5-10.1 GENERALLY
While simply concealing assets or making false statements in a bankruptcy proceeding make up the majority of bankruptcy frauds, there are a number of fraud schemes that are more complicated and are primarily designed to use the automatic stay provided by the bankruptcy laws to conceal an earlier crime, maximize profit from an ongoing fraud scheme, or buy time while the perpetrator finds a way to avoid victims or leave town.
The following sections detail some of the more common schemes. They are merely illustrative lists of common warning signs identified for each fraud scheme; many of the factors listed may be present in situations where there is no fraud. It is important to analyze all the factors in determining whether a fraud has been perpetrated.
5-10.2 BUSTOUTS
A bustout is conducted by a company that is set up to fail from the outset. The operator obtains merchandise from creditors, disposes of the goods (usually for cash), and does not pay suppliers. A bustout can also be conducted using an existing company's credit to obtain goods available on credit, without the intent to pay, and then disposing of the goods immediately for cash.
5-10.2.1 Examples of Bustouts
5-10.2.1.1 Consumer Products Distributors
A company operates for short period of time and establishes good credit ratings with large consumer goods manufacturers. Orders increase suddenly and payments are not made. Lulling techniques are used to forestall creditors. Goods are sold to retailers at below cost for cash. Bankruptcy is filed. Schedules show large trade debt owed to consumer products manufacturers with inventory unusually low compared to the date the debt was incurred.
5-10.2.1.2 Retail Bustouts
A company rents retail space and does not pay rent or suppliers. Bankruptcy is filed to stop eviction and to gain additional time to continue its illegal operation. Often times, these retail stores are part of distributor bustouts because they provide retail outlets for the consumable goods.
5-10.2.1.3 Tax Bustouts
An individual operates a series of businesses in the same industry and fails to pay taxes. He/she then usually files chapter 11 bankruptcy for the company just prior to or at the time the Internal Revenue Service files a lien on the debtor's assets. The company operates for a brief period of time in chapter 11 before the case is converted or dismissed. A new business is then started with the debtor's assets.
5-10.2.1.4 Credit Card Bustouts
Individuals in contemplation of bankruptcy run up large consumer credit card debt and then file bankruptcy. Purchases and cash advances occur within a short period of time. Frequently, the same individual files bankruptcy several times using false social security numbers or aliases, or assumes another person's name or social security number. False statements are usually made on credit applications and the assets acquired from the fraud are concealed when the bankruptcy is filed.
5-10.2.1.5 Travel Agency Bustouts
A travel agency opens and secures plates from an airline cooperative agency to write tickets. After paying the first few bills, a tremendous number of tickets, often overseas tickets, are written and not paid for. They are sold for cash in bargain sales. The travel agency may report the authorization plates stolen to continue the scheme. Plates and blank ticket stocks are often missing when the trustee or airline attempts to recover them.
5-10.2.2 Red Flags/Common Characteristics of a Bustout
5-10.3 BLEEDOUTS
A bleedout is similar to a bustout, only it usually involves an existing company and a depletion of assets over a relatively long period of time by insiders. There are often concealed assets or false statements in this situation. Long-standing owners or corporate raiders can be perpetrators of the crime.
5-10.3.1 Examples of Bleedouts
5-10.3.1.1 Corporate Raider Bleedouts
A stable company with very liquid assets, such as a large pension and/or profit sharing fund, is acquired in a leveraged buyout. The company is operated for the sole purpose of allowing the insiders to loot the company. A chapter 11 is filed to allow the insiders to complete their scheme. Business transactions are complex and purposefully confusing, which makes fraudulent conveyance actions expensive and difficult to prove. Scheme is used in all types of industries.
5-10.3.1.2 "White Knight" Bleedouts
A business consultant is hired by a troubled business to assist it in acquiring new financing and streamlining operations. On occasion, the "white knight" is given an ownership interest in the business. The consultant takes control of the financial operations of the business. He/she uses the position to convert company assets, including failure to pay withholding taxes, failure to make pension fund contributions, diverting receivables, paying personal expenses with company funds, taking an excessive salary and bonuses and, in some situations, paying false invoices to entities or individuals related to him/her.
