What Is Bankruptcy Fraud?

Posted by David Falvey on Sunday, October 6th, 2013 - 2,663 views

The bankruptcy system deals with fraud by relying on the honesty of the debtor, the attorney, the trustee, creditors, the judge and bankruptcy court clerks.

The federal bankruptcy laws also require full and complete financial disclosures for the system to work properly. In order to deter abuse during the bankruptcy process, Congress has described debtor actions which are criminal and may be prosecuted in the federal courts.

Bankruptcy fraud is a white-collar crime. Most bankruptcy fraud cases involve violating the federal law by concealing assets, concealing or destroying documents, and making fraudulent or false statements or declarations. Making false statements under oath (which includes disclosures on bankruptcy forms) may be prosecuted under perjury laws.

The Federal Bureau of Investigation (FBI) is primarily tasked with investigating allegations of bankruptcy fraud. Other federal agencies, such as the Internal Revenue Service, and other state agencies may become part of a fraud investigation as well.

Bankruptcy fraud is distinguished from bankruptcy planning, which is not a criminal act. Bankruptcy planning is expected and even encouraged by the courts. Planning may mean maximizing asset protection or strategically planning your bankruptcy to maximize its benefits.

How the process begins

The U.S. Trustees Program, part of the Department of Justice, oversees the bankruptcy system. When bankruptcy fraud is suspected, the individual trustee or bankruptcy judge refers the information to the appropriate U.S. attorney and to the FBI.

After review of the initial fraud allegation, a case file may be opened, interviews conducted, and financial documents requested and reviewed. In some complex cases, undercover operations and court-authorized electronic surveillance may be used to gather additional evidence.

Individuals not directly connected with the Department of Justice or the bankruptcy courts may also report bankruptcy fraud. Allegations may be sent to the U.S. Trustees Program at USTP.Bankruptcy.Fraud@usdoj.gov or by contacting your local FBI office.

I am personally happy to say that in all my years providing bankruptcy services, I’ve never encountered one case which was suspect to fraud and, thankfully, I never had to suspect one myself.

The culprits

The culprits in a bankruptcy fraud case typically include private citizens, small business owners, corporate CEOs, real estate agents, politicians, and loan officers. In rare cases a bankruptcy attorney, trustee or even judge may be accused of bankruptcy fraud.

The most common types of bankruptcy fraud

The majority of bankruptcy fraud cases are people who have lied under oath or provided false documentation during their bankruptcy proceedings, concealed or transferred their financial assets, or committed tax fraud.

Other schemes include using false identities to file for bankruptcy multiple times in multiple locations, bribing a bankruptcy trustee, and intentionally running up credit card bills with no intention of paying them off (also known as “credit card bust-outs”).

Many times, bankruptcy fraud is committed in conjunction with crimes such as credit card fraud, identity theft, mortgage fraud, money laundering, and/or mail and wire fraud.

Denial of discharge in Chapter 7

In Chapter 7 cases, the debtor does not have an absolute right to a discharge. An objection to a Chapter 7 discharge can be filed by a creditor, by the trustee, or by the U.S. Trustee.

The bankruptcy court sets a deadline for objecting to issuing a discharge order in the debtor’s case.

To object to the debtor’s discharge, a creditor must file a complaint in the bankruptcy court before the deadline set out in the notice. Filing a complaint starts an “adversary proceeding,” which is a case-within-a-case.

If the issue of the debtor’s right to a discharge goes to trial, the objecting party has the burden of proving all the facts essential to the objection.

Under Section 727(a) of the U.S. Bankruptcy Code, the court may deny a Chapter 7 discharge if you:

1. Intentionally transferred, removed, destroyed, mutilated, or concealed (or allow someone else to transfer, remove, destroy, mutilate or conceal) property within one year of the filing of your case or property after the filing of the case;
2. Concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which your financial condition or business transactions might be ascertained (unless such act or failure to act was justified under all of the circumstances of the case);
3. Knowingly and fraudulently made a false oath (in other words, that you lied);
4. Gave, offered, received, or attempted to obtain money, property, or advantage, or a promise of money, property, or advantage, for acting or forbearing to act;
5. Withheld recorded information, including books, documents, records, and papers, relating to your property or financial affairs;
6. Failed to explain satisfactorily any loss of assets or deficiency of assets; or
7. Refused to obey any lawful order of the court, other than an order to respond to a material question or to testify.

Additionally, a bankruptcy court cannot grant a Chapter 7 discharge to: an entity that is not an individual; a debtor who failed to complete the mandatory class on financial management; or to a debtor who received a Chapter 7 discharge within the past eight years or a Chapter 13 discharge within the past six years (although there are special exceptions when dealing with a prior Chapter 13 case).

Finally, under Section 523(a)(10) of the U.S. Bankruptcy Code, you can’t get a discharge in a subsequent Chapter 7 for debts that were denied a discharge in a prior Chapter 7. However, discharge is available in Chapter 13.

Denial of your Chapter 7 discharge doesn’t stop the bankruptcy case. The Chapter 7 trustee will continue to gather and liquidate any non-exempt assets, but the debtor does not receive the benefits of the Chapter 7 discharge.

The debtor may not ever discharge any of these debts through bankruptcy, and immediately loses the protection of the automatic stay. Essentially, a denial of discharge becomes an asset grab for the trustee and your creditors.

Denial of discharge in Chapter 13

In Chapter 12 and Chapter 13 cases, the debtor is usually entitled to a discharge upon completion of all payments under the plan. As in Chapter 7, however, discharge may not occur in Chapter 13 if the debtor fails to complete a required course on personal financial management.

A debtor is also ineligible for a discharge in Chapter 13 if he or she received a prior discharge in a Chapter 13 within the past two years, or a prior Chapter 7 discharge within the past four years. Unlike Chapter 7, creditors do not have standing to object to the discharge of a Chapter 12 or Chapter 13 debtor.

Creditors can object to confirmation of the repayment plan, but cannot object to the discharge if the debtor has completed making plan payments.

My advice

Do everything by the books and declare all information necessary. You don’t want to find yourself in a bind for a few hundred or even a few thousand dollars when your freedom and financial future is on the line