U.S. Attorneys' Bulletin Vol 47 No 04, Bankruptcy Fraud · Investigating bankruptcy fraud often...

USABulletinAugust 1999

BANKRUPTCY FRAUD

In This Issue

Interview with James K. RobinsonThe Attorney General's Systemic Weakness Reporting ProgramsInterview with Jerry Patchan and Kevyn Orr, EOUSTDeveloping a Successful Bankruptcy Fraud ProgramSuggestions for Proving IntentFlight and Fugitive IssuesA Bankruptcy Fraud Concealment CaseTracking Down a Trailer BustoutEnvironmental Issues in Bankruptcy CasesBankruptcy Foreclosure ScamsCivil Remedies for Bankruptcy FraudCivil and Criminal ContemptAdvice of Counsel DefenseSentencing Bankruptcy CrimesThe Criminal Side of Sears

Letter from the EditorWe are pleased to present an issue of the United States Attorneys Bulletin that addresses

the problem of bankruptcy fraud. Investigating bankruptcy fraud often leads to the discovery ofother white collar fraud cases, and many of the articles contained in this issue are instructive onbroader criminal matters such as proving intent, defeating the advice of counsel defense, and theuse of flight evidence. Our thanks go to all of the contributing authors who have graciouslydonated their time to produce the informative articles in this issue.

In this issue you will also meet James Robinson, our Criminal Division Assistant AttorneyGeneral. Mr. Robinson is a former United States Attorney and has had a distinguished career asboth a litigator and legal scholar. He brings great talent, energy, and vision to the CriminalDivision, and he is anxious to have a continuing dialogue with the prosecutors in the UnitedStates Attorneys' offices.

We feature a second interview with Jerry Patchan and Kevyn Orr, Director and DeputyDirector of the Executive Office for United States Trustees. This interview introduces us to theU.S. Trustee Program and provides information that is helpful to making bankruptcy fraudinvestigations and prosecutions more streamlined.

Finally, we wish to thank Jennifer Bolen, our managing editor, for her fine work on theBulletin and on other publications during her two-year detail with OLE. She has accepted aposition with the United States Attorney's Office in the Eastern District of Tennessee. We wishher continued success in her new position.

Please keep your comments and suggestions coming. Call me anytime at (340) 773-3920,or email avic01(dnissman).

David Marshall Nissman

Published by theExecutive Office for United States Attorneys

Washington, DCDonna A. Bucella, Director

United States Attorneys’ Bulletin Staff, (803) 544-5100David Marshall Nissman, Editor in Chief

Jennifer E. Bolen, Managing Editor

Send distribution address and quantity corrections to:Nancy Bowman, National Advocacy Center, 1620 Pendleton Street,

Columbia, SC 29201-3836(803) 544-5158 or fax (803) 544-5110

ContentsFEATURED ARTICLES

1 Interview with Assistant Attorney General James K. Robinson, CriminalDivision

6 The Attorney General's Systemic Weakness Reporting Programs10 Interview with Director Jerry Patchan and Deputy Director Kevyn Orr,

Executive Office for U.S. Trustees16 National Bankruptcy Training Institute Opens at the National Advocacy Center18 Tips for Developing a Successful Bankruptcy Fraud Program23 Bankruptcy Crimes: Suggestions for Proving Intent29 Flight and Fugitive Issues in Bankruptcy Fraud Cases34 Many Hands Make Light Work-A Bankruptcy Fraud Concealment Case36 Tracking Down a Trailer Bustout39 Environmental Problems in Bankruptcy Cases45 For $800 and the Deed to Your Home--Bankruptcy Foreclosure Scams

Target Distressed Home Owners50 Civil Remedies for Bankruptcy Fraud55 Civil and Criminal Contempt in Bankruptcy Court59 Prosecuting Bankruptcy Fraud: Meeting the Advice of Counsel Defense65 Sentencing Bankruptcy Fraud69 The Criminal Side of Sears

Columns

73 UNITED STATES ATTORNEYS' OFFICES/EXECUTIVE OFFICE FORUNITED STATES ATTORNEYSResignations/AppointmentsAGAC Subcommittee RestructuringOffice of Legal Education

James K. Robinson

Interview with Assistant AttorneyGeneral James K. Robinson, Criminal Division

James K. Robinson (JR) was appointed AssistantAttorney General of the Criminal Division in 1998.He brings an impressive level of experience to thisposition. In 1977, he became the United StatesAttorney for the Eastern District of Michigan.Since then, he has been a private practitioner,president of the Michigan Bar, a law schoolprofessor, and the Dean of Wayne State UniversityLaw School. He is a published author and experton evidence law. In 1993, Chief Justice Rehnquistappointed him to the Advisory Committee on Rulesof Evidence of the Judicial Conference of theUnited States. On October 14, 1998, he shared hisviews of the Department, then and now, withDavid M. Nissman (DN), Editor in Chief, UnitedStates Attorneys’ Bulletin.

DN: When you became the United States Attorneyin Michigan in 1977, what was your view of theCriminal Division?

JR: My sense then was that the Criminal Divisionprovided a resource for United States Attorneys’offices in matters that were beyond the normalcourse of activities in those offices. The Criminal

Division provided expertise on tough issues thatcame up only from time to time from a staff ofpeople with a national view of criminal justiceissues. There were requirements to get approvalson RICO prosecutions and a variety of other thingswhich were, and are, designed to deal withsensitive, developing areas in the law. RICO was agood example of a statute that needed to becarefully shepherded to protect and develop thejurisprudence in a way that would be mostadvantageous to the Justice Department.

DN: What is your perspective today from the otherside, as Assistant Attorney General of the CriminalDivision?

JR: The dynamics between United StatesAttorneys’ offices and the Criminal Division havealways been quite interesting, and create a healthytension. There is a sense that some things change,and some things never change. Years ago, the viewwas that there was too much of an obligation toseek and secure approvals from Main Justice onmatters that ought to be within the prerogative ofthe United States Attorney. Today, my sense is thatsome people in Main Justice feel that too muchauthority has been shifted to theUnited States Attorneys. Yet, if you ask United States Attorneys, you find that many stillfeel as they did years ago, that there is too great anobligation to report or secure concurrence fromMain Justice. I have a little different perspectivetoday than I might have had 20 years ago, and thatis understandable. I believe that at the end of theday most United States Attorneys will recognizethat there are particularly sensitive issues wherethe Department should coordinate, particularly ondifficult public relations issues, with Congressionalinitiatives like the 28 U.S.C. § 530B legislation,and with other oversight efforts. The Departmentmust have the ability to bring some sense of overallnational consistency and fairness to theenforcement of federal criminal law. This

AUGUST 1999 UNITED STATES ATTORNEYS’ BULLETIN 5

relationship between Main Justice and UnitedStates Attorneys will be a work in progressforever. It was true 20 years ago, and it is truetoday. There should continue to be a healthy,dynamic aspect to it. United States Attorneys areappointed by the President and confirmed by theSenate. They are the chief law enforcement officersin their Districts. It is appropriate that they viewtheir responsibilities from a District perspective,and yet each recognizes that the Department needsto have the bigger picture in mind in setting policy.The role of the Criminal Division with regard tothe enforcement of federal criminal law andcooperative arrangements with international, stateand local law enforcement, is to provide thatnational, and increasingly international,perspective.

DN: What is the greatest change you see in theDepartment today?

JR: I would say that the most stunningdevelopment to me in the 20 years since I becameUnited States Attorney has been the substantialincrease in the amount of international work theDepartment is doing, not just at Main Justice, butin the United States Attorneys’ offices as well. Inthe old days, we rarely dealt beyond the District,let alone the Nation’s borders. Today many of thesubjects and targets of criminal investigations areorganizations whose operations are either nationalor international in scope. There is no question inmy mind that international cases will continue toincrease as a percentage of the work at theDepartment.

DN: We also have the opportunity to assist somenew democracies in system building.

JR: Absolutely. Not only do we have theopportunity to assist new democracies as theydevelop their legal systems, but I think we have anobligation to do so. We have created two excellenttraining programs— the International CriminalInvestigative Training and Assistance Program(ICITAP) and the Office of Overseas ProsecutorialDevelopment, Assistance and Training(OPDAT)— and we have established International

Law Enforcement Academies in locations aroundthe world. At the same time, it is important for usto not be arrogant about the way we do business.We can always learn from what other people do.Other legal systems around the world manage toget along quite nicely using approaches differentfrom ours. The civil law systems are very different,and in many ways alien to us, but they seem towork. I hope we can learn more and judge less.

DN: What should the Criminal Division provide tothe field in terms of resources?

