When the Bankruptcy Trustee Suspects Fraud

Understanding what a bankruptcy trustee investigates can help you avoid committing bankruptcy fraud and turning a straightforward bankruptcy case into a legal nightmare. For instance, when bankruptcy fraud is suspected, a Chapter 7 or 13 trustee will hire an attorney to file a lawsuit against you. You'd need to hire a bankruptcy fraud lawyer, which is expensive and stressful.

Of course, if you suspect a trustee is up to foul play, which occasionally happens, it's possible to sue a Chapter 7 trustee (or any trustee, depending on where you live). This article explains the ins and outs of bankruptcy fraud and the bankruptcy trustee, including what to expect if a trustee suspects fraud, how the trustee learns about bankruptcy fraud, what a trustee who suspects fraud will do, and your recourse against trustee fraud.

Why Did My Bankruptcy Trustee Hire an Attorney?

The most likely reason a bankruptcy trustee would hire an attorney would be to file a motion or a lawsuit called an adversary proceeding in bankruptcy court. Although various scenarios could prompt the trustee's actions, they'll almost all relate to ensuring creditors receive the money they're entitled to under bankruptcy law.

Who Does the Trustee Sue in Bankruptcy Fraud Actions?

Recovering assets in bankruptcy is one of the primary bankruptcy trustee's duties. Who the trustee will sue will depend on the type of action. You'd be the trustee's target if you hid income or property or made false statements in your bankruptcy paperwork and were the only person involved.

However, the trustee can sue other implicated people, not just debtors. For instance, suppose you paid your favorite creditor in full while leaving the others high and dry before filing for bankruptcy. Or perhaps you tried to stiff creditors by giving property away or selling it off for less than it was worth. In those instances, the trustee would likely sue the person who received the asset in a "clawback" or preference action.

Explore this topic further in I transferred property out of my name. Should I wait to file for bankruptcy?

How Fraud Comes to the Trustee's Attention

Very few people are surprised by an unexpected bankruptcy lawsuit. In almost all cases, the debtor knows the circumstances that could raise suspicions of bankruptcy fraud.

The way the trustee learns about bankruptcy fraud varies. Something in your paperwork might raise a flag. Sometimes, a creditor appears at the 341 creditors meeting and sheds light on fraudulent action. Or, it could be that a fraud-related lawsuit exists in state court or you filed hoping to get rid of a lawsuit judgment in bankruptcy.

Creditors Alert the Bankruptcy Trustee to Fraud

Creditors can ask questions at the 341 meeting of creditors, the one hearing all bankruptcy filers must attend. They often do so when they think their input will increase the amount they'll receive in the bankruptcy.

Commercial creditors and lenders appear when considering whether to file an adversary proceeding asking the court not to "discharge" or erase the debt owed. These creditors gather evidence about the accuracy of reported income on a loan application and the location of the property securing the loan and use the evidence at trial if they decide to proceed.

A lawyer usually represents commercial creditors and lenders, and the questioning is relatively calm, although it isn't always the case. Creditor meetings involving disgruntled business partners and ex-spouses can be dramatic and emotional.

Other Ways the Bankruptcy Trustee Learns About Fraud

Sometimes, a bankruptcy trustee will learn about fraud from a third party not directly involved in the bankruptcy. For instance, the state attorney general might be pursuing the debtor in another court or want to inquire about the financial practices of a company owned by the debtor. The trustee might also research public filings and directories.

What Does the Bankruptcy Trustee Investigate?

The trustee investigates potential issues at every stage of the bankruptcy process to fulfill the bankruptcy trustee's primary role of protecting creditors' interests.

What the Bankruptcy Trustee Investigates in Filings

The trustee assigned to the matter reviews the bankruptcy paperwork the debtor fills out and files with the court and compares it to the financial documents the filer must supply. Often called "521 documents," the financials include bank statements, paycheck stubs, and tax returns.

However, a filer must provide anything the trustee needs if it's reasonably related to the debtor's finances, and turning over more documents is often required. Retirement account statements, profit and loss statements, monthly mortgage and car loan statements, marital settlement agreements, and more are frequently requested. It's a good idea to prepare by gathering documents before filing your bankruptcy case.

A trustee who suspects undisclosed property could exist might inspect and inventory the contents of your home, business, storage unit, or safety deposit box. If a property valuation appears too low, the trustee might go further and take pictures of a car or other property. Learn more in Will the Trustee Come to My Home to Collect Property?