5-10.3.1.3 Parallel Entities
A long-standing company experiences financial problems. Insiders create a new business in the same industry just prior to or soon after the bankruptcy filing. In some cases, a sale of some of the debtor's assets is made to the new entity for a fraction of their value just prior to the bankruptcy. The non-debtor entity is usually not disclosed. The insiders operate the debtor until they have successfully transferred the debtor's inventory, receivables, customers, and good will to the new company. In addition, the insiders may use the debtor to purchase goods and services for the new company with the intent of never repaying the chapter 11 administrative creditors. This is usually a lawyer-assisted fraud.
5-10.3.1.4 Insider Sales
Non-bankruptcy workouts in which misrepresentations are made to creditors (mail fraud) and the assets are sold to undisclosed insiders for inadequate consideration. Secured creditor agrees to the transaction because its security position improves if the new company is debt free. The scheme usually terminates in an involuntary bankruptcy.
5-10.3.2 Red Flags/Common Characteristics of a Bleedout
5-10.4 PONZI (INVESTOR FRAUD) SCHEMES
A ponzi scheme (also know as a pyramid scheme) involves soliciting investments by promising interest rates well above the market rate. Early investors recover their investments with the promised rate of return from funds provided by new investors, and then in turn encourage others to invest. As the pyramid begins to crumble, investors are unable to recover their original investments and interest is no longer paid. Chapter 11 cases are often filed to allow the debtor to continue the scheme. When the scheme collapses before bankruptcy, either a voluntary or involuntary chapter 7 case is filed.
The essence of a ponzi scheme is a promise of a high return on an investment. Once it fails, many investors are reluctant to complain because they realize they have been swindled. It is important to identify the investors; once they are contacted, they are normally cooperative and provide valuable information and assistance in the investigation and prosecution.
5-10.4.1 Examples of Ponzi (Investor Fraud) Schemes
5-10.4.1.1 Real Estate Schemes
Limited partnership interests and/or mortgages on residential property are sold to investors. The real estate securing the investment is insufficient to support the shares or interests sold. Funds are removed from the investment properties through large management and general partnership fees paid to insider companies. Investments are commingled. Numerous and complex banking transactions make it difficult to trace funds.
5-10.4.1.2 Church and Ethnic Schemes
An individual solicits funds from members of his/her church or religious faith. Investors believe in the individual because of his/her affiliation with their church and, therefore, trust him/her with their money and to not make appropriate inquiries. Likewise, members of ethnic groups are targeted by members of their community. Shared language and ethnic background allow the perpetrator to win the trust of his/her victims. Recent immigrants are often targets of these schemes. In both situations, the victims are reluctant to believe that their trust has been betrayed and, therefore, may be unwilling to complain about the perpetrator.
5-10.4.1.3 Overseas Funds Needing U.S. Investment
The operators of this scheme promise that they have an overseas investor who needs aid in moving money to this country. They will pay a very high return for the use of the victim's account and aid in transferring the money. The victim has to put up money to help start the transfer. The overseas investment never occurs.
5-10.4.1.4 Advanced Fee Swindle
This is a variation of a ponzi scheme. Either through advertisements or direct contact, individuals or businesses in financial trouble are contacted and offered generous loans. The loans require an advanced fee to guarantee the loan and start the processing. The perspective borrower pays the fee, the loan is not made, and the borrower is in even deeper financial trouble.
5-10.4.2 Red Flags/Common Characteristics in a Ponzi (Investor Fraud) Scheme
5-10.5 HEALTH CARE AND WELFARE FRAUD
Health care and welfare fraud is prevalent throughout the country, and there have been an increasing number of bankruptcy cases with these problems. The perpetrators usually file chapter 11 cases to allow their activities to continue and to stall investigations of their actions. The schemes generally involve obtaining funds through the promise of lower cost, greater coverage, or some other inducement to convince either individuals or companies to switch coverage to the new company.
