Bankruptcy Fraud: What It Is and How to Avoid It

When it comes to filing bankruptcy, a lot of emotions can rise to the surface. Relief is usually the most prevalent of these emotions; the erasure of anxiety-laden debt often provides a sense of liberation. Clients can also experience anger toward their harassing creditors or fear that their bankruptcy process will be hindered by several possible hurdles and landmines. Another common emotion for clients is embarrassment. It’s not easy for clients to come face to face with their debt.

Sometimes, these emotions can lead to rash and risky behaviors. A client might wish to conceal certain facts from an attorney or the bankruptcy trustee. They might consider hiding property, like jewelry or a second vehicle, or give property to someone else before filing. They might conceal being a Plaintiff in a lawsuit, credit card purchases or omit a small or infrequent source of income.

None of these moves are wise. Bankruptcy trustees are vigilant and unforgiving when it comes to fraud. Anyone caught filing a fraudulent petition can have that petition revoked. The filer may even face charges of perjury and can endure jail time as a result.

For these reasons, we advise that any clients considering bankruptcy be as honest and up front as possible about their property and finances. While bankruptcy fraud is not a common occurrence, being straightforward and candid about one’s financial situation means a smooth and stress-free bankruptcy process. The attorney has likely seen similar circumstances before and will best know how to handle any issues, no matter how uncommon they may seem at first.

It’s also important to understand that fraud is not the same as an error in one’s petition. Mistakes can happen and, as long as a client is honest with their attorney and the bankruptcy trustee, most errors can be fixed. However, an error in one’s petition can allow for a creditor to claim a debtor’s bankruptcy petition is fraudulent, which would then lead to extra time and money being spent on an adversary proceeding. Fraud charges can also lead to other civil actions against the client outside of bankruptcy court, which could also become costly.

With that in mind, a client might wonder what actions or omissions fall under the umbrella of bankruptcy fraud. We’ve outlined several possibilities below. This is by no means a complete list of all types of bankruptcy fraud, and a client should consult with their attorney if they have concerns about their past or current financial activity.

Before the Bankruptcy:

There are certain actions that a person may have taken before they fell into debt that could fall under the umbrella of fraud. Deceptive business practices, such as over- or underreporting one’s wealth or income, can be considered fraudulent activity that would prohibit the discharge of debt. Related to this, obtaining credit under false pretenses (like falsifying income on a loan application) or purchasing items on credit with no intention to repay (sometimes labeled as “Bust-out Schemes”) could also hinder one’s ability to have their debt discharged. Even the act of writing a bad check can summon a creditor’s suspicion of fraud.

Lenders and credit card companies are often on the lookout for these practices and will object to their debt being wiped away if they suspect this has happened. For that reason, it is often recommended that clients stop using their credit cards ninety days prior to considering a bankruptcy.

The ninety days before a bankruptcy petition is filed is called the “fraud presumption window.” If a fraudulent activity happens during this time frame, then the trustee will assume that the debtor intended to defraud the court and their creditors with that action and will respond accordingly. If the same activity happened over ninety days before filing the petition, then the debtor’s intent is more difficult to prove. This does not mean that such a determination is impossible, however.

Bankruptcy Assets

Concealing assets from the bankruptcy trustee is one of the most common forms of bankruptcy fraud. Sometimes, an inheritance or future source of income is not reported. Other times, a car is sold to a neighbor or friend at a very low value with the intention of getting the item back after a bankruptcy is discharged. Some debtors might even make valuable gifts to a charity instead of listing the asset or its transfer on their bankruptcy petition. In some cases, a large asset is never mentioned, with the hope that the trustee will never know it exists.

Hiding property in this fashion is considered fraud. When one declares bankruptcy, they are expected to list all of their assets (and any assets they had recently transferred or sold) within their bankruptcy petition. Those assets are, upon filing the bankruptcy petition, converted into the bankruptcy estate.

Once the exemptions to keep a person’s home and basic necessities are set aside, a person’s creditors are entitled to the rest of that estate for repayment. The client is giving up their property in exchange for debt relief (or, in the case of Chapter 13 bankruptcies, is agreeing to pay the value of their non-exempt property to their creditors over three-to-five years). Creditors would not agree to a bankruptcy otherwise.

If the creditors or the bankruptcy trustee suspect that property has been kept out of the estate, they will likely hold up the bankruptcy’s discharge, or have the debtor’s case dismissed altogether. If a client’s case is dismissed, filing a second bankruptcy will be more difficult.

It is also possible to commit fraud by undervaluing an asset, like a home or a fluctuating retirement account, in order to keep it as part of a bankruptcy exemption. Since the value of these items can range widely (especially in an uncertain market), it might be tempting to assume the lowest recent value is correct. This assumption could lead to questions by the bankruptcy trustee, and possibly the dismissal of one’s case and charges of perjury. For this reason, we recommend discussing the values of these items with a bankruptcy attorney to make sure they’re represented accurately on one’s bankruptcy petition. The attorney can then tell the client if their assets make them a better candidate for a Chapter 13 instead of a Chapter 7 bankruptcy.