JR: We should be a clearing house for expertise. Ifwe don’t have the expertise here, we ought to knowwhere it is in the Department, and elsewhere, sothat there will be a place where AUSAs and UnitedStates Attorneys can find expertise. One of theroles that the Criminal Division ought to beplaying is to know how to match up people’s needswith solutions to their problems. The Divisionshould be trying to identify trends in criminal lawenforcement in order to supply long range solutionsto criminal justice problems. I think those are allthings that appropriately ought to be done on acentralized basis, and I would like to think theCriminal Division can provide that sort of think-tank approach required to find the solution to theseproblems. There is a very important role for UnitedStates Attorneys to play in this area. United StatesAttorneys know better than anyone their districtsand what crimes are being committed within them.Their role is essential in identifying problems andpotential solutions, and crafting initiatives designedto solve them.

DN: Do you think the Department is too crisisoriented?

JR: Well, it is hard after putting out fires 12 hoursa day to elbow away the time to do the kind of longrange planning that really is necessary. It is achallenge, but it is part of our responsibility to tryto make the time to do those kinds of things.

DN: How much contact do you have with yourtrial lawyers and with Assistant United StatesAttorneys?

6 UNITED STATES ATTORNEYS’ BULLETIN AUGUST 1999

JR: The more contact I can have with attorneys inthe Division, with United States Attorneys andAUSAs in the field, the more effective I can be. Ihave been making an effort to visit with UnitedStates Attorneys’ offices whenever I have occasionto travel around the country. I have visited officesin Jacksonville, Nashville, Detroit, and SanFrancisco. The fact of the matter is that ever sinceI was United States Attorney, this was the one jobin the Justice Department that I was interested indoing. I enjoy the challenge and the richness of theopportunity for public service. It is every bit asexciting and rewarding as I thought it would be.This is the greatest criminal law enforcement job inthe country.

DN: What is your view of the current state ofcoordination between federal and local entities?

JR: I’ve been very pleased to see a greater concernfor coordination since I came back to theDepartment. Of course, we can all do a better job.We should try to be proactive in the identificationand solution of criminal law enforcement problemsby bringing people and resources together from alllevels of government— federal, state, and local.Sometimes there is competition between federallaw enforcement agencies, so requiring andinsisting that there be interagency cooperationbetween federal law enforcement agencies and thevarious departments of government is important.Increasingly, we see the need for the Department tointeract aggressively and carefully with ourinternational colleagues and with foreigngovernments because of the increasingglobalization of crime. People can commit crimeshere, flee across the border, come from foreigncountries to commit crimes here and leave, andeven commit crimes without entering the country.Our borders don’t mean as much as they used tomean. We have to have careful workingrelationships through Interpol, and through directone-on-one relationships with foreign investigativeand prosecutive agencies.

Increasingly, United States Attorneys andfederal law enforcement officers in the districts arereally having meaningful interactions with locallaw enforcement, police departments, county

prosecutors, and state Attorneys General. They aredeveloping joint programs to solve the uniquecrime problems that exist in each district andregion. Artificial boundaries or organizationalcharts can get in the way of solving the problem.Sometimes there are natural tendencies to protectagency turf, and we all need to overcome thoseobstacles. It is a major management challenge, butit is an important one. The Criminal Division canplay an important role as a fair and neutral brokerdealing with jurisdictional disputes between federaldistricts, United States Attorneys offices, and lawenforcement agencies.

DN: How important was it to you to fill the openpositions in the Criminal Division?

JR: I view the responsibility to identify and fillthose positions with the best people to be amongthe most significant contributions one could make.The way to mold the future of the CriminalDivision is through selecting outstanding lawyersto fill those offices. When I became Dean of thelaw school, I had a similar opportunity to hire athird of the faculty in five years. You can make abig difference to an institution if you choosewisely, and I believe I have done so. I have chosenseveral highly qualified attorneys from UnitedStates Attorneys’ offices and from within theDivision to fill critical positions. All of the keypositions are now full and, in the short time wehave been working together, I believe we havebecome a highly effective team.

DN: What qualities do you look for in the peoplethat you are now hiring?

JR: Among the most important qualities I look forare a sense of fundamental fairness, a totalcommitment to public service, and a clearlydemonstrated technical competency as a triallawyer or an appellate lawyer. There must be areal commitment to the mission of the CriminalDivision, and to the criminal law mission of theJustice Department. Applicants need to have afundamental sense that the role of a prosecutor isunique in our criminal justice system. There is amajor quasi-judicial responsibility in the exercise


of prosecutorial discretion. Opening aninvestigation has enormous consequences to targetsand subjects, some of whom may turn out not to beguilty of any crime. We must handle ourselveswith great care and sensitivity to the awesomeresponsibilities that prosecutors have. We are notthere to put notches on a gun. Our role is toadminister justice in an even-handed, vigorous,forceful, but ultimately fair, way. I felt that waywhen I was United States Attorney, and I feel thatway today.

DN: What makes a good prosecutor?

JR: In my view, what distinguishes the greatprosecutors from people who are just committed togetting a result is a sense of fundamental fairness,a sense that you are doing the people’s business ina way that would make everybody proud that theirgovernment is doing these kinds of things. Thatmeans that we need to be extraordinarily sensitiveto the powerful weapons we are using when weauthorize search warrants, conduct court-sanctioned electronic surveillance, make arrests,and when we make charging, plea, and appellatedecisions. We must always keep in mind that wehave a quasi-judicial responsibility to makedecisions, most of which are virtuallyunreviewable. We should make decisions thatallow us to sleep well at night. The great thingabout the job of the federal prosecutor is you cando the right thing and feel comfortable aboutmaking tough calls. Give people a fair shot, hearthem out, and keep in mind that everyone is entitledto have a vigorous, careful, and honest defense in acriminal case. So long as defense attorneys arecutting the corners square, we should respect theircritical role in the criminal justice system.

DN: What are some of your other goals and areasof interest in the Criminal Division? JR: I would like to spend some of my energytrying to increase our emphasis on white collarcrime, including the emerging problem of Internetrelated crime. I’d also like to concentrate on thetraditional mainstays of the Department, such asfighting major narcotics trafficking, public

corruption, and organized crime. It is essential thatthe Department positions itself to react vigorouslyand effectively to the national security threat ofinternational organized crime. We must not wait toorganize ourselves effectively until we have aproblem that is too big to handle. We are alreadyseeing some activities which lead us to believe thatwe need to be very seriously concerned aboutinternational organized crime groups penetratingour borders and creating serious problems for us,so we need to get ahead of the curve by organizingourselves to meet that challenge.

DN: Describe what you see as the Internet crimeproblem we will encounter?

JR: The Internet is a fabulous tool that we are allusing. Unfortunately, criminals are also takingadvantage of the opportunity to commit vastconsumer fraud. To name just a few examples ofonline fraud schemes we’ve already seen: auctionhouses where companies promise goods, takemoney, and intentionally refuse to deliver thepromised products; securities trading; productionof false immigration documents; financial fraudthrough the accumulation of personal financialdata of unsuspecting Internet users; and fraudulentlegal assistance. In one case, an Internet siteoffered people the opportunity for a quick divorcein the Dominican Republic without ever settingfoot on Dominican soil in violation of Dominicanlaw.

DN: Are consumers injured differently on theInternet when they are victims of fraud?

JR: They can be. For example, in the case of theDominican divorce fraud, anyone who obtains sucha “divorce” may find themselves ensnared in legalproblems at a later date when the truth comes outthat there is no valid divorce. So in this type ofcase, the injury is initially unknown and thedamage delayed.

DN: Do we have a national strategy to combatcyber fraud?


JR: We do. A few years back, the CriminalDivision recognized the need for a core group ofexperienced attorneys available to work on thesecases. So, the Division created the ComputerCrime and Intellectual Property Section (CCIPS).CCIPS lawyers are on the cutting edge of high-techissues, and they work with a number of differentagencies to combat computer crime. The effortagainst cyber fraud is proceeding on many fronts,and it has recently received attention from thehighest levels of our government. In fact, we arecurrently working on an Internet fraud initiative.

DN: What kinds of things have you started to doon the international front?

JR: I’ve met with Andres Pastrana, the newPresident of Colombia. We have major issues withColombia involving narcotics trafficking. I’ve metViktor Orban, the new Prime Minister of Hungary,and we have had discussions about organizedcrime in Hungary and in Eastern Europe. I havemet with the Attorney General of Mexico, JorgeMadrazo, to discuss our relationship with Mexico.Increasingly, this job is an international job. Thefuture of the Criminal Division includes a majorrole in international issues because it is notpossible for any one United States Attorney tohandle the problem of international crime. We needto proceed on a coordinated basis.

DN: I am curious to know, based on your longyears of studying evidence, what evidence rule doyou think needs refining?

JR: You asked me a question to which I couldrespond forever. The short answer is that the rulesconcerning scientific evidence deserve seriousattention in light of recent legal and scientificdevelopments in this area. Another very interestingarea of evidence involves encryption. Lawenforcement will increasingly deal with encryptedcommunications as time goes on. While we havethe tools to decrypt these messages, we must beable to authenticate that information to a jurywithout disclosing the methods we use to break thecodes. Otherwise, every time we introduceencrypted evidence we will give away our

encryption secrets, allowing criminals to defeatthem in the future.

