When the Bankruptcy Trustee Suspects Fraud

Here's how bankruptcy trustees investigate fraud, and what they'll do if they find it.

By Patricia Dzikowski, Attorney

Bankruptcy trustees take fraud very seriously. If the bankruptcy trustee suspects fraud, what the trustee will do depends on: the specific facts of case, who is suspected of fraud, and the type of fraud being committed.

Rule 2004 Examinations

If the trustee suspects fraud but does not have sufficient evidence to bring the matter before the court, the trustee can compel testimony and document production from just about anyone, anywhere, through a Bankruptcy Rule 2004 examination. The scope of the examination allowed is broad enough to include any action that could be considered fraud in a bankruptcy case.

Bankruptcy Rule 2004 authorizes the bankruptcy trustee to examine:

• the acts, conduct, property, liabilities or financial condition of the debtor

• any matter which may affect the administration of the bankruptcy estate, or

• any matter which may affect the debtor's right to a discharge

Adversary Proceedings

Once the trustee has gathered enough evidence to support a case, the trustee can file a lawsuit against the appropriate party. Under most circumstances, the trustee will file the lawsuit in the bankruptcy court -- this is called an adversary proceeding.

Comparison to lawsuits generally. Adversary proceedings are similar to lawsuits filed in other courts but proceed to trial much more quickly. The trustee can serve the initial pleadings -- the summons and complaint -- by first class mail. This eliminates the need to chase down someone who is avoiding service. The trustee can sue anyone in an adversary proceeding, not just debtors and creditors.

Adversary Proceedings

Once the trustee has gathered enough evidence to support a case, the trustee can file a lawsuit against the appropriate party. Under most circumstances, the trustee will file the lawsuit in the bankruptcy court -- this is called an adversary proceeding.

Comparison to lawsuits generally. Adversary proceedings are similar to lawsuits filed in other courts but proceed to trial much more quickly. The trustee can serve the initial pleadings -- the summons and complaint -- by first class mail. This eliminates the need to chase down someone who is avoiding service. The trustee can sue anyone in an adversary proceeding, not just debtors and creditors.

How adversary proceedings are used in fraud cases. When the trustee finds fraud, adversary proceedings can be used to:

• set aside fraudulent transfers (transfers for less than full value) and recover the property from the person or entity who received the transfer (learn more about prebankruptcy transfers of property)

• obtain turnover of hidden or undisclosed property from whoever is in possession of the property

• object to or revoke the discharge of a bankruptcy debtor who has hidden assets or attempted to transfer assets out of the reach of the trustee

• recover property from employees or officers who have wrongfully taken assets of businesses in bankruptcy

• recover property that has been wrongfully seized by creditors

• determine the validity, priority, and extent (amount) of liens fraudulently placed on bankruptcy assets, and

• recover money from people who have used their bankrupt business to operate a ponzi scheme