5-10.5.1 Examples of Health Care and Welfare Fraud
5-10.5.1.1 Bogus Health Care Plans
Perpetrator establishes bogus or grossly under-capitalized insurance plans to provide health care to individuals or companies at very favorable rates with no intent to provide services or pay claims. Chapter 11 allows the perpetrator to continue to collect premiums from the victims by paying on a few small claims and stalling on the payment of larger claims.
5-10.5.1.2 Theft of Employee Contributions for Health Insurance
Employer deducts employee's share of insurance premium, but does not remit the funds to the insurance company. This is typical in "bleedout" cases.
5-10.5.1.3 Sham Facilities
Nursing homes, shelters, drug rehabilitation programs, and other health- related homes are set up to secure federal and state funding. They provide little or no services to the clients and convert funds received for their own use. In some instances, the government funding programs require the services to be rendered at no cost to clients. In those situations, the perpetrators require clients to sign over food stamps and welfare checks to them in order to remain at the shelter.
5-10.5.2 Red Flags/Common Characteristics in Health Care or Welfare Fraud Scheme
5-10.6 RENT/EQUITY SKIMMING
Rent or equity skimming involves acquiring the titles to multiple properties with no intention of paying the mortgages. The perpetrator collects the proceeds from the property, and then files a bankruptcy to stall foreclosure and to allow the scheme to continue.
5-10.6.1 Examples of Rent/Equity Skims
5-10.6.1.1 Rent/Equity Skim
An individual acquires partnership interest
or title to property, but does not assume the mortgage. The perpetrator
puts his/her management company in control of the property. He/she collects
rent, pays exorbitant management fees, does not maintain the facilities,
and makes no payments to the secured lender. The lender is contacted by
the perpetrator who attempts to extort a buyout of his/her interest. When
the lender attempts to foreclose, the perpetrator deeds the property to
a corporate entity that files bankruptcy. The transfer of title is repeated
several times, with bankruptcies filed to cover all the transfers.
5-10.6.1.2 Property Title Skim
This fraud is similar to the one described above. The major difference is that the perpetrator convinces the victim to deed his/her home over to the perpetrator for little or no cash. The victim then pays rent to the perpetrator who does not pay the existing mortgage or seek new financing. Bankruptcies are filed to delay foreclosure. In some instances, the perpetrator will deed fractional interest of the property to other bankruptcy estates, without their knowledge. This complicates and delays foreclosure.
5-10.6.2 Red Flags/Common Characteristics in a Rent/Equity Skimming Scheme
5-10.7 CONCEALMENT AND FALSE STATEMENTS
The concealment of assets and related false statements constitute over 70 percent of all bankruptcy crimes according to the latest Federal Bureau of Investigation statistics. A debtor who fails to list assets on his/her bankruptcy schedules commits both the crime of concealment and false statement. By concealing assets, the debtor attempts to preserve property for future use and to deprive creditors of their fair share of assets. Concealment may take the form of omission of assets in their entirety or the gross undervaluation of assets.
5-10.7.1 Examples of Concealment
5-10.7.1.1 Failure to Schedule Assets
A debtor fails to schedule assets. Typical examples of assets not disclosed include personal injury lawsuits, real estate, bank and investment accounts, stocks, jewelry, art work, interest in non-debtor entities, etc.
5-10.7.1.2 Undervalued Assets
An asset is listed, but its value is grossly understated or deemed worthless. The intent is to persuade the trustee and creditors not to liquidate the asset.
5-10.7.1.3 Transfer of Assets Prepetition
A debtor transfers assets, with little or no consideration to third parties, with the agreement that after the case is closed the property will be returned to the debtor. The relationship to the debtor or the agreement with the transferee is not disclosed.