DN: What message do you have for AUSAs?

JR: The opportunity as a federal prosecutor tomake fair and even-handed judgments while doingthe people’s work, and rigorously, but fairly,enforcing federal criminal law is an extraordinaryhonor and an awesome responsibility. Federalprosecutors can hold their heads up high and feelgood every single day about their important workon behalf of the people of the United States. Whilewe all have frustrations from time to time, being afederal prosecutor is the greatest job a lawyer canhave. I look forward to the opportunity to workwith you. ò


“An Ounce of (Fraud) Prevention isWorth a Pound of Cure”: TheAttorney General’s SystemicWeakness Reporting ProgramsShelley R. SladeSenior Counsel for Health Care FraudCivil Division

Jonathan J. RuschSpecial Counsel for Fraud PreventionFraud Section, Criminal Division

Preventing fraud directed at governmentprograms, businesses, and individualsincreasingly has become a cornerstone ofthe Department’s anti-fraud programs.

The Attorney General views the prevention offraud– through public education, client riskcounseling, and other efforts–as an integral part ofour day-to-day responsibilities in combating fraud.To that end, she has made clear that our promotionof fraud prevention efforts must extend wellbeyond the deterrent effect of federal fraudprosecutions and civil enforcement actions, toinclude affirmative steps to facilitate compliancewith federal program requirements.

Key components of these efforts are theSystemic Weakness Reporting Programs that theAttorney General has established. This Article willdescribe two of these programs: the reportingprogram for health care fraud, administered by theCivil Division's Commercial Litigation Branch,and the reporting program for other types of fraud,administered by the Criminal Division’s FraudSection.

Background

There are essentially two prongs to theDepartment's fraud prevention efforts:

1) educating the public concerning fraud andabuse,^ and 2) identifying the vulnerabilities infederal statutes, regulations, procedures, andinterpretations that may contribute to fraud andabuse. The theory behind the latter effort is that theDepartment's investigators, prosecutors, andlitigators are positioned to detect weaknesses inagency programs that open them up to fraud andabuse, such as deficiencies in agency proceduresand loopholes in regulations. Indeed, opponents’defenses often bring problems with the systemsharply into focus. Sometimes the Department haslegitimate grounds to pursue a fraud casenotwithstanding the systemic weakness. On otheroccasions, the Department declines cases where itacknowledges that, for example, the government'spayment of excessive benefits was caused not bythe government contractor or beneficiary, but by

^ For example, the Department is expandingits Web site (www.usdoj.gov) to include Web pagesabout all major forms of fraud, both health care and non-health care. In addition, the Attorney General, theDeputy Attorney General, the Director of the FBI, andUnited States Attorneys around the country recentlyteamed up with the Office of Inspector General of theDepartment of Health & Human Services, the HealthCare Financing Administration, the Administration onAging, and the American Association of RetiredPersons to conduct 35 "fraud fighter rallies"nationwide. These rallies, which were attended bymore than 6,500 senior citizens, generated extensivepress coverage of ways to report fraud. Also, in thearea of health care fraud, the Department consults withthe Office of Inspector General (OIG) with regard tothe OIG's issuance of Compliance Guidance forspecific health care industries, and advisory opinionsconcerning the anti-kickback statute.


the government's own policies or ambiguities in theunderlying statutes or regulations.

The Attorney General has encouragedDepartment attorneys and investigative agents toparticipate in the systemic weakness reportingprograms. We have a duty to ensure that theshortcomings in agency programs, which createopportunities for fraud and abuse, are made knownto agency personnel who can improve theprograms.

The Systemic Weakness Reporting Process

A. Reporting Vulnerabilities in Health CarePrograms

In June 1997 the Attorney General issued aProtocol for the Reporting of SystemicVulnerabilities in Health Care Programs.(Appendix A.) This Protocol encouragesDepartment personnel to offer their opinionsregarding ways in which the rules, policies, andprocedures of federal health care programs renderthem vulnerable to fraud and abuse, and torecommend "fixes" for these problems, throughreports made to the Civil Division. The Protocolcalls for these reports to be made as soon aspossible after a problem is identified, regardless ofwhether the rule, policy, or procedure is at issue inan ongoing case.

The procedures that implement the AttorneyGeneral's Protocol are set forth in an October 1997Memorandum from Assistant Attorney GeneralFrank Hunger. (Appendix B.) These procedurescall for Department personnel to report systemicweaknesses on a form prepared by the CivilDivision that can be made available, filled out, andsubmitted electronically. (Appendix C.)^ Theform seeks the advice, opinions, andrecommendations of Department attorneys andinvestigators concerning possible legal advice toprovide client-agencies regarding systemicvulnerabilities in health care programs.

Once a health care report is submitted to theCivil Division, the Civil Division's Senior Counselfor Health Care Fraud works with the person whosubmitted the report to clarify the nature of thesystemic weakness, and to determine if it is ofnational significance. If the weakness appears to beof national significance, the Civil Division provideslegal advice to the client- agency regarding thenature of the problem and possible remedies.

Since the inception of the systemic weaknessreporting program for health care reports, twentyreports have been submitted to the CommercialLitigation Branch. Of these twenty reports, theCommercial Litigation Branch has determined thatfourteen involved issues of national significancewithin the scope of the program. (Two of therecommendations concerned matters outside thescope of the program, and four matters are stillunder consideration.) Based on these fourteenrecommendations and follow-up communications,and after additional analysis and legal research, theCommercial Litigation Branch drafted advice forthe Health Care Financing Administration, theOffice of Personnel Management and the Food &Drug Administration.

B. Reporting Vulnerabilities in All OtherPrograms

With the health care systemic weaknessreporting process as a precedent, the AttorneyGeneral’s Council on White Collar Crimerecommended that a similar systemic weaknessreporting process be established for other types offraud. On May 6, 1998, the Attorney General, in amemorandum to all Departmental components andto United States Attorneys, established the FraudPrevention Initiative. (Appendix D.) As part of thatInitiative, United States Attorneys’ Offices, FBIfield offices, and the Treasury Department havereceived copies of a form prepared by the CriminalDivision for reporting systemic weaknesses. TheInitiative’s reporting procedures call for agents andprosecutors to offer advice, opinions, andrecommendations, based on their investigations andcases, on statutes, regulations, and policies thatmay adversely affect the Department’s ability toprosecute various types of fraud.

^To obtain an electronic copy of this form,contact Shelley Slade, Senior Counsel for Health CareFraud, on e-mail, or at tel. no. 202-307-0264.


Once a systemic weakness report is submittedto the Criminal Division, the Fraud Section’sSpecial Counsel for Fraud Prevention contacts theoffice that submitted the report for any additionalinformation, contacts the agency whose statute,regulation, or policy is at issue to identify theproblem, and involves the reporting office asnecessary in subsequent discussions to explore asolution.

To ensure that it is receiving information fromall areas of the country, the Criminal Division notonly receives and processes the fraud systemicweakness reports, but actively solicits informationand ideas from federal prosecutors and agents.Since the establishment of the Initiative, theSpecial Counsel for Fraud Prevention has visitedUnited States Attorneys’ offices in a dozen citiesaround the country, and has met with supervisoryagents of the FBI, the Postal Inspection Service,and the United States Secret Service in many ofthose cities as well. Both the systemic weaknessreports and the information received in these visitshave identified several issues relating to variousforms of federal program fraud that the CriminalDivision is now exploring with the affectedagencies.

The Department regards the systemicweakness reports submitted to the Civil orCriminal Division on these reporting forms toconstitute privileged recommendations, advice, andopinions of Department personnel. Likewise, theDepartment considers the advice provided to itsclient-agencies to be confidential, attorney-clientcommunications. Encouraging Future Participation

The Department has taken steps to ensure thatthose who make significant contributions to fraudprevention will receive appropriate publicrecognition for those contributions. As part of theFraud Prevention Initiative, for example, theDepartment has established a special annual awardfor fraud prevention. This award, which is open tofederal prosecutors and agents, as well as otherDepartmental employees and even individuals ororganizations in the private sector, is intended torecognize all types of fraud prevention programsand projects.

In addition, to acknowledge the valuablecontributions of those who report systemicvulnerabilities in the health care fraud area, theAttorney General's continuing instruction is that theauthors of outstanding reports should berecognized. In early 1999, the Attorney General,the Civil Division, and the Executive Office forUnited States Attorneys recognized five attorneysfor preparing particularly outstanding systemicweakness reports during the first year of theprogram. Assistant United States AttorneysBarbara Bisno, Patricia Connelly, Suzanne Durrell,and Gail Nichols, and Trial Attorney Dan Spiro,each received letters of commendation from theAttorney General, and $500 awards. Theseattorneys prepared thoughtful recommendations forchange in the following areas: 1) certifications onclaims forms; 2) billings by home health agency subcontractors;3) regulations that implement the Prescription DrugMarketing Act; and 4) ex parte administrativeproceedings. The Civil Division may nominate additional Department attorneys and investigatorsfor monetary awards and special recognition in FY1999.

