The Truth About Bankruptcy Fraud
February 10, 2020
By Scott Mataya
Bankruptcy is a legal proceeding involving a person or business that is unable to repay outstanding debts. The bankruptcy process generally begins with the debtor filing a petition. On rare occasions, however, it can begin with a petition filed on behalf of the creditors. There are several types of bankruptcies that a business or individual can file, ranging from Chapter 7, the liquidation of assets; Chapter 11, the company or individual reorganizes; and Chapter 13, which involves debt repayment with lower debt covenants. Bankruptcy filings can vary among states, and depending on the type and nature of the case, the court may appoint a trustee.
As of the petition-filing date, the debtor’s assets are measured and evaluated in order to repay a portion of the debtor’s outstanding debt. While bankruptcy is intended to provide temporary relief for a debtor while they formulate a plan to repay creditors, it can also provide a dishonest debtor the opportunity to defraud others. Bankruptcy fraud is growing by both businesses and individuals and can manifest itself in many different forms. The common forms of bankruptcy fraud include:
- Concealment of assets
- Undervaluing assets
- Credit card fraud
- False incomplete form (making of false oaths or statements)
- Filing multiple times (in multiple states)
- Pre-payment of debts (creditor preference)
While there are many different ways a dishonest debtor can commit fraud during the bankruptcy process, here are a few of the most common.
Concealment of Assets
The concealment of assets is the most common form of bankruptcy fraud that occurs in the U.S. When filing for bankruptcy, the petitioner’s assets must be listed in Schedule A of the bankruptcy petition. Debtors often list small assets, such as household goods, in a generalized manner and assign an overall value. However, this method does not work for large assets, such as a house or a vehicle. In the past, it was common for individuals to sell assets to close family and friends for a nominal value, only to purchase them back post-bankruptcy. This technique rarely works in present-day bankruptcy proceedings, because appointed trustees have the time and resources to review each transaction in question to determine its legitimacy. This involves confirming transactions are at arm’s length and near market value. In addition, the timing of such transactions are taken into consideration, as the majority take place shortly before the debtor files for bankruptcy.
The undervaluing of assets is easier to defend than allegations of concealment of assets, especially when the debtor has sufficient evidence to support claims and asset amounts listed in Schedule A of the bankruptcy petition. One example is in valuing the debtor’s primary residence. Depending on the source used to determine the fair value of the house, whether it is the local tax assessor’s website or another similar source, the house would not be exempt under the applicable law. In the event that an IRS Quick Sale Value tool or home investor offers are used, an assigned fair market value of between 60% and 80% will be assigned to assets. This acts as a means to discount the house to consider the quick-sale nature of the property. The buyer would bear all of the risks of making the necessary repairs and improvements to the property. The most common way to justify the value of a property listed in Schedule A is a written offer from a home investor that is no older than 90 days.
Credit Card Fraud
Credit card fraud is a method used by debtors in an attempt to purchase goods on credit prior to filing for bankruptcy in which the debtor willfully and fraudulently purchased these items with no intentions to ever pay them back. In the event that the creditor is able to provide evidence that they were intentionally defrauded by the debtor, the court may rule that this particular debt will not be discharged during the bankruptcy proceedings. The common red flag for credit card fraud is when a person makes significant credit card charges close to the time of the bankruptcy filing. The higher the amount and the more recent the credit card charges, the higher the likelihood that a creditor will allege fraud.
The consequences for committing bankruptcy fraud are quite severe, ranging from denial of a bankruptcy discharge to prosecution for a federal felony. Even inadvertent mistakes made when filing for bankruptcy may lead creditors or the bankruptcy trustee to allege fraud. This could lead to a prolonging of the bankruptcy process, making things increasingly stressful, complicated and costly. In addition, bankruptcy fraud prosecuted as a felony offense is punishable up to five years in prison and up to $250,000 in fines.
In bankruptcy proceedings, honesty is the best policy. Whenever dealing with the government or financial institutions, honesty and transparency are critical. Most people who file for bankruptcy are honest. However, opportunistic creditors may take advantage of any misstep during the bankruptcy filing process and claim it shows an intentional effort to abuse the system. Raising questions regarding the debtor’s integrity may lead to unfavorable rulings against the debtor and in favor of the creditors during the bankruptcy proceedings. In addition to unfavorable rulings in the court proceedings, questions regarding the debtor’s integrity may bring about fraud accusations that can result in criminal penalties as indicated above.