Fraud-Related Questions the Bankruptcy Trustee Asks

The trustee fulfills many responsibilities related to identifying fraud at the 341 meeting of creditors. As part of verifying the debtor's identity and ensuring the accuracy of the petition, the questions the trustee will ask will include whether the debtor:

• included all income received over a particular period
• listed all assets and property, and
• anticipates receiving an inheritance or any other funds soon.

While these are standard questions all trustees ask, the trustee will ask more specific questions related to the case. In most instances, a bankruptcy lawyer can predict a trustee's questions and, when appropriate, handle potential issues before the 341 meeting of creditors. Learn what happens after the 341 meeting of creditors.

What Will a Bankruptcy Trustee Who Suspects Bankruptcy Fraud Do?

When allegations of fraud are raised in a bankruptcy matter, the next step usually involves obtaining information informally and through discovery and assessing whether bankruptcy fraud occurred.

Informal Discovery

If a creditor or someone else appears at the 341 meeting asking questions, and the trustee believes creditors might benefit from the information derived from the exchange, expect the trustee to continue it to another day. Most trustees will give the creditor an hour or more to explore financial wrongdoings.

As discussed above, the trustee can request additional financial information, photographs, and property appraisals. Some trustees will conduct property inspections and inventories of homes, businesses, storage spaces, and safe deposit boxes.

Rule 2004 Examinations

A trustee who suspects fraud but doesn't have sufficient evidence to bring the matter before the court can compel testimony and document production from just about anyone through a Bankruptcy Rule 2004 examination. The scope of the examination is broad enough to allow inquiry into any action that could be considered fraud in a bankruptcy case.

For instance, Bankruptcy Rule 2004 authorizes the bankruptcy trustee to examine:

• the debtor's acts, conduct, property, liabilities, or financial condition
• any matter which could affect the administration of the bankruptcy estate, or
• any issue which might affect the debtor's right to a discharge.

The Rule 2004 examination process resembles a deposition proceeding in state court.

What to Expect When the Bankruptcy Trustee Litigates Bankruptcy Fraud

Once the trustee or a creditor has enough evidence, the case will move into litigation. Litigation could involve a simple motion or an expensive, time-intensive adversary proceeding action.

A motion asks the bankruptcy court to resolve a problem at a hearing with little else occurring beforehand. For instance, suppose the trustee learns a debtor is actively depleting assets, and nothing will remain when the case finishes in bankruptcy court. The trustee can ask the court to hold a hearing with both sides and, when appropriate, issue a restraining order or injunction to stop the activity. In emergencies, the court will issue an order without the wrongdoer present.

Adversary proceedings are similar to lawsuits filed in other courts. An adversary proceeding begins by filing a complaint. After a formal discovery period, the bankruptcy judge decides the case at trial.

What Is a Fraud Adversary Proceeding in Bankruptcy Used For?

A trustee with evidence of fraud can file an adversary proceeding or lawsuit against the appropriate party in bankruptcy court. The point of an adversary proceeding is to gain money for creditors instead of prosecuting a crime.

The trustee can use an adversary proceeding to do many things.

• Set aside a property sale when the property was sold for less than its actual value. The trustee recovers the property from the person who purchased or received it. Learn more about prebankruptcy property transfers of property.
• Require someone to turn over undisclosed hidden assets.
• Recover wrongfully taken assets from creditors, employees, or officers of businesses in bankruptcy.
• Determine whether a property lien is valid or fraudulent.

The trustee can also use the process to ask the bankruptcy court to deny or revoke the discharge of a bankruptcy debtor engaging in wrongdoing. Learn about proving fraud in bankruptcy.

When the Trustee Suspects Fraud-Related Bankruptcy Crimes

Sometimes, fraudulent activity rises to the level of criminal activity, which is punishable by fines and incarceration. When a bankruptcy trustee suspects criminal fraud, the trustee refers the case to the Office of the United States Trustee before being assigned for investigation to the United States Attorney, Federal Bureau of Investigation (FBI), or another appropriate federal agency.

Examples of bankruptcy crimes include:

• filing false claims
• knowingly concealing assets
• making false oaths
• bribery
• embezzlement, and
• filing fraudulent petitions.

Like other federal crimes, the United States Attorney prosecutes these cases in the federal courts. Learn about bankruptcy fraud penalties and consequences.

Need More Bankruptcy Help?

Did you know Nolo has made the law accessible for over fifty years? It's true—and we wholeheartedly encourage research and learning. You'll find many more helpful bankruptcy articles on Nolo's bankruptcy homepage, and information needed to complete the official downloadable bankruptcy forms is located on the Department of Justice U.S. Trustee Program.

However, online articles and resources can't address all bankruptcy issues and aren't written with the facts of your particular case in mind. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.