It is vital to the success of these programs thatevery Assistant United States Attorney handlingfraud cases consider whether he or she has detecteda weakness in an agency rule, policy, or procedurethat creates opportunities for fraud and abuse. Ifthe answer is yes, the attorney should comply withthe Attorney General's Protocol and the FraudPrevention Initiative by spending a few minutespreparing the appropriate systemic weaknessreport. A timely filed systemic weakness report thathighlights a significant problem may result not onlyin helping a federal agency to achieve substantialreductions in fraud losses, but also in strengtheningour ability to prosecute fraud cases moreeffectively. ò


ABOUT THE AUTHORSë Jonathan J. Rusch is Special Counsel for Fraud Prevention in the Fraud Section of the CriminalDivision of the Department of Justice. In that capacity, he oversees the Department’s Fraud PreventionInitiative. He also coordinates the Department’s Internet Fraud Initiative and chairs the interagencyTelemarketing and Internet Fraud Working Group. a

ë Shelley Slade is Senior Counsel for Health Car Fraud in the Civil Division of the Department of Justice.a

If you are interested in the appendices mentioned in this article, contact Shelley Slade or Jonathan Rusch.


Jerry Patchan, DirectorExecutive Office for U.S. Trustees

Kevyn Orr, Deputy DirectorExecutive Office for U.S. Trustees

Interview with Jerry Patchan,Director, and Kevyn Orr, DeputyDirector, Executive Office for UnitedStates Trustees

Jerry Patchan is the Director of theExecutive Office for United StatesTrustees (EOUST), and has held thatposition since 1994. Prior to that, he was

the Deputy General Counsel for the ResolutionTrust Corporation from 1991 to 1994, and apartner in the law firm of Baker & Hostetler from1975 to 1991. He served as a bankruptcy judge forthe Northern District of Ohio from 1969 to 1975,and was in private practice prior to thatappointment. From 1978 to 1991, he served on theJudicial Conference of the United States’ AdvisoryCommittee on Bankruptcy Rules. He obtained hisJuris Doctorate from the John Marshall School ofLaw at Cleveland State University.

Kevyn Orr was appointed DeputyDirector of the EOUST in 1995.Before joining the Department, heserved in the Resolution Trust

Corporation, and was named Assistant GeneralCounsel for Complex Litigation and Bankruptcy in1994. Prior to that, he was a partner in the Miamilaw firm of Stearns, Weaver, Miller, Weissler,Alhadeff & Sitterson, and then a litigator for theFederal Deposit Insurance Corporation. Heobtained his Juris Doctorate from the University ofMichigan Law School in 1983.


Jerry Patchan (JP) and Kevyn Orr (KO) wereinterviewed on April 9, 1999, by Jennifer Bolen(JB), Managing Editor of the United StatesAttorneys’ Bulletin.

JB: Give us an overview of the United StatesTrustee Program.

JP: The United States Trustees are concerned withprotecting the integrity of the bankruptcy process.Their responsibilities include: appointing andsupervising the private trustees who administerChapter 7, 12, and 13 cases; ensuring thatbankruptcy estates are administered promptly andefficiently, and that professional fees arereasonable; taking legal action to enforce therequirements of the Bankruptcy Code and toprevent fraud and abuse; referring cases ofsuspected bankruptcy fraud for investigation andcriminal prosecution; and, in Chapter 11 cases,performing numerous duties to ensure that casesare administered expeditiously and fairly.

EOUST provides day-to-day policy and legaldirection, coordination, and control, as well asadministrative and management support for UnitedStates Trustees’ offices around the country.

The Program was created in 1978 as a pilotproject in 10 regions encompassing 18 judicialdistricts in order to separate the judicial andadministrative functions in bankruptcy cases. TheProgram was expanded nationwide in 1986. Thisexpansion was completed by 1989. The Program isdivided into 21 regions, each headed by a UnitedStates Trustee. Basically, our territory extendsfrom Guam in the West to the Virgin Islands in theEast. However, North Carolina and Alabama areexcluded from this list because the Senate decidedto use Bankruptcy Administrators under theJudicial Branch in those locations. Consequently,EOUST has no oversight authority overbankruptcy proceedings in North Carolina orAlabama. In addition, there are 93 field offices,each managed by an Assistant United StatesTrustee. EOUST’s executive office is inWashington, D.C.

JB: What is EOUST and what are itsresponsibilities regarding the implementation of theUnited States Trustees’ Program?

JP: To some degree, EOUST is structured like theExecutive Office for United States Attorneys(EOUSA). Essentially, our role is one of oversightand, like the United States Attorneys’ offices, ourUnited States Trustees’ offices have a great amountof discretion in the handling of bankruptcy cases.For example, United States Trustees decide how tohandle the cases in their region and when and if toinitiate suit. The cases handled by the United StatesTrustees’ offices start in court, but the practice isnot uniform because courts vary quite a bit due tomany variances including local legal culture. We’vefound that the best way to respond to thesedifferences is to allow each United States Trustee’soffice to handle these matters. Sometimes thisproduces variation where there should beuniformity, but we’re working on it.

JB: How many people work on EOUST’s D.C.staff?

KO: Approximately 65 people serve on EOUST’sDC staff. In addition, nationwide, including theUnited States Trustees and their staffs, we haveapproximately 970 employees. As Director, Jerry’srole is similar to that of a Chief Executive Officer.This means that he, through directives from theAttorney General or under the bankruptcy statute,has the ultimate responsibility for the program’sactivities. His position is strategic. I am responsiblefor executing those directives and supervisingEOUST’s staff.

JP: The professionals on our staff include: lawyers,accountants, and analysts. Similar, I think, to theFinancial Litigation Units in the United StatesAttorneys’ offices. These professionals examinebankruptcy documents and testimony to determinewhether, among other things, the law is beingfollowed by all parties. We also developinformation concerning abuse of the bankruptcylaws (which would warrant civil proceedings) orfraudulent or criminal conduct. When we find fraud,


we refer these cases to the United States Attorney’soffice.

JB: Describe how the United States Trustees’offices interact with the United States Attorneys’offices?

KO: Section 586(a)(3)(F) of Title 28 requiresUnited States Trustees to refer cases to and assistUnited States Attorneys’ offices in the prosecutionof bankruptcy fraud. This relationship can beinformal or very formal, depending on therelationship between our offices.

JB: Let’s say I’m an AUSA with a bankruptcyfraud case, what kind of assistance can I expectfrom the United States Trustee’s office and how doI get that process started?

KO: First, EOUST has a National FraudCoordinator who assists AUSAs with the review ofindictments, assembly of evidence, and training onbankruptcy prosecutions. Second, the UnitedStates Trustees’ Fraud Manual is available toAUSAs. Third, our Assistant United StatesTrustees are occasionally available to serve asSpecial Assistant United States Attorneys inbankruptcy fraud task forces.

JP: The United States Trustees refer cases ofsuspected bankruptcy fraud to the United StatesAttorney. Also, United States Trustee offices actas resources to the United States Attorney in thatthey are available to assist with the investigation ofbankruptcy fraud and the preparation of the casefor trial.

JB: Who is the National Fraud Coordinator forEOUST?

KO: Sandra Rasnak, an Assistant United StatesTrustee in the Chicago office. AUSAs shouldcontact her if they desire the assistance Jerrydescribed, or if they would like to know moreabout the United States Trustees’ Fraud Manual.

JB: When the United States Trustee’s office sends areferral to the United States Attorney’s office, whatdoes the referral package consist of?

KO: In a typical case, the referral package consistsof a letter addressed to the United States Attorneyor the Fraud Coordinator which embodies a basicexplanation of who the debtor is, the factscomprising the potential federal crime(s), why theconduct falls under one of the criminal bankruptcyprovisions (18 U.S.C. §§ 151-57), and a summaryas to why the facts justify investigation andprosecution. Sometimes, the referral packageincludes forensic evidence, such as writing samples.

JP: By statute we have to refer every case that hasa criminal aspect to it. However, we attempt tohighlight those cases which have special criminalramifications.

JB: Let’s focus on training for a moment. Tell usabout EOUST’s current training program.

KO: We recently opened the National BankruptcyTraining Institute, which is housed at the NationalAdvocacy Center (NAC) in Columbia, SouthCarolina. Before that, we would conduct periodictraining in district offices throughout the country.Our Assistant United States Trustees and analystsreceive regular training. We are also willing to trainAUSAs and plan to do more cross-training ofAUSAs and FBI agents at our new training site atthe NAC. We have also recently developed tapedpresentations that we hope to use nationwide in ourbankruptcy training program. We filmed them inLos Angeles and I think they will prove helpful inthis area.

