Bankruptcy Fraud and Abuse: How to Avoid Allegations During a Chapter 11 Reorganization

A recent article from the Government Accountability Project discusses the role of forensic accountants employed by the U.S. Department of Justice (DOJ) in uncovering fraud and abuse during the bankruptcy process. While the article focuses specifically on the DOJ’s recent firing of a forensic accountant in Texas, forensic accountants continue to play a key role in bankruptcy cases in Florida and other jurisdictions across the country. Since fraud and abuse allegations can derail the bankruptcy process (and potentially even lead to federal criminal charges), it is imperative that business owners and executives work closely with an experienced Miami business bankruptcy attorney to avoid costly mistakes throughout the process.

Understanding When Businesses (and Their Owners and Executives) Can Face Allegations of Bankruptcy Fraud and Abuse

All of this raises an important question: When can businesses (and their owners and executives) be held liable for bankruptcy fraud and abuse?

Bankruptcy fraud and abuse can take many different forms. “Fraud” and “abuse” are both defined broadly under federal law, and the U.S. Trustee (which oversees Chapter 11 bankruptcy proceedings and is part of the DOJ) can investigate potential fraud and abuse in a wide range of circumstances. Some of the more common examples of issues that can lead to high-risk scrutiny include:

Concealing Assets from the Bankruptcy Court

According to the Legal Information Institute (LII), “[n]early 70% of all bankruptcy fraud involves the concealment of assets.” When initiating the Chapter 11 bankruptcy process, businesses must disclose their assets to the bankruptcy court. This is done by attaching a Schedule of Assets to the business’s bankruptcy petition. Since a business’s assets play a key role in determining both its ability to pay and its viability as a going concern, concealing assets is considered a form of bankruptcy fraud.

Concealing Revenue from the Bankruptcy Court

Concealing revenue is considered a form of bankruptcy fraud as well. Along with filing a Schedule of Assets, businesses seeking to reorganize their debts under Chapter 11 must also file a Schedule of Current Income and Expenditures. If a business understates its income or overstates its expenditures (or attempts to hide expenditures that it doesn’t want to be made known to creditors or the court), this can potentially jeopardize the bankruptcy process.

Fraudulent Conveyances and Preferential Transfers

Fraudulent conveyances are prohibited under the U.S. Bankruptcy Code, and they are subject to being unwound by the U.S. Trustee. They fall into two broad categories:

• Conveyances made with action intent to defraud; and,
• Conveyances made for less than reasonably equivalent value.

Preferential transfers can give rise to bankruptcy fraud claims as well. If an insolvent business makes a payment or transfer to one of its creditors to the detriment of others, this can have adverse consequences for the business’s Chapter 11 reorganization efforts as well.

Omitting Creditors or Failing to Provide Notice

Businesses pursuing reorganization under Chapter 11 must produce a complete and accurate list of their creditors. They must also notify their creditors of their bankruptcy proceeding; and, “[w]hen a debtor amends [its] schedule of liabilities to add a creditor or change the status of any claims to disputed, contingent, or unliquidated, the debtor must provide notice of the amendment to any entity affected.” Omitting creditors from a business’s bankruptcy filing or failing to provide adequate notice as required can also give rise to fraud allegations.

Misrepresenting Future Business Prospects or Investments

Businesses (and their owners and executives) can also get into trouble if they misrepresent the business’s future financial prospects or capital investments when negotiating with creditors. Giving a false impression of the business’s ability to comply with its reorganization plan and pay down its debts over time is another common issue that can lead to costly litigation down the line.

Avoiding Allegations of Bankruptcy Fraud and Abuse During the Chapter 11 Reorganization Process

When preparing to pursue reorganization under Chapter 11, it is imperative that businesses (and their owners and executives) take the necessary steps to ensure compliance with all applicable provisions of the U.S. Bankruptcy Code. This includes, but is not limited to, taking the necessary steps to avoid any implications of fraud or abuse. Some examples of these steps include:

• Gaining a Clear Understanding of What is Required – Business owners and executives should ensure that they have a clear understanding of what is required when initiating a reorganization proceeding under Chapter 11. This includes, but is by no means limited to, ensuring a clear understanding of the U.S. Bankruptcy Code’s disclosure and notice requirements.
• Gaining a Clear Understanding of What is Permitted – Along with understanding what is required, business owners and executives should also ensure that they have a clear understanding of the options they have available.
• Gathering and Preserving Relevant Documentation – Gathering and preserving all relevant documentation is key not only to ensuring compliance with the U.S. Bankruptcy Code, but also to being prepared to demonstrate compliance to the U.S. Trustee or the bankruptcy court if necessary.
• Making Informed and Strategic Decisions – From deciding what type of bankruptcy proceeding to pursue to deciding how to structure their proposed reorganization plans, business owners and executives need to make informed and strategic decisions throughout the process.
• Prioritizing Compliance During the Filing Process – While business owners and executives should prioritize maximizing the benefits of the reorganization process when filing under Chapter 11, it is critical that they prioritize compliance during the filing process as well.

Again, these are just examples. By taking an informed and proactive approach to preparing for a Chapter 11 bankruptcy, businesses can not only substantially mitigate their risk of facing fraud allegations, but they can also substantially improve their chances of efficiently securing a favorable outcome. If you have questions about what you should (and shouldn’t) do as you consider your business’s options, we invite you to contact us for more information.

Schedule an Initial Consultation with a Miami Business Bankruptcy Attorney at Edelboim Lieberman

To request an initial consultation with a Miami business bankruptcy attorney at Edelboim Lieberman, please call 305-768-9909 or contact us online. We are more than happy to schedule an appointment at a time that is convenient for you.