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Bankruptcy Fraud: How To Identifying And Wich Are Common Fraud Schemes

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.

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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.

Parallel Entities: A long-standing company experiences financial problems. Insiders of the company create a new business in the same industry just prior to or soon after the bankruptcy filing. In some cases, the debtor sells some of its assets 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 goodwill 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.

Assignment for the Benefit of Creditor (ABC)/Insider Sales: These cases include non-bankruptcy workouts in which misrepresentations are made to creditors (mail fraud) and the assets are sold to undisclosed insiders for inadequate consideration.

The 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.

Red Flags/Common Characteristics

· Recent changes of ownership/new players
· People with no prior involvement in the business have money transferred to them, both pre-petition and during the bankruptcy
· Changes in accounting or cash flow practices for no apparent business reason
· Payment stream to a certain creditor suddenly balloons
· Sudden decrease in inventory; sharp increase in aged receivables
· Inventory, equipment and machinery are sold a short time before the case is filed
· Capital infusions of corporate officers suddenly renamed “loans” and paid back
· Excessive salaries and bonuses
· Complicated asset transfers with no apparent purpose
· Depleted pension funds
· Leveraged buyouts
· Employee contributions for health care and pension funds have been deducted and converted by the debtor
· A new company is formed just prior to or immediately after the bankruptcy case is filed

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Civil Responses To Consider

· Motion to appoint a Chapter 11 trustee, an examiner or an involuntary “gap” trustee
· Extensive 2004 exams
· Require debtor to provide pension fund documents and bank statements for the pension fund prior to the 341 meeting of creditors
· Convert case to a Chapter 7, rather than dismissal
· Fraudulent conveyance actions

Criminal Responses To Consider

Mail Fraud, 18 U.S.C. Section 1341: Misrepresentations and the use of U.S. mail.

Wire Fraud, 18 U.S.C. Section 1343: Misrepresentations and the use of interstate wires.

Bankruptcy Fraud, 18 U.S.C. Section 152: Pre-petition transfers, concealed assets, or false statements to the court at the 341 meeting of creditors or in court filed documents such as the schedules and statement of financial affairs.

Bankruptcy Fraud, 18 U.S.C. Section 157: If any act of the fraud occurs after October 22, 1994, this statute may be used. The use of bankruptcy must have aided the fraud scheme in some way. Delaying creditors, allowing the debtor to continue to operate or covering up the scheme is an example under this section. The statute will be easier to use than 18 U.S.C. Section 152, “concealment” or “in contemplation” because the fraud scheme can be explained in greater detail. False statements under oath is the same under either statute, although 157 will allow a broader description of the fraud.

Use of False Social Security Number, 42 U.S.C. Section 408: lf used to obtain credit or in the bankruptcy filing.

Credit Card Fraud, 18 U.S.C. Section 1029: One thousand dollars or more charged on one unauthorized card in one year or possesses more than 15 fraudulent cards.

Tax Fraud, 26 U.S.C. Section 7201-7203: If there is a failure to pay withholding taxes and other taxes, or failure to file returns. The IRS should be notified so they may investigate.

Next; Ponzi Schemes (Investor Fraud)

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