How to Prove Bankruptcy Fraud

Bankruptcy fraud usually occurs when a debtor attempts to avoid paying a creditor what the creditor is owed under bankruptcy law. This article explores the proof necessary to find a debtor has committed the most common bankruptcy crimes: concealing and undervaluing assets. You'll also learn how to defend against bankruptcy fraud actions and where to report bankruptcy crimes.

What Is Bankruptcy Fraud?

Typically, bankruptcy fraud occurs when a filer commits a dishonest act before or in conjunction with a bankruptcy filing. Bankruptcy fraud can take on many forms, but in most cases, the debtor attempts to retain something of value, such as property, product, or money, without paying the amount owed to a creditor.

Here are some of the actions a court might consider fraudulent (some of these actions would be brought by the creditor, others by the trustee):

• using credit with the intent to "discharge" or eliminate the debt in bankruptcy
• attempting to discharge credit debt obtained under false pretenses, such as by inflating income when applying
• charging expensive items or taking large cash advances soon before bankruptcy (known as "presumptive fraud")
• falsifying financial documents to inflate (or decrease) the debtor's worth
• knowingly making a false statement in bankruptcy paperwork or to the bankruptcy trustee, or
• hiding (and failing to list) property in the bankruptcy paperwork to prevent it from being sold for the benefit of creditors
• falsifying bankruptcy forms
• perjuring oneself by making false statements under oath
• using a false identity or filing in several bankruptcy courts
• bribing a court official, and
• embezzling from the bankruptcy estate.

Most bankruptcy crimes can be found in the federal statutes. (18 U.S.C § 152 and 18 U.S.C. § 157.)

Bankruptcy Fraud in Chapter 7 and Chapter 13

Bankruptcy fraud can occur in any bankruptcy chapter. For instance, suppose a bankruptcy filer concealed an asset, such as a tractor, by failing to list it in the bankruptcy paperwork. Regardless of the chapter filed, the creditors would receive less money than they'd be entitled to.

In Chapter 7, the trustee wouldn't sell the concealed tractor, and less money would be available to distribute to creditors, resulting in Chapter 7 bankruptcy fraud. Bankruptcy fraud would occur in Chapter 13 because creditors would receive less in Chapter 13 plan payments than they would have if the filer paid the value of the concealed tractor through the plan as required.

Exposing Bankruptcy Fraud With Bankruptcy Audits

An official bankruptcy audit conducted by the U.S. Trustee's Office can uncover evidence of bankruptcy fraud. Such audits occur one of two ways: the case is selected for review on a random basis, or it gets flagged because it doesn't fit within expected parameters, perhaps because the debtor claimed substantial monthly expenses.

How the Trustee Uncovers Bankruptcy Fraud

In many instances, the bankruptcy trustee assigned to manage the case will suspect a bankruptcy crime because of inconsistencies in the official paperwork the debtor must file with the court. The documentation provided to the trustee, such as tax returns, pay stubs, bank statements, insurance inventories, and accounting records, could also raise the possibility of bankruptcy fraud. Other sources of information include informants, like creditors, family members, and former spouses, public record searches, and appraisals.

When the trustee suspects fraud, the trustee will question the debtor at the 341 meeting of creditors, the hearing all filers must attend. In many instances, the debtor's answers can be used against the debtor during a bankruptcy fraud trial.

How the Prosecution Proves Bankruptcy Fraud

Proving fraud can be complicated. For almost all bankruptcy crimes, proving that someone intended to defraud a creditor of payment in some way involves resolving two questions:

• Did the defendant misrepresent a material (important) fact?
• Did the defendant intend to deceive, hinder, or delay the court or the creditors?

Establishing that a defendant took a particular action, such as hiding property—or failed to do something, such as reporting all property owned—is easier than proving that the debtor intended to cheat his creditors. However, the government must prove that the wrongful act wasn't the result of an innocent mistake.

Example. The trustee conducted an asset search and discovered that Barry, the Chapter 7 debtor, sold real estate worth $10,000 to his brother for $1,000 three months before filing for Chapter 7 bankruptcy. Barry didn't disclose the transfer in his paperwork or at his creditors' meeting.

The fact that Barry made the transfer but failed to disclose it will be simple to establish with land records and the bankruptcy schedules. However, the prosecutor must also prove that Barry's failure to disclose the transfer wasn't an oversight but was designed to hide the land from the court and, ultimately, the creditors.

