Everything Must Go: Types of Bankruptcy Fraud

Welcome to the December 2017 edition of our newsletter!  In this issue, we’ll examine issues that arise during bankruptcy, including fraudulent conveyances, and discuss methods for recovering funds lost to bankruptcy fraud.

Here and Gone: Common Types of Bankruptcy Fraud

Bankruptcy fraud is a difficult field simply because the forms it can take are nearly limitless – any transaction undertaken by a business or individual who later seeks bankruptcy protection or reorganization can be susceptible to fraud.  In one prior instance, we helped identify recoverable assets after a family-owned business, having grown for more than 50 years, agreed to be sold, only to have the patriarch siphon its assets to various entities and trusts he created after receiving a sizable down-payment on the ultimately compromised sale.

On other occasions, the fraud occurs simply when an entity’s leadership declares bankruptcy after using remaining assets to pay themselves, or certain vendors but not others.  This leaves unpaid parties to bring adversary proceedings before the bankruptcy court, to argue that when the assets were in the company’s coffers that they, not others, were the proper parties to be paid.  These fraudulent conveyance actions are a more common form of bankruptcy fraud.  One variant on that theme is a “bust out” scheme, where a company buys a large amount of inventory on credit – say, prepaid gift cards – and sells them quickly, only to declare bankruptcy, and often shuttering their entire operation, when the bill from the creditor comes due.

How to Make Your Client More Whole After Bankruptcy Fraud

Recovering assets after a bankruptcy fraud has been committed can be a time consuming endeavor.  In the first example above, numerous companies were created by family members in the months after the sale was announced, before the bankruptcy petition was filed.  In that time, several of those companies were used in fictitious vendor schemes, billing the company for goods or services never received.  In another example from that case, we learned that one principal had diverted substantial sums to subsidize an expensive hobby – and were able to trace those funds when he made a down payment on a transaction with a merchant but failed to pay the balance, leading to litigation – including the person’s bank account set up to fund his hobby, via transfers from his soon-to-be-bankrupt company.  There are often multiple layers to such frauds, and they often include a circle of relatives, friends or other trusted associates.  By establishing a framework of involved parties via public records, a seasoned investigator can then look at various records, either submitted to the bankruptcy court or identified via discovery in an adversary proceeding, to create  time line of events and ideally how a pattern and practice between principals and their associates used to perpetrate a fraud.