Why Bankruptcy Fraud?

Ameer Shafiq Kamalullail

Abstract This paper is initiate to explain on why

bankruptcy fraud? A false representation of a matter of
factwhether by words or by conduct, by false or
misleading allegations, or by concealment of what should
have been disclosedthat deceives and is intended to
deceive another so that the individual will act upon it to her
or his legal injury.

KeywordsBankruptcy, Fraud, Bankruptcy Fraud

Introduction

Bankruptcy fraud is a white-collar crime that takes four

general forms. First, debtors conceal assets to avoid
having to forfeit them. Second, individuals intentionally
file false or incomplete forms. Third, individuals
sometimes file multiple times using either false
information or real information in several states. The
fourth kind of bankruptcy fraud involves bribing a courtappointed trustee. Commonly, the criminal will couple one
of these forms of fraud with another crime, such as
identity theft, mortgage fraud, money laundering, and
public corruption.

Figure 1.
Figure 1. U.S. Daily Bankruptcy Filings 2004 - 2014

bankrupt within that period after they faced problems

involving vehicle sales transactions.

A. Bankruptcy Filing Statistic

According to the United States Bankruptcy Court, there
were more than 1.2 million bankruptcy filings in fiscal
year 2012. Bankruptcy fraud results in serious
consequences that undermine public confidence in the
system, taint the reputation of honest citizens seeking
protection under the bankruptcy statutes, and have a
negative impact on voluntary compliance in our income
tax system. With so much at stake, the detection and
prosecution of bankruptcy fraud continues to be an area of
focus for the IRS, as well as the Department of Justice.
Fig. 1, shows the statistic data in United States
individual or company that filed for bankruptcy.
" Most incidents of bankruptcy in Malaysia arise from
the sale and purchase of vehicles, making up 26.54% of
the total cases between 2007 and this year.
Minister in the Prime Minister's Department Nancy
Shukri said some 33,570 Malaysians were declared

Figure 2.
Figure 2. Malaysia statistic on Bankruptcy Filing

Fig. 2, on the other hand shows Malaysia statistic data

on Malaysia bankruptcy filing since 2014 till early 2015
B. Common Fraud Schemes Involving Bankruptcies
I.

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 by buying an existing company and using that
companys good credit to obtain goods, without the intent
to pay, and then disposing of the goods immediately for
cash.
Examples Of Bustouts
Distributors of Consumer Products (including cigarettes,
diapers, etc.):
Company operates for a short period 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. Afterwards, a bankruptcy petition is filed. Schedules
filed by the debtor after the bankruptcy filing report trade
debt owed to consumer products manufacturers with
inventory unusually low compared to the date the debt
was incurred.
Retail Bustouts:
The merchant rents retail space and does not pay rent or
suppliers. He files bankruptcy to stop eviction and to gain
additional time to run the illegal operation. Oftentimes,
retail stores are part of the distributor bustouts because
they provide outlets for the consumable goods. (Examples
include retail jewelry stores, oriental rug stores and
discount stores.)
Tax Bustouts:
An individual operates a series of businesses in the
same industry and never pays taxes. He usually files
Chapter 11 bankruptcy for the company just prior to or at
the time the IRS files a lien on the debtor's assets. He
operates the business for a brief period of time while in
Chapter 11 before the case is converted or dismissed. He
starts a new business with the debtor's assets. (Examples
include restaurants and employee leasing services.)
Credit Card Bustouts

Individuals contemplating bankruptcy run up large

consumer credit card debt and then file bankruptcy. The
purchases and cash advances occur within a short period
of time. Frequently, the same individual files bankruptcy
several times, using false social security numbers and
aliases. Or the fraudulent perpetrator 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.

II.

Bleedouts

A bleedout is similar to a bustout. It usually involves an

existing company and a depletion of assets by insiders
over a relatively long period of time. There are concealed
assets or false statements in this situation. Long-standing
owners or corporate raiders can be perpetrators of the
crime.
Examples Of Bleedouts
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. This
type of scheme is used in all types of industries.
"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 and uses
his position to convert company assets. Often this includes
failing to pay withholding taxes, failing to make pension
fund contributions, diversion of receivables, paying
personal expenses with company funds, taking excessive
salary and bonuses and, in some situations, paying false
invoices to entities or individuals related to the consultant.
Red Flags/Common Characteristics Table

Concealment of assets

Serial bankruptcy cases

Payoff of loans to directors, officers, shareholders,

relatives or other insiders shortly before filing.

Failure to keep usual business records

Incomplete or missing books and records

Transactions with non-debtor subsidiaries, parent

companies or affiliated corporations owned by the
same or related persons or entity

Conduct well outside ordinary business or industry

standards and practices

Unusual depletion of assets shortly before the

bankruptcy filing

A history of prior litigation or post-petition litigation

involving
breech
of
contracts,
fraud
misrepresentations, etc.

Recent departure of debtor's officers, directors or

general partners

Complicated corporate structures and relationships.

Unanswered questions or incomplete information on

debtors schedules and statement of financial affairs

Creditor confusion concerning corporate structure.

Fire, theft or loss prior to or after filing.

Frequent amendments to schedules, statements of

financial affairs and monthly operating reports

Failure to pay withholding and sales tax.

Startup of a similar business near the time of

bankruptcy filing.

Inconsistencies among recent financial statements,

tax returns and debtor's schedules and statements of
financial affairs

Absence of knowledgeable officers to testify at the

Section 345 meeting

Inability to contact principals of debtor at debtors

stated location

Frequent dealings in cash rather than recorded

transactions

Sudden depletion of inventory post-petition without

plausible explanation

Inflated salaries, payments of bonuses or cash

withdrawals by officers, directors, shareholders or
other insiders

Transfer of property to insiders, shareholders and

relatives shortly before bankruptcy

REFERENCES
[1]

[2]
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[4]

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Fraud. Retrieved May 30, 2015, from FBI Web site:
http://www.fbi.gov/about-us/investigate/white_collar/bankruptcyfraud.
Joe B. Brown, B. N. (1999). Identifying Bankruptcy Fraud. United
States: Credit Research Foundation.
MEIKENG, Y. (2014, April 9). Bankruptcy cases on the rise in
Malaysia. Retrieved May 30, 2015, from Star Online:
http://www.thestar.com.my/News/Nation/2014/04/09/Bankruptcyon-the-rise-in-Malaysia/
Services, I. R. (n.d.). Criminal Investigation : Internal Revenue
Services. Retrieved May 30, 2015, from Internal Revenue Web
site:
http://www.irs.gov/uac/Bankruptcy-Fraud-CriminalInvestigation-(CI)