JB: Will these tapes be available to AUSAs? And,if so, how do AUSAs go about getting these tapes?

KO: Certainly, these tapes will be made availableto AUSAs. If anyone is interested in reviewing thesetapes, they should contact Maureen Tighe, who isthe United States Trustee in Los Angeles, or SandraRasnak or me.


JB: Because there are civil and criminal areas inbankruptcy cases, tell us how the United StatesTrustee Program handles the division of labor onthese cases, and what type of red flags do youremployees look for to distinguish a civil case ofbankruptcy abuse from a criminal case ofbankruptcy fraud.

JP: All of our individual bankruptcy cases haveprivate trustees assigned to review the paperwork.These private trustees are generally lawyers oraccountants who serve as members of a panel ofexperienced trustees. A private trustee’s primaryresponsibility is to take testimony from the debtorand review the debtor’s paperwork. Based on thepapers submitted by the debtor and the privatetrustee’s examination of the debtor, the privatetrustee recommends that the case be handled as anabuse of the bankruptcy law subject either to civilremedies or penalties for criminal fraud, or handledas a case in which the debtor is entitled to adischarge of debts. Most cases are preciselythis–people or companies who have really hit thewall in their financial affairs. The Programoversees this process. The private trustees willadvise us of any case which has an indication ofstatutory abuse or criminality. Sometimes, we arethe trustee if there is a conflict of interest and youcannot get a private trustee quickly or if the case isvery difficult. For example, we’ve just done amassive amount of work on a case out of theNorthwest involving the sale of cattle. The privatetrustees did not want to handle this case.

JP: We maintain a list of “red flags”— indicia of bankruptcy fraud— in our training materials.AUSAs are invited to obtain these materials fromus by contacting Sandra Rasnak. Editor’s Note: Alist of red flags is published on page 22 of thisissue.

JB: Bankruptcy crimes often involve relativelysmall amounts of loss (amounts under $5,000).Why should prosecutors devote their resources tobankruptcy fraud prosecutions?

JP: There are at least two important reasons whyprosecutors should seek to prosecute bankruptcy

fraud. First, bankruptcy fraud threatens the integrityof the entire bankruptcy system, and it threatenspublic confidence in the integrity of that system.Bankruptcy prosecutions deter individuals whomight otherwise take advantage of the bankruptcysystem’s reliance upon self-reporting of financialobligations. Second, bankruptcy fraud is oftenfound in connection with other types of fraud, suchas tax fraud, credit card fraud, bank fraud, use of afalse Social Security Number, insurance fraud, andinvestment fraud, as well as a host of differentconsumer scams that prey on financially distressedpeople. Consequently, the “small” bankruptcy fraudmay be just the tip of the iceberg. Close scrutiny ofbankruptcy documents can yield a wealth ofinformation about the other frauds.

JB: Why shouldn’t a prosecutor simply leave thesmall cases to the local and state law enforcementauthorities?

JP: The Bankruptcy Code is a federal statute, sothe local and state authorities lack jurisdiction toenforce most bankruptcy crimes. We have the dutyto police the bankruptcy system. Dollar-limitguidelines and resistance to taking small casesprovide immunity to would-be abusers of thesystem.

KO: Also, prosecution of the smaller bankruptcycases sends a deterrent message, like any otherprosecution in the community, that we’re not onlygoing after the big, multi-million dollar bankruptcycases.

JB: How can AUSAs benefit from the UnitedStates Trustee Program attorneys’ experience inbankruptcy fraud cases?

JP: AUSAs can look to program attorneys forsupport in gathering and analyzing bankruptcy documents. Program attorneys are also available toserve as expert witness and provide testimonyregarding bankruptcy crimes.

JB: I understand that the United States TrusteeProgram employs accountants. Are their services


available to AUSAs in bankruptcy fraudprosecutions?

JP: Yes. AUSAs can use program accountants todocument the bankruptcy paper trail. Specifically,these accountants are available to reconstructfinancial records to determine how the fraudoccurred. They are also available to testify asexpert witnesses and in that regard help the courtor jury understand the fraudulent financialtransactions.

JB: How would you counter the perception thatbankruptcy fraud prosecutions are too complicatedand require too much time for the amountstypically involved?

JP: Most bankruptcy crimes involve lying,cheating, and stealing. They are merely variationsof the crimes that AUSAs prosecute.

JB: How can prosecuting bankruptcy crimes helpUnited States Attorneys fight other crimes?

JP: Bankruptcy documents are supposed to lay outthe scope of the debtor’s financial affairs. Theyoften yield written evidence to use in prosecutingother white collar crimes that the perpetratorengaged in. Familiarity with the detail of financialand other information contained in bankruptcydocuments signed by the debtor is a great tool forlaw enforcement officials. United States TrusteeProgram attorneys and financial analysts canidentify and interpret this evidence for the AUSAto use in the prosecution.

JB: Tell me about the bankruptcy fraud workinggroups that have been established in manydistricts.

JP: At least 70 districts have bankruptcy fraudworking groups consisting of representatives fromvarious law enforcement agencies such as theUnited States Attorney, the United States Trustee,the Federal Bureau of Investigation, the UnitedStates Postal Service, the Social SecurityAdministration, and others. Working groups poolthe various agencies’ resources to assist in the

prosecution of bankruptcy fraud and related crimes.They hold regular meetings, provide training forworking group members and for other entities, shareinformation on suspected criminal activity, andexamine and prioritize cases for referral to theUnited States Attorney’s office.

JB: Jerry, what is your most significantaccomplishment during your tenure as Director ofthe Program?

JP: It’s awfully hard to pick one and say that theothers are less important or less significant. And, Ican’t take full credit for anything as “my majoraccomplishment.” I’ve built on things that were inplace at EOUST prior to my arrival. People herehave been working on a lot of good things for a longwhile. I would say that one very importantaccomplishment has been the development of betterrelationships with our constituents, e.g., withprivate trustees and standing trustees who handlewage-earner cases, with practitioners, with thebankruptcy bench, and with various lawenforcement entities like the United StatesAttorneys’ offices, the FBI, and the Social SecurityAdministration. A major development has been theestablishment of the National Bankruptcy TrainingInstitute, which will provide an expanded trainingprogram to help all employees reach theirprofessional potential. It takes professional trainingand talent to develop a long-term relationship andunderstanding of bankruptcy law and what we doand why we do what we do. The government’sfocus is on the integrity of the system. Thepractitioners are focused on the needs of theirclients. It takes a skillful United States Trustee andvery able Assistant United States Trustees to handlethis well over a period of time. ò


EOUST Training at the National Advocacy Center



National Bankruptcy TrainingInstitute Opens at the NationalAdvocacy Center

The National Bankruptcy TrainingInstitute opened February 9, 1999, atthe National Advocacy Center, with aceremony that brought together Justice

Department officials, bankruptcy judges, andJustice Department employees attending theInstitute’s first class session. The United StatesTrustee Program operates the Institute.

“The existence of our Bankruptcy Instituteand a permanent site for our training was one ofthe goals set when I joined the Program,” JerryPatchan, Director of the Executive Office forUnited States Trustees in Washington, D.C.,announced at the opening ceremony. “I realizedthat for the Program and its people to achieve theirfull professional potential, and be recognized forthe valuable work they do in the bankruptcysystem, we had to develop a comprehensive,systematic and effective training program.”

Senator Ernest Hollings (D-SC) sent acongratulatory message noting that South Carolinais a particularly appropriate home for the Institute:South Carolinian Charles Pinckney, a delegate tothe Constitutional Convention in 1787, proposedthe constitutional provision enabling Congress toestablish uniform laws upon the subject ofbankruptcies. “With the participation of leadingjudges, legal scholars, practitioners and privatetrustees, the Institute will not only enhance theprofessional development of the personnel of theUnited States Trustee’s Office, but will strengthenthe entire bankruptcy process,” Hollings stated inhis message.

Patchan pointed out that the NationalAdvocacy Center provides an ideal structure toplan and house the Institute’s training courses. “Itgives us access to state of the art training facilities,and puts us in a community of the most able and experienced of the Justice Department’slegal trainers,” he said.

The Institute will offer all Program employeesregular access to a range of courses to enhanceprofessional development. Just as important, it willallow the Program to maintain a permanenttraining site on the campus of the University ofSouth Carolina and to develop an experiencedcorps of instructors.

Stephen I. Goldring, who heads the Institute,hopes to make it a national center for scholarshipin bankruptcy, and a source of comprehensiveskills and management training for Programemployees. “The extremely knowledgeable staff ofthe Office of Legal Education in the ExecutiveOffice for United States Attorneys, with their yearsof experience in designing and presenting trainingseminars, will be an invaluable resource indeveloping our curriculum,” he noted. “In thefuture we will invite judges, practitioners, and legalscholars to contribute to the training programs.The Institute will offer the opportunity for theexchange of ideas not only among Programpersonnel, but also among participants in the entirebankruptcy community.”

