Bankruptcy Fraud: Signs of Trouble and How to React

January 2016

IN THIS ISSUE

— Faltering Business or Shady Business? Signs of Bankruptcy Fraud
— Falling Victim to Bankruptcy Fraud: How to Respond

GREETINGS!

Welcome to the January edition of our newsletter! In this issue, we’ll examine the signs that a bankruptcy proceeding may have been initiated by, or tainted by, fraudulent acts as well as tips on how creditors can respond.

FALTERING BUSINESS OR SHADY BUSINESS? SIGNS OF BANKRUPTCY FRAUD

Since the financial crisis of 2008, courts have been awash in personal and corporate bankruptcy proceedings, with myriad companies seeking relief or protection from creditors. Some of these proceedings are likely the result of difficult economic circumstances, but some may also be the result of intentional, fraudulent acts by executives, and if your company has done business with a vendor, or client, that is considering bankruptcy, there are some signs to look for that may merit further investigation.

One potential indicator may be a significant change in ownership or management. If your company had supplied automobile parts to a large repair shop chain, for example, and new owners replaced the long-standing ownership (also replacing their executives), the background of the new owners and managers may be relevant. Although not an overt indicator of fraud, an established company presents such an opportunity for new managers to trade upon the company’s reputation as a means of extending lines of credit that the owners never intend to repay, for example.

Another potential indicator is that a company suddenly begins accruing a great deal more debt than it has traditionally; if your client has a relationship with the company, they may know about this directly, but sources such as Dun & Bradstreet or Experian also track the age and amount of debt, as well as a company’s payment habits and history.

FALLING VICTIM TO BANKRUPTCY FRAUD: HOW TO RESPOND

The process of being victimized by bankruptcy fraud is a painful one that begins long before a petition is filed, with repeated calls or letters seeking payment typically being the first course of action. Once a petition has been filed, if it is accepted by the court, creditors can file an adversary proceeding, a separate action before the bankruptcy court most often used to recover monies or property the creditor believes were fraudulently withheld or converted before the petition was filed. For instance, if the company owned a warehouse for many years and it was transferred to an unknown limited liability company shortly before bankruptcy, that could be a fraudulent conveyance. The best way to research this type of transaction is to review public records and, if approved by your counsel, to have a researcher speak with former employees in a position to know more about questionable decisions or transactions.

Bankruptcy fraud takes many forms and has numerous nuances, but the same principles apply no matter the particulars: vigilance and persistence during a relationship, and thorough research of a party’s actions after a petition is filed, can help prevent, or at least mitigate, the prospect of your client losing all they were owed or, at best, getting only pennies on the dollar via the typical bankruptcy process.