Bankruptcy Fraud

Bankruptcy laws are intended to provide fair treatment for all creditors when people or businesses end up with more debt than they can possibly repay. Bankruptcy also gives individuals (and sometimes companies) an opportunity to make a fresh start.

Despite this equitable intent, approximately 140,000 bankruptcy cases per year involve some type of bankruptcy fraud.

Types of Fraud

Bankruptcy fraud cases can be divided into two types based on how the bankruptcy occurs. The two types can be labeled as "situational" and "planned."

In situational bankruptcy fraud, the debtor (whether a person or company) does not plan to commit bankruptcy fraud. However, when faced with the prospect of losing everything, the debtor attempts to hide or undervalue his assets. Experts estimate that 70 percent of all bankruptcy fraud cases are situational bankruptcies.

Specific types of bankruptcy fraud that fall under this category are false statements and sham transactions:

• false statements: To conceal assets from creditors, debtors may fail to list everything they own on forms filed with the court. Types of assets often omitted including bank and investment accounts, easily concealed artwork and jewelry, partial interest in companies or properties or potential proceeds of lawsuits.Debtors may also grossly undervalue some assets they do list for the court. The goal is to convince creditors not to bother attacking the property for payment of debts.Filing false statements in a bankruptcy proceeding is bankruptcy fraud. Punishment includes a fine and up to five years imprisonment.

• sham transactions: Sham transactions occur when the debtor realizes that bankruptcy is imminent. The debtor transfers ownership of key assets to another party. The two parties agree that after the bankruptcy, the property will be returned to the debtor.Another sham transaction that may occur during bankruptcy occurs when the debtor receives court approval to sell an asset, the proceeds of which are to be under court supervision. Through a side agreement with the buyer, however, the court-approved sale price may be well below actual value, and the buyer slips the debtor an additional payment under the table.These types of transactions also invoke the false statements and concealment statute (18 U.S.C., Section 152) and are punishable by up to five years in prison.

The second category of bankruptcy fraud is planned bankruptcy fraud. In a planned bankruptcy scheme, an individual, sometimes operating through a company or even a series of companies, engages in business transactions with the intent of declaring bankruptcy. By declaring bankruptcy, they escape payment for property or goods acquired. This is a form of theft using the bankruptcy court to aid in the scheme.

Types of Planned Bankruptcy Fraud

Here is a closer look at two examples of criminally premeditated bankruptcy fraud:

• planned business bankruptcies: Some criminals have developed sophisticated bankruptcy schemes that involve starting retail businesses. Criminals will legitimately operate these businesses for a short while then declare bankruptcy while hiding money accumulated during the final months of operation. To accumulate money, they order large quantities of goods from suppliers with whom they have established credit. They then sell the goods quickly at a discount, skipping out on paying rent, employees, taxes and creditors.One of many variations in planned business bankruptcy uses travel agency businesses. Instead of goods, the criminal agent prints and sells large quantities of airline tickets without paying the airline. He then claims the plates for printing tickets were stolen. The agent hides the money, and the debt to the airline is forgiven in bankruptcy.Although these crimes are punishable by the False Statements and Concealment Statute, Congress passed a new provision in 1994 to make these types of crimes easier to prosecute. Statute 18 U.S.C, Section 157 makes it a crime to use the bankruptcy court for executing or concealing a fraud. Punishment includes up to five years in prison.

• investment cons: Operators of Ponzi schemes and other investment swindles sometimes use bankruptcy as a means of preventing investors or creditors from filing suit for recovery of assets. Meanwhile, the criminals consolidate and hide their loot, then making their escape.

Real estate investment partnerships and advance-fee loan operations are other types of businesses that may use the bankruptcy court to help perpetrate a fraud. These crimes are also punishable by up to five years in prison under either Section 152 or 157.

Resources

Brown, Joe B.; Netoles, Brian; Rasnak, Sandra Taliani; Tighe, Maureen (1999). Identifying Bankruptcy Fraud. Retrieved April 6, 2008, from the Credit Research Foundation Web site: http://www.crfonline.org/orc/pdf/ref11.pdf.

Cornell University (2006). U.S.Code Collection. Retrieved April 6, 2008, from the Cornell University Law School Web site: http://www.law.cornell.edu/uscode/18/usc_sec_18_00000152——000-.html.

Internal Revenue Service (2007). Bankruptcy Fraud Criminal Investigation (CI). Retrieved April 6, 2008, from the IRS.gov Web site: http://www.irs.gov/compliance/enforcement/article/0,,id=117520,00.html.