5-10.7.1.4 Transfer of Assets Postpetition
A debtor sells or transfers assets without court approval. If the debtor does seek court approval, the debtor does not disclose his/her relationship to or agreements with the purchaser. For example, the debtor sells property below its value to a straw buyer who agrees to convey it back to him/her. A similar situation is where the purchaser agrees to give the debtor part of the purchase price "under" the table and court approval is sought for the purchase at a lower price to allow for the transfer.
5-10.7.2 Red Flags/Common Characteristics in Cases of Concealment and False Statements
5-10.8 COLLUSIVE INVOLUNTARY BANKRUPTCY
There has been an increase in collusive involuntary bankruptcies in which creditors file an involuntary bankruptcy case at the debtor's direction or with his/her approval. The collusive bankruptcy is often part of a larger scheme, frequently involving real estate foreclosures.
In the typical collusive involuntary, the perpetrator has co-conspirators file an involuntary for him/her or his/her corporate entity. The involuntary is used by the debtor if he/she has been prohibited from filing for a period of time. A bustout or bleedout perpetrator uses the involuntary to conceal his/her involvement in the case, where he/she is involved in a number of pending corporate bankruptcies. The bankruptcy system is used to gain the benefit of the automatic stay without information having to be disclosed about the debtor during the involuntary period.
5-10.8.1 Red Flags/Common Characteristics in a Collusive Involuntary Scheme
5-10.9 STRAW BUYER/FICTITIOUS BIDDER
The debtor sells assets to a court approved buyer and the assets are secretly resold at a profit pursuant to a previous agreement with the real buyer. Where fictitious bidding is suspected, potential purchasers should be required to state on whose behalf they are bidding.
5-10.9.1 Examples of Straw Buyer/Fictitious Bidder
5-10.9.1.1 Kickbacks
An insider agrees to sell assets to a purchaser who has agreed to pay the insider a kickback. The purchase price disclosed in the motion to sell is less than the price agreed upon by the insider and the purchaser. When the sale is completed, the debtor receives the difference between the court approved price and the undisclosed sale price.
5-10.9.1.2 Straw Sales
An insider wants to conceal his/her purchase of estate assets because he/she wants to orchestrate the sale to allow him/her to buy the assets for a depressed price. A fictitious purchaser or nominee is used to acquire the assets. Once the sale is consummated, the assets are transferred to the insider for a fee. The insider and the purchaser do not disclose the relationship to the court. Often times, both parties will make affirmative statements claiming that there are no connections or agreements between them.
5-10.9.2 Red Flags/Common Characteristics in a Straw Buyer/Fictitious Bidder Scheme
5-10.10 SERIAL FILERS
A serial filer is typically an individual. The debtor files numerous cases to take advantage of the automatic stay to prevent foreclosure and collection on other debts. The petitions usually contain false social security numbers, variations of the debtor's name, or fictitious names. Chapter 7 and chapter 13 cases are filed interchangeably.
5-10.10.1 Red Flags/Common Characteristics in a Serial Filer Scheme
5-10.11 CREDITOR FRAUD
Creditor fraud exists in the system, but is more difficult to uncover. Typical crimes committed by creditors include filing false proofs of claim, collusive bidding for estate property, and extortion or intimidation in attempts to collect prepetition debt postpetition.
5-10.11.1 Examples of Creditor Fraud
5-10.11.1.1 False Proofs of Claim
A creditor files a false proof of claim in a bankruptcy case. A more complex scheme is where an individual files proofs of claim in numerous unrelated bankruptcy cases. Usually, the claims are filed in large cases where objections to small claims will not be made because of the cost of pursuing claim objections.
5-10.11.1.2 Automatic Stay/Extortion
A creditor threatens, intimidates, and uses force against a debtor to have a prepetition debt paid postpetition, notwithstanding the prohibition of such payment by the automatic stay.