Goldring was appointed in November 1998 asSpecial Assistant United States Trustee in chargeof training and will serve as the “Dean” of theInstitute. Previously, he served for 10 years as theAssistant United States Trustee in Pittsburgh.Before joining the Program, Goldring worked for12 years as an Assistant United States Attorney inPittsburgh, including 7 years as First AssistantUnited States Attorney. Goldring began his careerin the Department of Justice in 1974 as an attorneywith the Organized Crime and Racketeering StrikeForce. He received his law degree in 1970 from Duquesne University LawSchool in Pittsburgh.

While Goldring’s first priority is to develop atraining curriculum, he also plans to work withpersonnel from the National Advocacy Center and



the University of South Carolina to establish aprogram for distance learning and to set up alibrary of training videos. Other future projectsinclude developing a web site for the Institute andcreating print and online course catalogues.

To ensure that the Institute’s courses meetemployees’ needs, Goldring intends to regularlyseek employees’ comments on desired topics andon training techniques they have found mosteffective. He will also establish an advisory groupof Program employees to assist in coursedevelopment.

The Institute has already received kudos fromparticipants in the first training session, a four-dayadvanced course on Chapter 11. The mockcourtrooms won favorable reviews, even from theProgram financial analysts put on the stand asexpert witnesses. Participants also had high praisefor the convenient built-in electronic facilities forvideotaping and projection. The comfortablecommon areas and dining hall provided a pleasantgathering place to get acquainted with colleaguesfrom the Program and from other components ofthe Department.

Overall, the establishment of the Institute willbring many new and exciting opportunities, just asthe Program enters its second decade as apermanent part of the national bankruptcysystem. ò


Tips for Developing a SuccessfulBankruptcy Fraud ProgramMaureen A. TigheUnited States Trustee, Region 16Los Angeles, California

Every district should have a bankruptcyfraud prosecution plan. It may belimited and small if bankruptcy fraud isnot a big problem in your area, or it

may involve the creation of a large task force if thereferrals warrant it, but each district should havesome considered approach to this crime.

Bankruptcy cases are being filed in significantnumbers in every district in the country, and, givenhuman nature, not everyone filing is beingcompletely honest. Bankruptcy fraud has been apriority of Attorney General Janet Reno and,before her, Attorney General William Barr. Thegood news is that setting up an effective programis not difficult, and you will find that it helps youreconomic crime prosecutions overall.

Setting up a specific structure for abankruptcy fraud prosecution program (the“program”) will ensure that your efforts do not gounnoticed and increase the chances for continuityshould the original individuals move on to otherprojects. This article contains some ideas forstructuring a bankruptcy fraud prosecutionprogram.

Follow the Leader

Each United States Attorney’s office (USAO)should assign the responsibility to coordinate theprogram to an Assistant United States Attorney(AUSA). All agencies should be informed of theappointment. The program coordinator shouldhave a good overview of all referrals, players, andcases. Likewise, the program coordinator should seek the cooperation of all federal agenciesinvolved in bankruptcy prosecutions.

If prosecuting bankruptcy fraud is a priority, the United States Attorney (USA) can ensure that

the program coordinator’s workload is appropriate.If the program coordinator is a novice tobankruptcy law, it is important that a civilbankruptcy AUSA or an attorney from the UnitedStates Trustee’s Office (USTO) is available forconsultation.

Safety in Numbers

A task force or working group is an importantaddition to a bankruptcy fraud program. It helpscoordinate the different resources necessary for aneffective program. The essential members of abankruptcy fraud working group are the USTOand the Federal Bureau of Investigation (FBI). TheUnited States Trustee (UST) makes mostbankruptcy fraud referrals and the FBI hasprimary responsibility for the investigation. Otherkey members of the group are the Internal RevenueService and the Postal Inspection Service. Youshould also consider including the BankruptcyCourt Clerk’s office, the Inspector General for theSocial Security Administration, the Department ofLabor, and the Secret Service. Bankruptcy fraud isfound in connection with so many other violationsthat many different agencies can benefit fromlearning about various bankruptcy issues.

Regular Meetings

Holding regular meetings of the working groupis important; quarterly meetings are probablysufficient for most districts. Meeting regularlypromotes effective communication and heightensawareness. Combining the efforts of differentagencies is also beneficial. Routinely scheduledmeetings maintain the group’s focus. Finally,distribute a contact list with everyone’s name,mailing address, e-mail address, and telephone andfax numbers. This list serves as an importantnetworking tool and resource.


Get the Word Out

Issue a media release for every bankruptcyfraud prosecution to ensure the public is aware thatthe government prosecutes bankruptcy fraud. Yourlocal newspaper may report only on the larger ormore sensational cases, but the various bankruptcynewsletters are likely to cover every case. In LosAngeles, before the Bankruptcy Fraud Task Forcewas formed, there was a widespread belief that wedid not prosecute bankruptcy crimes. To counterthat perception, we made it a policy to issue amedia release in every bankruptcy fraud case.^

Judges and panel trustees want to know aboutbankruptcy fraud prosecutions and appreciate anynews you provide. Consider sending a copy of thepress release, indictment, or other update to thejudge and trustee in every case. By doing this, youwill develop a network of tipsters and experts tohelp in other cases.

Have a System

Set up a formal referral system for dealingwith complaints and referrals. In our district, wetry to have all referrals directed to the UST first.The UST can add information to the complaint orreferral before sending it to the USA, or can warnthe USA if someone is attempting to manipulatethe referral process for purposes of a civilproceeding.^^ The USA then sends each potentialcase to the FBI or other investigative agency.

A referral ranking or category system can behelpful in a district with too many referrals for theUSAO to process. For example, in Los Angeles,

we find that having three different treatments ofcomplaints helps us effectively review theextraordinary volume of referrals.

First, we receive hundreds of complaint lettersfrom private parties that state a crime but provideno supporting documentation, detail, or evidence toenable an AUSA reasonably to evaluate whether topursue the complaint. These complaints are sentdirectly to the FBI for investigation. The FBI oftendiscovers that the subject of the complaint isalready under investigation for another type ofcrime. The bankruptcy fraud complaint is thenforwarded to the investigating agent. The second category consists of complaintsthat provide solid evidence of a bankruptcy crimewarranting further investigation, but that might notbe prosecuted in all cases due to limited resources.These referrals are sent to the USA with a coverletter briefly describing the violation. The USAdecides whether to send them to an investigativeagency.

Finally, sometimes the crime is so large or soegregious that the UST engages in a significantinitial investigation and develops a substantialreferral package. The UST sends the referralpackage to the USA and, if the case is extremelysignificant, contacts the USAO’s programcoordinator.

This three-category system allows the LosAngeles office to coordinate around 300bankruptcy fraud referrals each year amongappropriate agencies. The UST does not haveinvestigatory powers or resources to develop everyreferral. Using this system, we can prioritize cases and hone our referrals to the USA.

Any referral system should also identify whowill respond to private citizens, judges, andtrustees who make referrals. Citizens, judges, andtrustees will help your efforts and often developgreat referral packages if you keep them informedand avoid letting them feel like they are sendinginformation into the proverbial black hole.

^ If you fax a copy of your media release toPublic Information Officer Jane Limprecht at theEOUST, (202) 616-4576, she will make sure it is sentto the bankruptcy law trade publications.

^^ 18 U.S.C. § 3057 requires trustees andjudges to refer bankruptcy crimes to the USA. In theUST’s view, this requirement is met if the crime isreferred to us, because we pass them all on to the USA.Judges or trustees who disagree with thisinterpretation of the statute are asked to at least copythe UST on all referrals.


Education and Training

A successful bankruptcy fraud program mustprovide regular training for every group withbankruptcy-related responsibilities. Consideroffering the following training and educationopportunities.

If you have a working group or task force,each meeting should include an educationalcomponent. For example, discuss a recentappellate decision or a lesson learned in a recentprosecution. This information will make themeeting worthwhile and increase the group’sexpertise over time. I like to distribute at least onesubstantive handout at each meeting.

In addition, a basic “what is bankruptcy fraud”program can be valuable for AUSAs and agentswho have never worked a bankruptcy fraud case.This training can be provided in one or two hoursas part of any office’s continuing educationprogram. The program can educate non-bankruptcy employees about useful tools inanalyzing economic crimes. Bankruptcy fraudoccurs with many other crimes and can be aneasier violation to prove. The UST Program isdeveloping a bankruptcy fraud training video.Contact the UST in your district to arrange acourse that includes this video.

Prosecutors and law enforcement agents canbenefit from an introduction to basic bankruptcyconcepts. These courses have been popular aroundthe country and may help prosecutors andinvestigators realize how often they encounterbankruptcy crimes, and how valuable knowing thebasics of bankruptcy is. The course is intended tohelp prosecutors and investigators deal withbankruptcy investigations and prosecutions.Contact the UST in your district about presentinga program.