Creditor Preference

Creditor Preference, on its surface, can seem like a harmless practice when one first hears about it. A client with a sudden windfall of cash (like a tax return or a lucky lottery winning) knows that money won’t be exempt when they file bankruptcy. So, instead of that money going to the bankruptcy estate upon filing, the client decides to pay back one of their creditors. Often, they’ll pay down the debt on a car loan or catch up on mortgage payments, because they’ll still be in their house or car after filing bankruptcy and those debts are the most logical ones to pay off.

A bankruptcy trustee would see this very differently. All creditors must be treated equally when a debtor files for bankruptcy. Paying back only one creditor and leaving the rest to suffer the full discharge of the client’s debt, especially within the ninety day “fraud presumption” window, can be considered fraud. One of the left-out creditors could bring this treatment up with the trustee, causing a delay in a client’s discharge or a revocation of their petition.

False Filings and Incomplete Records

A false filing happens when an individual files a petition with false or incomplete information or files with real information in multiple courts. This can cover a wide range of activities, from a debtor excluding a credit card from their bankruptcy (often because they wished to keep the card) to filing a second bankruptcy in a new state with a stolen identity.

While excluding information is often similar to concealing an asset, it can cover all parts of a bankruptcy petition. Leaving off a source of income in order to qualify for a Chapter 7 bankruptcy is fraud, as is not reporting accurate expenditures or past bankruptcies. Destroying or withholding documents, such as a tax return or loan paperwork, may also be considered a fraudulent act. Even leaving a creditor off a petition can be seen as creditor preference, as discussed above. Submitting false or incomplete information on a petition can result in perjury charges on top of having one’s bankruptcy dismissed.

A false filing can result when an individual files for bankruptcy in multiple places, or jurisdictions, in order to get around the eight-year limit on filing Chapter 7 bankruptcies. They might do this with the same name and information as their previous filing, or use an alias in order to get new debts discharged. Some debtors have even turned to identity theft in order to complete a fraudulent filing in a new state.

These types of filings can clog a bankruptcy court’s docket, drawing out the time before the petition is found fraudulent and dismissed. However, in our interconnected world, these types of fraudulent filings are easier for a trustee to find and, thus, are less common than they were previously. They also draw the stiffest penalties. False information on a petition always falls within the fraud presumption window and the intent to commit fraud is often much clearer to the trustee.

Bribery

Though rare, especially where Chapter 7 bankruptcies are concerned, bribery has been known to happen from time to time. This can happen, not just by bribing the court-appointed trustee for preferential treatment, but also by bribing someone to help hide one’s assets from the court. And the exchange need not be strictly in cash. Giving a court official gifts, such as lunch after the creditor meeting, can be considered a bribe. Campaign contributions also fall into this fraud category. Accepting these gifts would create a conflict of interest for the trustee, and most trustees would avoid this situation for the sake of their own appointments. Also, attempting to bribe a trustee could mean that there’s a cash asset that’s being hidden from the bankruptcy estate, which creditors would be interested in discovering.

Consequences

If fraud is suspected, federal prosecutors can bring criminal charges against the debtor. If an individual is found guilty of knowingly and fraudulently representing the facts in their petition, they can face up to twenty years in prison, or a fine of up to $250,000.00, or possibly both. Even if the debtor’s fraud was not successful, even the attempt or intent to commit fraud can be punished.

And those would just be the criminal elements to the fraud matter. The automatic stay could be revoked and the bankruptcy case itself could be dismissed. The debts would then remain intact and the creditors could still go after the debtor, only now they’d know about the attempted bankruptcy. Credit cards can be cancelled without debt relief. Loans may need to be reaffirmed at a higher interest rate. Foreclosures and evictions could continue as before. And, on top of all this, any debts listed with the first fraudulent petition cannot be discharged in subsequent bankruptcy filings.

For these reasons, most attorneys take fraud very seriously, as having their clients suffer these penalties are in no one’s best interest. A good attorney will often ask many questions while they are assembling their client’s petition, just to make sure that information isn’t inadvertently left out. It’s also important for the client to review their petition before filing, just to make certain there’s no reason for the trustee to suspect fraudulent information.

Even so, sometimes mistakes happen and a client will forget to report a source of income or an asset they’d long since forgotten about. As soon as the client realizes this, they should inform their attorney as soon as possible. Their attorney can then file an amendment to the bankruptcy petition. This might cost an additional fee, but it is better than facing the consequences of bankruptcy fraud. As long as the client didn’t intend to hinder, delay, or defraud their creditors by filing the amendment, the case can often continue as planned. Of course, catching the mistake before a creditor or the trustee notices it always helps the client’s case.

For additional information on bankruptcy fraud or determining whether you qualify for a Chapter 7 bankruptcy, please contact the bankruptcy attorneys at Luh & Associates. We look forward to answering your questions!