How To Become a Really Bad Bankruptcy Client And Maybe Even Get Prosecuted

Follow the Rules or You Might Become a Bad Bankruptcy Client

What makes a bad bankruptcy client? Failure to follow the rules.

The Bankruptcy Code requires a multitude of things from debtors. One of those things is full disclosure of all assets, liabilities, and other details regarding the debtor’s financial circumstances. A failure to satisfy the full disclosure requirement creates problems of major proportions for the debtor. Such issues can include a loss of bankruptcy discharge and even criminal penalties for bankruptcy fraud.

So, failing to provide adequate and complete information to their attorney is a primary way that a debtor becomes a bad bankruptcy client.

Mistakes Happen, but Bad Bankruptcy Clients Make More

In my experience, most errors in full disclosure are accidental. And this is to be expected, to some degree. After all, most bankruptcy disclosure documents are prepared under difficult time pressures and require a large amount of information.

“Oops, I forgot to mention the [fill in the blank] asset and the [fill in the blank] creditor” is a common refrain that every bankruptcy attorney hates to hear.

These are the documents that every bankruptcy debtor should provide to their attorney:

• Tax returns for the past 3 years
• All promissory notes and security agreement documents
• The latest statement from each credit card company and all unpaid invoices from each vendor
• List of all assets in a place of business or residence, prepared in a recent walk-through
• All certificates of title to personal property and deeds to all real estate
• All financial statements (including those provided to lenders) prepared over the past three years, all bank statements and checks for the past year

A Bad Bankruptcy Client is “Too Clever By Half “

The “too clever by half” type is a know-it-all who believes they have a clever strategy and then fudges on information provided to the attorney to advance that strategy.

An example is a rancher who has, for many years, been exaggerating the number of cattle on hand in financial statements to the bank. Now, at bankruptcy filing, when the true number of cattle must be told, the rancher tells the attorney that a bunch of cattle wandered off and were stolen or swept away during the recent flooding.

If that’s not the truth, then the attorney is in a terrible spot. The attorney cannot evaluate the true circumstances, which means the attorney cannot develop a legitimate strategy for dealing with the cattle numbers problem and protecting the debtor in bankruptcy.

This is a recipe for disaster. The too clever by half debtor is a terrible bankruptcy client.

Bankruptcy Clients Engaging in Criminal Activity

Occasionally, debtors have engaged in criminal activity and fail to disclose that fact to their bankruptcy attorney. So, the bankruptcy attorney unknowingly enables that debtor to compound the problem by swearing falsehoods to cover up the original crime.

For example, a potential bankruptcy debtor is a hog farmer. The farmer provides information to the bankruptcy attorney on the number of hogs on hand. The attorney has a basic understanding of a farrow-to-finish hog operation (i.e., owning the breeding hogs and raising their progeny to market weight). With three months, three weeks, and three days gestation period, and a standard period of time from birth to market weight, a farrow-to-finish hog operation should have a predictable number of hogs on hand at any given time.

However, the number of hogs provided to the attorney does not make sense. The attorney asks the hog farmer to count the hogs again and provide updated numbers. When the new numbers don’t make sense either, the attorney goes back and forth with the farmer on the explanations being provided, but nothing makes sense.

Finally, the hog farmer’s accounting professional gets involved and insists to the attorney that the information being provided “is correct!” So, the attorney makes a huge mistake by allowing the hog farmer to sign bankruptcy documents under oath with those numbers and then filing those documents. Then, at the first meeting of creditors, the hog farmer testifies to the accuracy of those numbers.

It doesn’t take long thereafter for creditors to produce trucking receipts and invoices showing the hog farmer had taken hogs to a neighboring state where the creditors’ liens did not appear, sold them, and developed a strategy to address the problem. But the hog farmer kept the attorney in the dark.

And the farmer ended up in federal prison — not because of the hog sales, but because of bankruptcy fraud.

Fraudulent Transfers from a Bankruptcy Client

Another way to become a bad bankruptcy client is by making a fraudulent transfer before seeking advice from a bankruptcy attorney.

A potential bankruptcy debtor walks into the attorney’s office, looking to file bankruptcy. The attorney asks for information on assets, and the debtor provides a lengthy list. The list does not include a residence, so the attorney asks, “Do you rent or own your home?”

“Neither,” is the reply. The explanation is that the debtor transferred the house to a spouse a year ago. “For love and affection and care in my old age” is the answer to an inquiry on payment received for that transfer.

“This is a problem,” says the attorney. After some investigation, the attorney adds: “Your spouse already owned half of the house, and your share of the equity isn’t much more than the amount of your homestead exemption. You didn’t need to do that to keep your house.”

Then, the attorney adds, “But now, everyone will assume that the value of the house is much greater and that your intent was to hide substantial value from your creditors.” So, the attorney must figure out a strategy for minimizing the negative impact of that transfer. That’s being a bad bankruptcy client.

Bankruptcy Clients Making Preference Payments to Insiders

There is a nasty downside to a bankruptcy filing. It’s called “insider preferences.”

Here’s what that means: if a debtor makes a payment to a family member or other insider on a pre-existing debt within one year before the bankruptcy filing, that payment can be clawed back into the bankruptcy estate. Defenses may exist, but a clawback is a real risk.

So, a debtor needs to do an insider preference analysis before filing for bankruptcy. That means looking back over the prior year to see if any payments or other transfers of any type were made to insiders on pre-existing debt. If any such payments were made, those need to be disclosed to the attorney so the attorney can plan for and adapt strategies and tactics to deal with that issue.

It’s not that an insider preference is “wrong” in any moral or ethical sense. It’s merely a practical issue that needs to be addressed before bankruptcy is filed.

So, a failure to do an insider preference analysis before filing bankruptcy is one more way to be a bad bankruptcy client.

Be a Good Bankruptcy Client!

Being or becoming a bad bankruptcy client usually has something to do with failing to provide adequate information to the attorney. That prevents the attorney from providing full and effective representation to and for the benefit of the bankruptcy debtor. And criminal prosecution is an extreme result that could follow.

Avoiding such failings, and being a good bankruptcy client, is something every bankruptcy debtor should strive to do.

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We think you’ll also like:

• Personal Chapter 7 Bankruptcy Petition, Are Single-Member LLC Assets Safe from the Trustee?
• Fraudulent Transfer Remedies: How Much is Enough?
• Opening the Kimono: Operational and Financial Reporting Obligations at the Outset of a Chapter 11 Case
• Chapter 11 Reporting Requirements: How Debtors Must Stay Transparent

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can watch at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Help, My Business Is in Trouble
2. Anatomy of a Fraudulent Transfer

This is an updated version of an article originally published on December 20, 2019.]

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