When the Bankruptcy Trustee Suspects Fraud

Here's how bankruptcy trustees investigate fraud, and what they'll do if they find it.

By , Attorney

You can count on the bankruptcy trustee assigned to your case to take 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. This article will teach you what to expect if a trustee suspects fraud, including:

  • how the trustee learns about bankruptcy fraud
  • what a trustee who suspects fraud will do, and
  • the actions a trustee can take to stop fraud in its tracks.

If you'd like to start with the basics, start out by reading our bankruptcy fraud overview article, What Is Bankruptcy Fraud?

How Fraud Comes to the Trustee's Attention

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.

The Bankruptcy Trustee Reviews Filings for Signs of Fraud

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. Expect to turn over retirement account statements, profit and loss statements, monthly mortgage and car loan statements, your marital settlement agreement, and more.

The Bankruptcy Trustee Asks Fraud-Related Questions

The trustee fulfills many responsibilities related to identifying fraud at the 341 meeting of creditors, the hearing all filers must attend. As part of verifying the debtor's identity and ensuring the accuracy of the petition, the trustee will ask 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.

How Creditors Alert the Bankruptcy Trustee to Fraud

Creditors can also attend the meeting and ask questions. Creditors will appear at 341 meetings when considering filing an "adversary proceeding" or bankruptcy lawsuit asking the court not to "discharge" or erase the debt owed to the creditor.

For instance, a lender might want information about:

  • the accuracy of reported income on a loan application
  • the location of property securing the loan, and
  • whether you've sold or given away assets.

The lender might know or suspect criminal activity, too. These situations can often tip off a trustee to potential fraud and provide the trustee with additional information.

Other Ways the Bankruptcy Trustee Learns About Fraud

Often, 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.

It's also not uncommon for a former business partner to surface, claiming a mishandling of funds or business property. Or an angry ex-spouse might report a failure to list assets or income in the bankruptcy petition.

What Will a Trustee Who Suspects Fraud Do?

When allegations of fraud enter into a bankruptcy matter, the next step usually involves obtaining information informally and through discovery. Once the trustee or a creditor has enough evidence, the case will move into litigation.

Informal Discovery

If a creditor or someone else appears at the 341 asking questions, expect the trustee to continue the 341 meeting to another day. Most trustees will give the creditor an hour or more to explore financial wrongdoings.

The trustee can also 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 may affect the administration of the bankruptcy estate, or
  • any issue which may affect the debtor's right to a discharge.

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

How the Trustee Stops Fraudulent Activity

Sometimes the trustee learns a debtor is actively depleting assets, and nothing will remain when the case finishes in bankruptcy court. If the trustee can show the debtor is depleting assets belonging to creditors, the trustee can ask the court to issue a restraining order or injunction to stop the activity.

In most cases, the bankruptcy court will hold a hearing before issuing an order. However, in emergencies, the order will let the trustee recover the property without first telling the person possessing the assets.

What Is a Fraud Adversary Proceeding in Bankruptcy?

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 (more below).

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.

What to Expect When the Trustee Litigates Fraud in Bankruptcy

Adversary proceedings are similar to lawsuits filed in other courts. They can proceed to trial more quickly, depending on the particular case. An adversary proceeding begins by serving the initial pleadings by first-class mail, eliminating the need to chase down someone avoiding service.

The trustee can sue anyone involved in the matter, not just debtors and creditors. Find out more about adversary proceedings in bankruptcy.

When the Trustee Suspects Fraud-Related Bankruptcy Crimes

Sometimes the fraudulent activity rises to the level of criminal activity, 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.

Why Did My Bankruptcy Trustee Hire an Attorney?

A trustee will retain counsel to handle contested matters before the bankruptcy court. So if your trustee has hired an attorney, the trustee will likely initiate litigation against you.

Contact a Bankruptcy Lawyer With Litigation Experience

If you paid your bankruptcy lawyer a flat fee to complete your bankruptcy, it likely doesn't include litigation. Check your retainer agreement. Then decide whether you're comfortable with your bankruptcy lawyer handling the issue or if you should retain a lawyer specializing in bankruptcy litigation.

Need More Bankruptcy Help?

Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure 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!

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Helpful Bankruptcy Sites

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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.

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