Bankruptcy Trustee Suspects Fraud
Here's how bankruptcy trustees investigate fraud, and what they'll do if they find it.
Bankruptcy trustees take fraud very seriously. If the bankruptcy trustee suspects fraud, what the trustee will do depends on: the specific facts of case, who is suspected of fraud, and the type of fraud being committed.
(Learn more about what bankruptcy trustees do in bankruptcy cases.)
Rule 2004 Examinations
If the trustee suspects fraud but does not have sufficient evidence to bring the matter before the court, the trustee can compel testimony and document production from just about anyone, anywhere, through a Bankruptcy Rule 2004 examination. The scope of the examination allowed is broad enough to include any action that could be considered fraud in a bankruptcy case.
Bankruptcy Rule 2004 authorizes the bankruptcy trustee to examine:
- the acts, conduct, property, liabilities or financial condition of the debtor
- any matter which may affect the administration of the bankruptcy estate, or
- any matter which may affect the debtor's right to a discharge.
Once the trustee has gathered enough evidence to support a case, the trustee can file a lawsuit against the appropriate party. Under most circumstances, the trustee will file the lawsuit in the bankruptcy court -- this is called an adversary proceeding.
Comparison to lawsuits generally. Adversary proceedings are similar to lawsuits filed in other courts but proceed to trial much more quickly. The trustee can serve the initial pleadings -- the summons and complaint -- by first class mail. This eliminates the need to chase down someone who is avoiding service. The trustee can sue anyone in an adversary proceeding, not just debtors and creditors.
How adversary proceedings are used in fraud cases. When the trustee finds fraud, adversary proceedings can be used to:
- set aside fraudulent transfers (transfers for less than full value) and recover the property from the person or entity who received the transfer (learn more about prebankruptcy transfers of property)
- obtain turnover of hidden or undisclosed property from whoever is in possession of the property
- object to or revoke the discharge of a bankruptcy debtor who has hidden assets or attempted to transfer assets out of the reach of the trustee
- recover property from employees or officers who have wrongfully taken assets of businesses in bankruptcy
- recover property that has been wrongfully seized by creditors
- determine the validity, priority, and extent (amount) of liens fraudulently placed on bankruptcy assets, and
- recover money from people who have used their bankrupt business to operate a ponzi scheme.
In cases where the trustee has sufficient evidence to show that the assets that the trustee is attempting to recover are being depleted or further transferred, and that the bankruptcy estate will be irreparably harmed if the trustee has to wait until an adversary proceeding is concluded, the trustee can seek emergency relief called a temporary restraining order or a temporary injunction.
How it works. Depending on the circumstances, the court can enjoin (prohibit) the transfer of the disputed assets through orders called temporary injunctions or temporary restraining orders. The trustee can even use this type of relief to obtain an order allowing the trustee to take possession of the assets pending the outcome of the adversary proceeding. Temporary relief can be granted without first notifying the person in possession of the assets if the trustee can show by evidence and affidavit that notifying them would likely result in the depletion of the assets. However, a full hearing with notice generally takes place within ten days of the original order.
Most bankruptcy crimes involve fraud. Although you have probably heard the term, you might not know that bankruptcy crimes are not prosecuted in the bankruptcy court. Like other federal crimes, they are prosecuted by the United States Attorney in the Federal Courts.
Criminal Referrals. When a bankruptcy trustee suspects a fraud that constitutes a bankruptcy or other federal crime, the trustee makes a criminal referral to the Office of the United States Trustee. The matter is then passed along to the United States Attorney or the Federal Bureau of Investigation or other appropriate federal agency for investigation.
Examples of bankruptcy crimes. Bankruptcy crimes are punishable by fines and/or up to five years in prison. Examples of bankruptcy crimes include:
- filing false claims
- knowingly concealing assets
- making false oaths
- embezzlement, and
- filing fraudulent petitions.
For more information, check out Nolo's section on The Bankruptcy Trustee.