Proving Intent to Commit Bankruptcy Fraud

Proving intent is rarely straightforward. Unless the debtor admits the crime, prosecutors have to rely on circumstantial evidence that, when seen as a whole, shows that the debtor intended to deceive, delay, or hinder creditors. This type of circumstantial evidence is known as "badges" of fraud and can include the following:

• the debtor transferred or concealed property soon before filing the case (or shortly after someone threatened a lawsuit)
• the property isn't exempt (protected from creditors)
• the asset was transferred to or hidden by the debtor's business, spouse, relative, or friend (an insider)
• the debtor transferred the title but retained the use of the asset
• the debtor transferred or listed the property for much less than its value, or
• the debtor was insolvent (had more debt than assets) when the ownership was transferred or concealed.

In the example above, a prosecutor would likely argue that Barry must have been trying to hide the real estate from his creditors because he:

• should have turned over the nonexempt property to the Chapter 7 trustee
• didn't disclose that he owned or transferred the asset, despite repeated opportunities to do so
• sold it for a tenth of what it was worth
• sold it to someone close to him, and
• sold it shortly before he filed his bankruptcy case.

If you believe you might be involved in a fraud case in bankruptcy, you should seek counsel from a knowledgeable bankruptcy or defense attorney.

Bankruptcy Fraud Defenses

You don't have to prove your innocence if you've been accused of bankruptcy fraud. However, you'll have a better chance of beating the case if you present a defense that contradicts the prosecution's claim, pokes holes in the prosecution's evidence, or offers a legal explanation for your actions.

Mistake

A defendant might claim that the failure to list a valuable asset or to disclose the transfer of an asset in the bankruptcy petition was accidental. For instance, the debtor could present evidence that the attorney preparing the petition knew about the missing information, but the debtor didn't notice that it wasn't included before signing the schedules and statements filed with the court.

Legitimate Purpose

The defendant could present evidence that a particular action was taken to accomplish a lawful purpose. For instance, the defendant might have sold an asset for half its value to take advantage of a tax deduction or because the defendant needed to raise money quickly for an emergency medical procedure.

Statute of Limitations

The debtor could argue that the government lost the right to prosecute the crime because the statute of limitations period for bankruptcy fraud—the time the government has to bring an action—already elapsed. For most bankruptcy crimes, the statute of limitations is five years from the date of the offense. When the crime is concealment of assets, the limitations period runs five years from the discharge date or denial of discharge.

Withdrawal or Renunciation

The debtor might testify or present evidence showing that the paperwork was corrected soon after the debtor discovered the error or regretted the decision to omit the asset intentionally.

How to Report Bankruptcy Fraud

When you suspect that someone has committed bankruptcy fraud, you can contact any number of people involved in the bankruptcy case. Here's how to get the information to the appropriate authorities.

Trustees

In each case, the bankruptcy court assigns a trustee whose job is to oversee the case. One of the trustee's duties is to review the matter for fraud, and it isn't unusual for a trustee to receive information from people such as a disgruntled spouse or business partner. Contact the local bankruptcy court clerk's office to determine who the trustee is in a particular matter.

In all states other than Alabama or North Carolina, the Department of Justice (DOJ) oversees the U.S. Trustee Program. The DOJ website suggests including the following information in your summary:

• name and address of the person or business you are reporting
• bankruptcy case file number and location
• a brief description of the alleged fraud
• the type of asset involved, and
• your name, address, telephone number, and email address.

A well-thought-out report with documentation will make it much easier for the authorities to follow through. The DOJ is less likely to put much energy into a report that contains vague assertions.

You can also make a report by contacting the local U.S. Trustee's office. If the case is in Alabama or North Carolina, contact the Office of the Bankruptcy Administrator.

Other Organizations

Depending on the circumstances, many other agencies can become involved in a bankruptcy case. The U.S. Trustee refers an investigation of suspected bankruptcy fraud to the FBI, which might, in turn, elicit help from the IRS.

Anonymous Reporting

Every report of a bankruptcy crime gets taken seriously, even if made anonymously. Identifying yourself can make it easier if the investigators have questions. However, be aware that the government will not necessarily protect your identity.

Seek Legal Advice

The penalties associated with bankruptcy fraud are steep. If you're facing bankruptcy fraud charges or suspect you might, you should speak with a knowledgeable bankruptcy lawyer.

Need More Bankruptcy Help?

Did you know Nolo has made the law easy for over fifty years? It's true, and we want to ensure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.