You can count on the bankruptcy trustee taking action if it appears that a fraudulent act could deprive creditors of money they’re entitled to receive. If warranted, the trustee might also refer the matter for criminal prosecution. In this article, you’ll learn what to expect if a trustee suspects fraud.
(If you’d like to start with the basics, read What Is Bankruptcy Fraud?)
One of the primary roles of the bankruptcy trustee is to protect the interests of creditors—and the trustee takes steps to do so at every stage of the bankruptcy process.
For instance, the bankruptcy case begins when a debtor fills out the official bankruptcy paperwork and files it with the court. The trustee assigned to the matter will then review the paperwork and compare it to additional documentation—such as bank statements, paycheck stubs, and tax returns—supplied by the debtor (often referred to as 521 documents).
Also, all debtors must attend at least one hearing called the 341 meeting of creditors. At that meeting, the trustee will verify the debtor’s identity and take further steps to ensure the accuracy of the petition. For instance, the trustee will ask whether the debtor:
Creditors can also attend the meeting and ask questions—and in fact, they often provide the trustee with additional information. For instance:
These situations and others can often tip off a trustee to potential fraud.
When allegations of fraud enter into a bankruptcy matter, the next step usually involves obtaining information through discovery. Once the trustee has enough evidence, the case will move into litigation (an adversary proceeding—more below).
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:
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 called an adversary proceeding in the bankruptcy court.
The point of an adversary proceeding is to gain money for creditors (as opposed to prosecuting a crime—see below). The trustee can use an adversary proceeding to:
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.
(For more information, see Adversary Proceedings in Bankruptcy.)
Stopping the Depletion of Assets: Temporary Injunctions
In cases where the trustee has sufficient evidence to show that assets will be depleted or transferred to the irreparable harm of creditors, the trustee can seek emergency relief called a temporary restraining order or a temporary injunction. The order allows the trustee to take possession of the assets pending the outcome of the adversary proceeding and can be granted without first notifying the person in possession of the assets if the trustee can show 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 and are punishable by fines and incarceration Examples of bankruptcy crimes include:
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. Like other federal crimes, the United States Attorney prosecutes these cases in the federal courts.