Civil Remedies for Bankruptcy Fraud

Journal Issue

Jul/Aug 2000

Column Name

Journal HTML Content

Bankruptcy Fraud. The mere mention of the phrase to bankruptcy practitioners—and perhaps the general
populace—conjures images in the mind's eye of unsavory persons who merit prosecution under federal
criminal law for their efforts to cheat the full-disclosure requirements of the bankruptcy system. However,
those who are victimized by bankruptcy fraud should not rest all of their hopes for procuring a fair result
on the criminal justice system. Instead, victims of bankruptcy crimes—whether they are individuals,
businesses or government entities—should remember that the civil provisions of Title 11 contain a multitude
of remedies to use against those who strive to gain an unfair advantage over their creditors.

<h3>Chapter 7 Remedies</h3>

In a chapter 7 case, upon a motion properly made by a party in interest, the court can deny the debtor a
discharge—the ultimate goal of chapter 7—if the debtor has engaged in certain fraudulent acts. For
example, the discharge can be denied if "the debtor, with intent to hinder, delay or defraud a creditor or an
officer of the estate charged with custody of property under this title, has transferred, removed, destroyed,
mutilated or concealed, or has permitted to be transferred, removed, destroyed, mutilated or concealed, (A)
property of the debtor within one year before the date of the filing of the petition, or (B) property of the
estate after the date of the filing of the petition."<a href="#2" name="2a">2</a> The chapter 7 discharge is in jeopardy if "the debtor has
concealed, destroyed, mutilated, falsified or failed to keep or preserve any recorded information, including
books, documents, records and papers, from which the debtor's financial condition or business transactions
might be ascertained, unless such act or failure to act was justified under all of the circumstances of the
case."<a href="#3" name="3a">3</a> Under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §727(a)(4)</a>, the court can deny a discharge if "the debtor knowingly and
fraudulently, in or in connection with the case, (A) made a false oath or account; (B) presented or used a
false claim; (C) gave, offered, received or attempted to obtain money, property or advantage, or a promise
of money, property or advantage, for acting or forbearing to act; or (D) withheld from an officer of the
estate entitled to possession under this title any recorded information, including books, documents, records
and papers relating to the debtor's property or financial affairs."

<blockquote><blockquote>
<hr>
<big><center>
...victims of bankruptcy crimes...should remember that the civil provisions of Title 11 contain a
multitude of remedies to use against those who strive to gain an unfair advantage over their creditors.
</center></big>
<hr>

</blockquote></blockquote>

Three additional provisions in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §727(a)</a> provide authority for the court to withhold the discharge benefit from a debtor. The discharge can be denied if:

<ol>
<li>the debtor has failed to explain satisfactorily, before determination of denial of discharge under this
paragraph, any loss of assets or deficiency of assets to meet the debtor's liabilities;<a href="#4" name="4a">4</a>

</li><li>the debtor has refused in the case (A) to obey any lawful order of the court, other than an order to
respond to a material question or to testify; (B) on the ground of privilege against self-incrimination to
respond to a material question approved by the court, or to testify after the debtor has been granted
immunity with respect to the matter concerning which such privilege was invoked; or (C) on a ground
other than the properly invoked privilege against self-incrimination, to respond to a material question
approved by the court or to testify;<a href="#5" name="5a">5</a> or

</li><li>the debtor has committed any act specified in paragraph (2), (3), (4), (5) or (6) of this subsection, on
or within one year before the date of the filing of the petition, or during the case, in connection with
another case, under this title or under the Bankruptcy Act, concerning an insider.<a href="#6" name="6a">6</a>

</li></ol>

<h3>Non-dischargeability of Debts</h3>

Those aggrieved by fraudulent acts of a debtor can also request that the court not allow a specific debt
to be discharged under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §523(a)</a>. A discharge under §§727, 1141, 1228(a), 1228(b) or 1328(b)
does not discharge an individual debtor from certain debts, including those owed due to fraud. Under
§523(a)(2), a debt is not dischargeable if it is "for money, property, services or an extension, renewal or
refinancing of credit, to the extent obtained by (A) false pretenses, a false representation or actual fraud,
other than a statement respecting the debtor's or an insider's financial condition; (B) use of a statement in
writing (i) that is materially false; (ii) respecting the debtor's or an insider's financial condition; (iii) on
which the creditor to whom the debtor is liable for such money, property, services or credit reasonably
relied. Debts that the debtor intentionally fails to disclose in the bankruptcy are non-dischargeable under
§523(a)(3), with some exceptions. Debtors are likewise prohibited by law from escaping debts owed due
to "fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny." §523(a)(4). Criminal
restitution debts are non-dischargeable.<a href="#7" name="7a">7</a>

<h3>Remedies in Chapters 11, 12 and 13</h3>

In chapter 11 cases, creditors who uncover fraud on the part of a debtor-in-possession (DIP) can request
the appointment of a trustee under §1104(a)(1), and can move for dismissal or conversion of the case for
cause. Removal of the DIP for fraud is allowed in chapter 12 under §1204, and a chapter 12 can be
dismissed or converted to a chapter 7 for fraud in connection with the case under §1208. Section 1307(c)
gives the bankruptcy court wide latitude to dismiss or convert a chapter 13 for cause, which would certainly
seem to include the grounds of fraud.

The remedy of conversion to a chapter 7 proceeding—combined with a request for denial of the
discharge—are a potent combination of remedies that would seem to give creditors the most bang for their
buck. Use of these remedies allows the wronged creditor to have the debtor's non-exempt assets (if any)
liquidated for prompt payment of whatever debt is owed, and further leaves any deficiency open for
subsequent collection efforts. While debtors faced with motions to convert often attempt to have their case
voluntarily dismissed prior to the time the motion to convert is heard, case law supports the proposition that
it is within the discretion of the court to decide which of the competing motions should be heard first.
Often, the court will convert the case, reasoning that allowing the debtor to dismiss after being caught in
an effort to cheat the system would be contrary to the honesty principles enshrined in the Bankruptcy Code.

<h3>Conclusion</h3>

The foregoing discussion is not exhaustive. However, it should serve to put the bankruptcy practitioner
on notice that there are numerous methods of combatting bankruptcy fraud short of prosecution that can
be used by those in both the private and public sectors.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Chair, South Dakota Bankruptcy Fraud Task Force; Chair, ABI Commercial Fraud Task Force; Former Law Clerk to Hon. Frank W. Koger, Chief Judge, U.S. Bankruptcy Court, Western District of Missouri. The views expressed in this article are solely those of the author and should not be attributed to any persons or entities associated with him. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §727(a)(2)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §727(a)(3)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §727(a)(5)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §727(a)(6)</a> <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §727(a)(7)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> Restitution obligations, imposed on the criminal defendant as conditions of her probation in state criminal proceedings, were not subject
to discharge in chapter 7 proceedings. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. Code, 11 U.S.C.A. §523(a)(7)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Robinson, 479 U.S. 36 (1986)</a>. <a href="#7a">Return to article</a>

Journal Authors

Craig Peyton Gaumer

Journal Date

Saturday, July 1, 2000 - 12:00