On another front, consider offering a trainingprogram for your district’s Chapter 7 “panel”trustees on how to distinguish criminal from civilviolations and what kind of cases they shouldreport to the UST and USA. With the properguidance, the panel trustees can provide valuableassistance to an agent or prosecutor.

What Kinds of Cases Should You Prosecute?

There are many different philosophies andapproaches regarding bankruptcy fraudprosecutions. One common stumbling block inbankruptcy fraud prosecution has been themandatory minimum dollar loss guideline.Bankruptcy frauds come in all sizes, from the no-loss case to the multi-million dollar case. Settingan artificial loss cut-off may undermine truedeterrence and enforcement efforts.

A significant problem in the bankruptcy courtsis the high volume of small frauds that threaten toundermine the integrity of the entire bankruptcysystem. Yet taking some small fraud cases isimportant. The bankruptcy community is usuallysmall and insular, and word gets out that certaintypes of crimes are or are not prosecuted.

One technique for publicizing the prosecutionof smaller cases is to batch them and announcethem as a group. For example, a group of casesinvolving the use of a false Social Security numbercan be prosecuted together to highlight the problemof identity fraud. Similarly, you can combine smalland large concealed asset cases to highlight the need to disclose all assets inbankruptcy.

Another way to make the most of limitedresources is the “flip-flop” or “wobbler” approach.For smaller offenses, a pre-indictment offer of amisdemeanor plea can be made in exchange forforbearing to file a felony charge. Two statutesthat lend themselves to misdemeanor pleas are 18U.S.C. § 403, contempt, and 18 U.S.C. § 156,dismissal of a case for willful failure to followrules. While the determination must always bemade on a case-by-case basis, such a deal is anappropriate disposition in some circumstances.

Two for the Price of One

Look for opportunities to combine bankruptcyfraud prosecutions with other violations. A whitecollar crime investigation is not complete until theinvestigator checks whether the subject has filedfor bankruptcy. The bankruptcy schedules cannotonly produce useful information for the


investigation, but also provide evidence of non-bankruptcy crimes.

Often investment fraud and bank fraud areinterwoven with bankruptcy fraud. Storefront“paralegal” services routinely combine bankruptcyfraud with immigration and credit repair fraud.Finally, bankruptcy fraud increasingly followshealth care fraud. The additional losses, and theenhancements for bankruptcy fraud, can lead toadditional jail time when bankruptcy fraudviolations are added to existing criminal counts.

Conclusion

Most people who file for bankruptcy are notonly honest but in desperate need of the reliefbankruptcy provides. Working together, we canpreserve the system for the honest, but unfortunate,debtors and prosecute the creative white collarcriminals. ò

ABOUT THE AUTHORë Maureen Tighe served as the Deputy Chief ofthe Major Frauds Section for the Central Districtof California before becoming United StatesTrustee for Region 16 (the Los Angeles area) inApril 1998. At the USAO, she prosecuted morethan 100 bankruptcy fraud cases. Before joiningthe USAO, she worked for two years as a litigationassociate in Sullivan & Cromwell’s New Yorkoffice. She graduated from Rutgers Law School in1984. a


Bankruptcy Fraud Warning Signs

ë Concealment of assets

ë Serial bankruptcy cases

ë Failure to keep usual business records

ë Incomplete or missing books and records

ë Conduct well outside ordinary business orindustry standards and practices

ë Unusual depletion of assets shortly before thebankruptcy filing

ë Recent departure of debtor’s officers,directors, or general partners

ë Unanswered questions or incompleteinformation on debtor’s schedules and statementof financial affairs

ë Frequent amendments to schedules,statements of financial affairs, and monthlyoperating reports

ë Inconsistencies between recent financialstatements, tax returns, and debtor’s schedulesand statements of financial affairs

ë Absence of knowledgeable officers to testifyat Section 345 meeting

ë Inability to contact debtor’s principals atdebtor’s stated location

ë Frequent dealings in cash rather thanrecorded transactions

ë Sudden depletion of inventory post-petitionwithout plausible explanation

ë Inflated salaries, payments of bonuses or cashwithdrawals by officers, directors, shareholders,or other insiders

ë Transfer of property to insiders,shareholders, and relatives shortly beforebankruptcy

ë Payoff of loans to directors, officers,shareholders, relatives, or other insiders shortlybefore filing

ë Transactions with non-debtor subsidiaries,parent companies, or affiliated corporationsowned by the same or related persons or entity

ë A history of prior litigation or post-petitionlitigation involving breeches of contracts, fraud,misrepresentations, etc.

ë Complicated corporate structures andrelationships

ë Creditor confusion concerning corporatestructure

ë Fire, theft, or loss prior to or after filing

ë Failure to pay withholding and sales taxes

ë Startup of a similar business near the time ofthe bankruptcy filing

EOUST MANUAL AVAILABLE

The training manual for the Executive Office for United States Trustees is available to prosecutorsand Department attorneys. You can obtain this Manual by visiting the EOUST web site athttp:/www.usdoj.gov/UST. Once you have reached the EOUST web site, look for the manual in theFreedom of Information Act section.


Bankruptcy Crimes: Suggestions forProving IntentDean Wyman, Senior Attorney-AdvisorOffice of the United States TrusteeCleveland, Ohio

Sections 152 and 157 of Title 18 delineatecommon bankruptcy crimes. Bothsections require the government to proveintent. Under 11 U.S.C. § 152, the

government must establish that the defendant acted“knowingly and fraudulently.” Similarly, thegovernment must show specific intent to defraudunder 18 U.S.C. § 157.

Bankruptcy law has its own terminology.Consequently, specialized lawyers practice inbankruptcy courts. Despite the jargon, manyprinciples are simple. The underlying goal ofbankruptcy is to give an honest debtor a fresh startunder which his debts are modified or discharged.To accomplish this fresh start, the bankruptcycourt requires the debtor to identify his assets,liabilities, and financial history. In a Chapter 7case, the trustee takes charge of the debtor’sassets, sells them, and distributes the proceeds tocreditors. In Chapter 13 cases, a standing trusteereviews assets to decide whether to recommend arepayment plan.

Typically, bankruptcy is a rapid practicewhere either side to a dispute rarely has theresources or the inclination for prolongedlitigation. Most issues are negotiated to resolutionunder severe time and economic constraints. Oftenbankruptcy proceedings are abbreviated, withcourts issuing rulings solely upon oral argumentsand briefs. Bankruptcy courts and creditors relyupon the trust and veracity of bankruptcy lawyersand their clients. See United States v. Ellis, 50 F.3d 419, 423 (7th Cir. 1995) (Bankruptcy processcannot function if debtors are dishonest about theircredit history).

In exchange for the discharge of debts, debtorsare expected to supply accurate information abouttheir financial affairs. The most important

documents upon which courts and creditors relyare the petition, schedules, and statement offinancial affairs. The purpose of these documentsis to provide the debtor’s financial history. In reMcAllister, 215 B.R. 217 (Bankr. N.D. Ala.1996); United States v. Stone, 282 F. 2d 547 (2dCir. 1960) (The purpose of a statement offinancial affairs is to give dependableinformation). Statements made by debtors atmeetings of creditors, conducted pursuant to 11U.S.C. § 341, are also important. At thesemeetings, debtors are required to testify underoath about their financial affairs. Typically, thebankruptcy lawyer for the debtor will representthe debtor at these meetings. Unfortunately, somedebtors do not tell the truth on documents or at themeeting of creditors. These false statements formthe basis for many bankruptcy fraud prosecutions.The challenge, however, is to show that a debtorintended to commit bankruptcy crimes and torefute arguments that a debtor simply made amistake.

The Bankruptcy Environment

In 1997 approximately 1.4 million bankruptcycases were filed throughout the United States.This represented an approximate increase of 19percent from 1996, when around 1.18 millionbankruptcy cases were filed. A petition, schedules,and statement of financial affairs accompany eachof these filings. Debtors are required to use theofficial bankruptcy forms. These forms contain adeclaration under the penalty of perjury in whichthe debtor states that the information contained inthe documents is true and correct to the best of hisknowledge. See Bankruptcy Rule 1008.

Often, however, debtors file amendments tocorrect or supplement their schedules. UnderBankruptcy Rule 1009, debtors have the unilateralright to amend their documents any time beforethe case is closed. Therefore, the bankruptcy rules


contemplate that debtors may need to revise theirschedules and statement of financial affairs. Thenotion that schedules are often inaccurate wasendorsed by the National Bankruptcy ReviewCommission when it recommended that trusteesshould be directed to perform random audits ofdebtors’ schedules to verify the accuracy ofinformation. However, the commission concludedthat “malfeasance is unlikely to be the cause ofmuch of the alleged inaccuracy.” NAT’L BANKR.REV. COMM’N FINAL REPORT, p. 108 (1997).Accordingly, imprecise and ambiguous financialreporting often marks the bankruptcy environment.

