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How Can the Department of Justice Better Combat Bankruptcy Crimes

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A foul wind is blowing in the world of bankruptcy. As bankruptcy filings in the United States exceed one million for a record third straight year, special interest groups, some members of Congress and even a significant portion of the American public are clamoring for reform of the bankruptcy system.

Those who seek changes in the bankruptcy system frequently argue either that debtors are, prior to filing bankruptcy, intentionally running up large credit charges with no intent to pay them, or that persons who can afford to repay some or all of their debts are abusing the system. While this second claim is largely related to the argument that the bankruptcy laws should be written to establish specific monetary thresholds that persons must meet in order to remain in chapter 7, it also suggests that the bankruptcy system is rife with fraud, and that such crimes are underprosecuted.

Federal law does not, however, need to be rewritten to address the problem of bankruptcy fraud. Sections 152 and 157 of the U.S. Criminal Code and other federal statutes provide a powerful arsenal for federal prosecutors to wield in the Department of Justice's stated goal of waging war on those who attempt to cheat the bankruptcy system. Although weapons adequate to accomplish this task may exist, the public perception may remain that the Department of Justice is not doing enough to address the problem. The few government facts, figures and statistics available on the subject of bankruptcy fraud support the claim that this crime is a major problem that needs greater attention.

For years, the Department of Justice has suggested to the public (based on a source the author has been unable to identify) that fraud is committed in 10 percent of all civil bankruptcy cases. Based on this percentage, more than 300,000 bankruptcy crimes were committed in the United States in the last three years alone. In a busy year, the department may prosecute several hundred bankruptcy fraud cases. Are hundreds of thousands of crimes being ignored, and if so, why?

If the underprosecution phenomena really exists, one likely reason for it may be because bankruptcy frauds are not reported in a timely fashion to the proper authorities.

Consider the case of the most prevalent bankruptcy crime: the debtor's intentional undervaluing of assets. The vast majority of debtors use low figures to value their property in an effort to retain the property rather than having to use it to pay creditors. While using the low end of a valid market value is permissible, simply making up a number, e.g., using a liquidation value in a reorganization case, may be characterized as an intentional act of deception. A review of the civil bankruptcy case law reveals that creditors often succeed in using evidence of such misrepresentations to prevent unscrupulous chapter 7 debtors from obtaining a discharge. And yet, a review of criminal bankruptcy fraud case law turns up only one published decision involving the prosecution of a debtor who intentionally undervalued assets. Why?

Could it be that creditors are content to avail themselves of their civil remedies under the Bankruptcy Code, and thus see no need to report the debtor's misdeeds to the local U.S. Attorney or the FBI? If so, creditors are sending the wrong message to debtors and debtors' counsel. A few convictions for intentionally undervaluing assets or income would undoubtedly put debtors' attorneys on notice that they—and their clients—run the risk of jail time if they try to abuse creditors in this manner.

Another reason for a relatively low number of bankruptcy fraud prosecutions might be that federal prosecutors shy away from such cases due to the low dollar values involved, and/or because they consider bankruptcy fraud too complex an area to delve into, given their available resources. The answer to the question of what the Department of Justice can do to better safeguard the bankruptcy system and meet its goal of vigorously prosecuting those who commit bankruptcy crimes is not contained in this column. As the former law clerk to a federal bankruptcy judge, a federal prosecutor, a bankruptcy practitioner and a professor of advanced bankruptcy practice, the author is interested in whether an underprosecution problem exists, and what can realistically be done about it.

For a future column addressing this topic, the author invites judges, debtors' and creditors' counsel and their clients, U.S. Trustees and their staffs, prosecutors, investigators and defense counsel to assist in identifying the scope of, and solutions for, addressing these issues. How many bankruptcy frauds are really out there? Are some bankruptcy crimes ignored, and why? What can the Department of Justice do to better combat bankruptcy crimes? Please send your comments to:

Craig Peyton Gaumer
P.O. Box 5073
Sioux Falls, SD 57117-5073

Although this "survey" is not sanctioned by the Department of Justice or the U.S. Attorney's Office for the District of South Dakota, the author will forward copies of all responses to the Executive Office of U.S. Attorney's Bankruptcy Fraud Working Group.

The Department of Justice cannot fix the bankruptcy system alone. To quote the Army, "Uncle Sam wants you!" Please write.

Journal Date: 
Monday, February 1, 1999

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