5-10.11.1.3 False Invoices
A creditor, with the debtor's knowledge, submits a false bill for postpetition goods or services which it has not provided to the debtor. The invoice, thus, allows the debtor to pay the creditor its prepetition debt "under" the table.
5-10.11.1.4 Secured Creditor Fraud
A secured creditor and the debtor agree to cure the defect in the lender's lien through use of a cash collateral order. The defect in the lien is not disclosed to the court, creditors, or the United States Trustee. The insiders who have personally guaranteed the debtor's secured obligations are usually willing to engage in this scheme. A similar scheme involves transferring the debtor's assets to a non-debtor entity in which the secured creditor has a properly perfected lien, but may be undersecured.
5-10.12 FRAUDULENT PETITION MILLS
The individual running the mill is a self-styled, unlicensed financial advisor/paralegal/eviction counselor, who solicits clients from foreclosure publications or unlawful detainer filings. The perpetrator's advertisements promise to help solve the financial problems of the victim. On meeting with the victim (debtor), the "advisor" tells the debtor that matters can be resolved--the eviction can be stopped, the mortgage rate can be lowered, interest rates reduced, or car payments and repossession stopped. A large fee is collected up front and the debtor signs papers in blank. The "advisor" then files a bankruptcy petition for the debtor.
Often times, the debtor is not aware that a bankruptcy has been filed and will not show up for the section 341 meeting. When the case is dismissed, the "advisor" may claim to the victim debtor that a mistake has been made and, for an additional fee, it can easily be corrected. A subsequent bankruptcy is filed, many times with a slight change to the name or social security number. In many cases, the "advisor" directs the debtor to make mortgage/rent/car payments to him/her as part of the agreement and he/she then converts the money to his/her personal use.
5-10.12.1 Examples of Petition Mills
5-10.12.1.1 Financial Counseling Skim
Homeowners whose properties are in foreclosure are contacted, usually through the mail, by a financial consultant. The consultant tells the homeowner that he/she will find a new lender to assume the delinquent mortgage. The homeowner is instructed to make mortgage payments directly to the consultant. The perpetrator files bankruptcy, many times without the victim's knowledge, to forestall the foreclosure and to maintain the stream of income being received from the victim.
5-10.12.1.2 Property Title Skim
This fraud is similar to the one described above. The major difference is that the perpetrator convinces the victim to deed the home over to him/her for little or no cash. The victim then pays rent to the perpetrator who does not pay the existing mortgage or seek new financing. A bankruptcy is filed to delay foreclosure. In some instances, the perpetrator will deed fractional interest of the property to other bankruptcy estates, without their knowledge. This complicates and delays foreclosure.
5-10.12.1.3 Petition Mill
The mill will hold itself out as an eviction counseling service, but instead of providing actual eviction defense services, will file a bankruptcy in the tenant's/owner's name to stay eviction. Often the tenant/owner does not know that a bankruptcy has been filed or that he/she will be evicted once the stay is lifted or the bankruptcy dismissed. The landlord/mortgage holder will have a valid eviction repossession order, but must obtain relief from the stay or wait for dismissal of the case to execute it.
5-10.12.1.4 Scrivener Typing Services
An individual sets up a storefront office and advertises a scrivener service that will assist individuals in filing a pro se, simple chapter 7 bankruptcy and will prepare all the paperwork for a low fee. Names like "Attorney Assisted Legal Centers" or "Paralegal Centers" are often used. Attorney approved services are stressed. A debtor may or may not sign bankruptcy papers in blank, and will usually not pick up the bankruptcy document until just before filing.
5-10.12.1.5 Legal Advice Typing Services
Many typing services will prepare petitions and schedules and will advise the debtor of the law. The advertisements will state that the service can perform the same quality of service as attorneys, but for less money. Debtors file petitions and schedules pro se and do not disclose that they were assisted in filing their cases.
5-10.12.2 Red Flags/Common Characteristics in a Petition Mill Scheme