Most bankruptcy fraud (also called bankruptcy crime) occurs when someone wrongfully attempts to gain an economic advantage over someone else—usually creditors—in a bankruptcy case. Most crimes are committed by the debtor filing the bankruptcy matter as a result of hiding property, although everyone involved has an opportunity to game the system. This article explores the proof necessary to convict a debtor who has committed the most common bankruptcy crime: concealing or undervaluing an asset.
On occasion, the bankruptcy trustee assigned to manage the case will suspect a bankruptcy crime because of inconsistencies in the official paperwork the debtor must complete and file with the court. Or, the trustee might question the debtor’s testimony at the hearing all filers must attend, the 341 meeting of creditors.
But that isn’t the only way. Other sources of information include:
Also, an official bankruptcy audit conducted by the U.S. Trustee’s Office can uncover evidence of wrongdoing. 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 the debtor claimed unusually large monthly expenses).
Proving fraud can be difficult. For almost all bankruptcy crimes, the government has to resolve two questions:
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. But the government must do just that—prove the wrongful act wasn’t the result of an innocent mistake.
Example. The trustee conducts an asset search and discovers that Barry, the Chapter 7 debtor, sold a piece of real estate worth $10,000 to his brother just three months before he filed Chapter 7 bankruptcy. His brother paid only $1,000 for the property. When Barry filed his Chapter 7 case, he didn’t disclose this transfer in his paperwork or at his meeting of creditors. The fact that Barry made the transfer but failed to disclose it is easy to establish with land records and the bankruptcy schedules. But the prosecutor will also have to prove that Barry’s failure to disclose the transfer wasn’t just an oversight and that the transfer itself was designed to hide the land from the court and ultimately the creditors.
Keep in mind, however, that the bankruptcy court has been witness to many different types of schemes, and is quick to see through claims of innocence.
Proving intent is rarely straightforward. Unless the perpetrator admits the crime, prosecutors have to rely on circumstantial evidence that, when seen as a whole, shows that the defendant intended to deceive, delay, or hinder creditors. This type of circumstantial evidence is known as “badges” of fraud:
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:
If you believe you might be involved in a fraud case in bankruptcy, you should seek counsel from a knowledgeable bankruptcy or defense attorney.