How to Prove Bankruptcy Fraud

Proving fraud often requires the prosecutor to dig deeper than the debtor's schedules and testimony.

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.

Uncovering Evidence of Bankruptcy Crimes

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:

  • informants, like creditors, family members, and former spouses
  • public record searches
  • appraisals, or
  • documentation provided to the trustee, such as tax returns, pay stubs, bank statements, insurance inventories, and accounting records.

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).

How the Government Proves Bankruptcy Fraud

Proving fraud can be difficult. For almost all bankruptcy crimes, the government has to resolve 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. 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.

Signs of Fraud That Prove Intent

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:

  • 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 title but retained 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) at the time 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.

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