What is Bankruptcy Fraud?

Bankruptcies are increasing in the U.S., which means financial dishonesty is also on the rise.

The legal term is “fraud,” which is an all-purpose word for lying, cheating, or other behavior your mother would be ashamed of.

With bankruptcy, fraud can take many forms. Whether it’s hiding assets or selling your BMW to a buddy for $50, the bottom line is you are trying to deceive the bankruptcy court and not own up to legal obligations.

The FBI estimates about 10% of bankruptcy filings involve fraud and the consequences can be severe. It’s a criminal offense, punishable by up to five years in prison and/or a $250,000 fine.

If the fraudulent act is unintentional, it’s not considered a crime. Because bankruptcy proceedings can be complicated, honest mistakes are common.

Here’s what you need to know about the process, and how to stay out of trouble. Just remember what your mother probably told you: Honesty is the best policy. Especially when you’re in court.

Chapter 7 and Chapter 13 Bankruptcy Fraud

Personal and business bankruptcy filings totaled 504,112 in the 2024 fiscal year, an increase of 16.2% over 2023. If the FBI estimate is right, that means about 50,000 cases weren’t on the up-and-up.

The vast majority of bankruptcy filings are Chapter 7 or Chapter 13.  (In case you’re wondering, bankruptcies are called “chapters” because they are named after chapters in the U.S. Bankruptcy Code).

In Chapter 7, your property is sold by a court-appointed trustee, who uses the proceeds to pay off your creditors. Necessities like clothing, appliances, and automobiles (up to a certain value) are exempt, so you won’t be left naked on the street.

But most non-essential items will be sold – assuming they are properly listed.

In Chapter 13, you keep your property but the bankruptcy court puts you on a strict repayment plan. A trustee oversees the process, which usually takes 3-5 years to complete.

In both cases, you must list all your assets. This is where fraud can set in.

Common Types of Bankruptcy Fraud

There are plenty of ways to commit fraud, but they all boil down to trying to pay the creditor less than you are legally obligated to pay. Here are some of the primary ways that are done.

• Money laundering. You transfer money to an acquaintance or give them your property with the intention of getting it back after bankruptcy.
• Multiple filings. You take on debt and travel to separate states filing for bankruptcy in each of them.
• You lie about your income, assets, or other material facts.
• Credit card bust out. You run up bills on several credit cards with no intention of paying. Then you file for bankruptcy and don’t properly list all the assets you’ve acquired.
• Concealing assets. You hide bank accounts, fail to list all your property or downplay how much your assets are worth. In one famous case, prosecutors accused retired baseball star Lenny Dykstra of selling jerseys and other memorabilia for $15,000 and concealing it from the bankruptcy court.

Most bankruptcy filers don’t have game-worn Major League jerseys to surreptitiously sell. But the consequences can be the same.

Dykstra was sentenced to 6-½ months in prison, 500 hours of community service, and had to pay $200,000 in restitution.

Avoiding Common Mistakes

The fraud listed above is intentional, but unintentional mistakes are common. There are a few things you can do to minimize the chances you’ll accidentally become a fraudster.

• Be totally transparent. List all your income, assets, and transactions like property sales and donations.
• Watch the calendar. The bankruptcy process has a variety of deadlines. Don’t blow them.
• Properly fill out the forms. From the original petition to listing assets, there are a variety of forms you have to fill out. Follow the instructions as if your financial life depended on it, which it does.
• Hire a bankruptcy attorney. The best choice for avoiding trouble. A lawyer can handle all the ins, outs, deadlines, and requirements that come with filing bankruptcy. It typically costs $1,000-$3,000 for a Chapter 7 filing. It’s money well spent if you want to make sure it’s done right.

Fraud Before Filing for Bankruptcy

Have you ever exaggerated your income when applying for a credit card? That would be a case (albeit relatively minor) of committing fraud before even filing for bankruptcy. Here are other examples that could come back to bite you.

• Buying an item on credit with no intention of paying for it. The idea is to inflate your debt just before filing for bankruptcy in hopes it will get discharged.
• Opening a new bank account and transferring funds to conceal the money.
• Making large cash withdrawals, so they won’t be listed as assets.
• Falsifying information when applying for a loan or credit card.
• Writing a check while knowing you don’t have the funds to cover it.

Fraud During Filing for Bankruptcy

Once the bankruptcy wheels start turning, the temptation to fudge can heighten. Among the forms they take:

• Lying about the value of your property. If you have a Rolex, don’t list it as a “$35 watch.”
• Concealing property. Dykstra, for instance, was accused of hiding, selling, or destroying at least $200,000 worth of items.
• Destroying documents. If you have a certificate of authenticity for your $225 Lenny Dykstra rookie baseball card, don’t stuff it in the shredder as the trustee knocks on your front door.
• Paying someone to hide your assets from the bankruptcy court.
• Attempting to bribe the bankruptcy trustee.

Civil Bankruptcy Fraud vs. Criminal Bankruptcy Fraud

Actions have consequences. When it comes to bankruptcy fraud, the consequences are usually civil or criminal charges. Neither one is good.

Civil Bankruptcy Fraud

Civil bankruptcy fraud is when one creditor accuses you of wrongdoing. You won’t be sent to jail if it’s proven, but there will be consequences.

The court could deny your discharge of debt and make you pay all your overdue bills. It could throw out your entire bankruptcy filing. It could ban you from filing for several years.

Criminal Bankruptcy Fraud

Criminal bankruptcy usually involves multiple creditors and instances of fraud. Bankruptcy courts are under federal jurisdiction, so your case could become an FBI file if you:

• Transfer money or items to family or friends to avoid listing the assets.
• Omit or misrepresent assets on your disclosure form.
• File any other false or misleading information.
• Exchange assets for less than their market value.
• Destroy or hide records.
• Try to bribe a trustee or other bankruptcy official.

Speak to an Expert Before Filing for Bankruptcy

When it comes to bankruptcy, the best results are having your debts discharged or getting time to pay them back and get a fresh financial start.

The worst is you commit fraud, lose your property, and end up sharing a jail cell with a lonely drug kingpin.

You obviously want the former. A good way to make that happen is to get all the advice possible on bankruptcy. Your first stop could be a nonprofit credit counseling agency, which could provide pre-bankruptcy counseling, so you are sure there is no other way out. The counseling is required within 180 days of filing bankruptcy.

That is what a bankruptcy lawyer would tell you and hiring one could be the best decision you make. There are so many subtleties, demands, and deadlines involved with bankruptcy that make it almost mandatory that you consult with an experienced lawyer.

With proper guidance and the proper approach, you won’t end up like Dykstra.

“I don’t think I’m a bad person,” he said as he was being led off to jail. “I made some bad decisions.”

If you do the same, bankruptcy could cost you a lot more than you ever imagined.