Bankruptcy Fraud: 7 Ordinary Owner Mistakes That Look Like It to a Trustee

Bankruptcy fraud is a crime of intent, and intent is read from paperwork that honest owners often fill out badly. The core criminal statute, 18 U.S.C. 152, punishes concealing estate property and making false oaths or declarations only when done "knowingly and fraudulently," with up to five years in prison. The warning printed in the signature section of the business statement of financial affairs is blunter: false statements or concealment "can result in fines up to $500,000 or imprisonment for up to 20 years, or both," citing sections 152, 1341, 1519 and 3571 of title 18.

A mistake is not a crime. It can, however, look like one to a trustee who has never met the owner, and a trustee who has "reasonable grounds for believing" a violation occurred must report it to the United States attorney under 18 U.S.C. 3057. The seven mistakes below are ordinary ones. Each has an honest way to avoid it, and none of what follows is a method for hiding anything; the point is the opposite.

1. Leaving Off the Account That Seemed Not to Matter

The dormant savings account with forty dollars in it, the PayPal balance, the deposit held by a former landlord, the second processor account opened for a promotion two years ago: each of these is property, and schedules that omit them are incomplete in exactly the way section 152(1) and, for an owner who files personally, the discharge bar in 11 U.S.C. 727(a)(4)(A) describe, which is to say incomplete in form even when nothing was meant by it. An owner who leaves them off may do so because they seemed too small to list. Smallness is not a category the forms recognize.

The statutes separate the two cases by state of mind, and a trustee infers state of mind from pattern. One omitted account, promptly corrected, is easily read as an oversight. Three omitted accounts, each discovered by the trustee rather than disclosed by the owner, read differently, and the owner's explanation arrives after the trustee has already formed a view.

The rules provide the cure. Bankruptcy Rule 1009(a) lets a debtor amend a petition, list, schedule or statement "at any time before the case is closed," with notice to the trustee and affected parties. An amendment does not erase a false oath already made, and it is not offered here as a remedy for one. It is how an honest error is corrected before anyone mistakes it for something else, and the earlier it is filed, the less there is to explain.

2. Repaying Family Without Saying So

Paying back a relative's loan is not illegal. Leaving it off Form 207, which asks at line 4 for payments within a year on debts owed to insiders and at line 30 for any value given to an insider, turns a recoverable payment into an unexplained one. List it, with the loan documents.

3. Selling Equipment Cheaply to Someone the Owner Knows

Ninety days before a filing, an owner sells a truck to a former employee for what seemed a fair price at the time and keeps no appraisal. Line 13 of Form 207 asks for every transfer outside the ordinary course within two years, "both outright transfers and transfers made as security." The sale belongs there, with the bill of sale, the payment record, and whatever the owner relied on to set the price.

Criminal exposure under section 152(7) requires a transfer made "in contemplation of" bankruptcy, or with intent to defeat the Code, "knowingly and fraudulently." An arm's-length sale that is fully disclosed is a fact the trustee can test and, if the price was low, pursue as a civil matter. The same sale left off the statement becomes a question about why.

4. Books That Were Never Kept, or Were Cleaned Up

An individual owner can lose a discharge under 11 U.S.C. 727(a)(3) for failing "to keep or preserve any recorded information ... 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." Some small companies run on a bank statement and a memory, and the statute asks whether that was justified for this business, not whether it was typical.

The more dangerous error runs the other way. An owner who rewrites ledger entries, deletes old invoices, or recategorizes owner draws in the weeks before filing, perhaps only to make the books presentable, has done in form what 18 U.S.C. 1519 describes when done with intent to obstruct: altering or falsifying a record in relation to or contemplation of a case under title 11, punishable by up to twenty years. Honest owners avoid it by leaving the history alone and correcting errors in a disclosed note prepared with counsel. Line 26 of Form 207 will name the bookkeepers anyway.

5. Depositing Receivables Into the Wrong Account After Filing

Customer payments keep arriving after the petition, and some land in accounts the owner forgot to redirect. Section 549 lets a trustee avoid unauthorized postpetition transfers of estate property, and U.S. Trustee operating guidelines, such as those for Region 21, require a chapter 11 debtor to close prepetition accounts and open debtor-in-possession accounts. An owner who routes a customer check through a personal account, even to cover payroll, may have moved estate property without authority.

The explanation may be innocent.

The record will show only the deposit, and the honest course is to report the misdirected payment to counsel and the trustee the day it is noticed.

6. Answering Questions at the Meeting of Creditors From Memory

The debtor's representative is examined under oath at the section 341 meeting, and the answers are compared with schedules that were signed under penalty of perjury weeks earlier. An owner who guesses at a date or a balance, and guesses differently from the schedules, has created two sworn versions of the same fact (a problem section 152(2) addresses when the difference was knowing and fraudulent, and one that invites follow-up even when it was not). Bring the documents. "I do not know, and I will find out" is a lawful answer.

7. Forgetting the Advisers Paid Before Filing

Line 11 of Form 207 asks for payments within one year to anyone "that the debtor consulted about debt consolidation or restructuring, seeking bankruptcy relief, or filing a bankruptcy case," including attorneys. Fees paid to a debt settlement company, a turnaround consultant, or a lawyer consulted about options all belong there, and a missing entry invites the question of what else was paid that did not appear. There is an argument that a small consulting fee is not worth listing, though the form does not recognize it.

That includes Delancey Street. It is a business debt settlement company, not a law firm, and it does not file bankruptcy cases or give legal advice; it offers a free, confidential review of merchant cash advance and other business debt and negotiates settlements outside court, which some owners pursue before deciding whether a filing is necessary. An owner who later files should list any fees paid to Delancey Street exactly as the form asks, and an owner already facing a trustee's questions needs bankruptcy counsel rather than a settlement company.

The forms are long because the Code treats disclosure as the price of the discharge. A trustee cannot read intent. A trustee can read what was left out.