Intent

The requirement that the government proveintent is rooted in federal criminal practice. SeeMorissette v. United States, 342 U.S. 246, 250(1952). The rationale is that a jury should notconvict a defendant unless the government provesthat he made a choice “between good and evil.” Id.An act is done knowingly when it “is donevoluntarily and intentionally, not because ofaccident.” United States v. Smithson, 49 F. 3d138, 141 (5th Cir. 1995). Intent is an elusiveconcept and therefore courts uniformly permit theintroduction of circumstantial evidence to establishintent. See generally, The Reindeer, 69 U.S. 383,401, 17 L. Ed. 911, 2 Wall. 383 (1864)(Circumstances may be considered conclusiveproof); see also United States v. Grey, 856 F.Supp. 1515, 1520 (D. Kan. 1994), aff’d and rev’don other grounds, United States v. Grey, 56 F.3d1219 (10th Cir. 1995) (Circumstantial evidencemay be used to establish fraudulent intent tocommit bankruptcy fraud).

One witness who may be important is thedebtor’s bankruptcy lawyer. Before issuing asubpoena for the debtor’s attorney, prosecutorsmust obtain approval from Edgar N. Brown,Chief, Witness Immunity Unit of the CriminalDivision. In bankruptcy cases, the attorney for thedebtor ordinarily helps in the preparation of thepetition, schedules, and statement of financialaffairs. See Matter of Olen, 15 B.R. 750, 752(Bankr. E.D. Mich. 1981). The bankruptcyattorney signs the petition as attorney of record and

in consumer cases certifies that he has explainedto the debtor chapters of the bankruptcy code. SeeOfficial Form No. 1. The bankruptcy attorneytypically explains to a debtor the bankruptcyforms and terminology. See Columbus BarAssociation v. Flanagan, 77 Ohio St. 3d 381, 674N.E. 2d 681 (1997). He also represents the debtorat the meeting of creditors. In re Landis, 2 B.R.341, 342 (Bankr. S.D. Ohio 1980). Therefore, thebankruptcy attorney will usually confirm that theinformation placed on the schedules came directlyfrom the debtor.

Still, there are limits to the testimony thatprosecutors may elicit from bankruptcy counsel.The attorney-client privilege will not protectinformation debtors provide to counsel forpurpose of “assembly into a bankruptcy petitionand supporting schedules.” United States v.White, 950 F.2d 426, 430 (7th Cir. 1991).However, the attorney-client privilege may barany testimony from the attorney regarding anylegal advice he gave to a debtor while preparingthe petition and schedules. United States v. Bauer,132 F. 3d 504, 508-09 (9th Cir. 1997).

A. Secrecy and Deviousness

An underlying theme in bankruptcy is fulldisclosure. When transactions are hidden ordeviously structured, a finding of intent isjustified. See United States v. Knight, 336 U.S.505 (1949). The case United States v. Rauer, 963F.2d 1332, 1337 (10th Cir. 1992), illustrates adebtor who behaved deviously. In Rauer, anindividual debtor deposited a cashier’s checkrepresenting property of the estate into a bankaccount she had opened under an assumed name.The Court of Appeals ruled that the jury couldhave properly found that the debtor had engagedin fraudulent concealment because she falselyendorsed the cashier’s check and further openedan account under a fictitious name. A debtor may engage in duplicitous conductbefore the bankruptcy case is filed. In Metheany v.United States, 390 F.2d 559 (9th Cir. 1968), adefendant was convicted of making false oaths ina bankruptcy case. At trial, he objected to theintroduction of evidence which showed he issued


checks pre-petition to fictitious payees. The Courtof Appeals ruled that this evidence was properlyadmitted to establish the defendant’s intent ormotive to make false statements in the bankruptcycase. Sometimes the debtor engages in deviousbehavior that is not difficult to unravel. In UnitedStates v. Shadduck, 112 F.3d 523 (1st Cir. 1997),the debtor held an undisclosed interest in a jointbank account. On the date of filing a joint petition,the debtor obtained funds from this joint bankaccount and purchased a bank check. During thenext several months, the debtor continued to issuechecks drawn upon the unscheduled account. Atthe meeting of creditors, the debtor did not correcther spouse when he denied the existence of theaccount. The Court of Appeals concluded thatthere was sufficient evidence of intent to conceal,especially considering the timing of the financialtransactions affected by the debtor. Shadduck, 112F.3d at 525. The timing of transactions is a key to findingintent. In United States v. Weichert, 783 F.2d 23(2d Cir. 1986), a business was operating underChapter 11. A few weeks before the case wasconverted to Chapter 7, the debtor’s principalorchestrated a scheme under which assets of thedebtor were diverted to a newly formed entity witha name similar to the name of the debtor. TheCourt of Appeals concluded that the jury wasentitled to infer intent to defraud from “the hurriedformation” of the new entity and the diversion ofassets “immediately prior to conversion” of thecase to Chapter 7. Weichert, 783 F.2d at 25.

Another direct example of deceptive conductwas recounted in United States v. Key, 859 F.2d1257 (7th Cir. 1988), where the debtor falselystated the date on which she acquired corporatestock. At trial, witnesses testified that the debtor’shusband instructed corporate employees to altercorporate records and to create new stockcertificates with a false date. These witnesses alsostated that the defendant “participated actively inthe typing of the substitute corporation recordbook entries.” Key, 859 F.2d at 1259. The debtor’ssignature and handwriting were found on thesefabricated records. The Court of Appealsconcluded that the testimony and documentary

evidence provided “overwhelming support” for thefinding of intent to defraud. Key, 859 F.2d at1260.

Proof that the debtor fabricated corporaterecords is an excellent indicator of intent. InUnited States v. Center, 853 F.2d 568 (7th Cir.1988), an attorney was convicted of bankruptcyfraud. He acted as counsel for a Chapter 11,corporate debtor and prepared the bankruptcyschedules. More than a year after the case wasfiled, the attorney learned that the debtor omittedan asset in the form of a debt owed to it. Ratherthan amending the schedules, the attorney directedthe backdating of corporate records to show that apost-petition set-off extinguished this omittedasset. The Court of Appeals affirmed theconviction, noting that the attorney knew “thetransaction was legally impossible and that theentry reflected a legally invalid transaction.” Center, 853 F.2d at 570.

B. Pre-petition Financial Statements

Debtors ordinarily seek protection in thebankruptcy court because they are experiencingfinancial distress. Often debtors prepare financialstatements as a routine practice during the yearsand months before a bankruptcy case is filed.These statements may track the onset anddirection of financial difficulties. The analysis ofthese statements is relevant to prove intent todefraud. In United States v. West, 22 F.3d 586,595 (5th Cir. 1994), the Court Appeals ruledthose pre-petition financial statements wereproperly admitted to establish intent:

[T]he financial statements prepared onWest’s behalf indicate that West’s networth fell dramatically after 1985.Because the deterioration of West’sfinancial situation bears strongly on bothhis incentive and need to seek bankruptcyprotection, such evidence is relevant . . .to West’s motive for hiding assets . . . .

Consequently, a review of pre-petitionfinancial statements may provide clues to thedebtor’s intent to defraud.


C. Examination and Comparison of theBankruptcy Schedules

A debtor is required to list all of his assets onhis bankruptcy schedules. Review these schedulesfor indicators of the debtor’s intent to commitbankruptcy fraud. In United States v. Shapiro, 101F.2d 375 (7th Cir. 1939), the debtor filedschedules which listed only one asset, an accountreceivable with a value of $500. These schedulesdid not reflect the debtor’s tangible assets. TheCourt of Appeals concluded that the omission ofthese assets was not due to mistake orinadvertence. Rather, the Court of Appeals statedthat the “size of the omissions indicated a criminalpurpose.” Shapiro, 101 F.2d at 379. A comparison of the items that the debtorincludes in the petition with the items that thedebtor omits from the petition presents furtherevidence of intent. In United States v. Lindholm,24 F.3d 1078 (9th Cir. 1994), the debtor filed aseries of bankruptcy petitions, with the goal ofinvoking the automatic stay. In one filing, thedebtor stated that he had only filed one prior case.After conviction, the debtor appealed andcontended that there was insufficient evidence ofintent. The Court of Appeals rejected thisargument on several grounds, and concluded thatthe defendant:

[M]ade false statements by selectivelylisting one previously filed petition andactively omitting to mention the otherpetitions previously filed.

Lindholm, 24 F.3d at 1085.

The effectiveness of establishing a false oathby comparing assets the debtor stated he owned tothose he failed to schedule was discussed in UnitedStates v. Diorio, 451 F.2d 21 (2d Cir. 1971).There, the debtor denied under oath that he held aninterest in a defunct corporation. The debtorargued that the corporation was defunct and, as aresult, he had a loss of memory of this corporation.However, he did list another defunct corporation inhis “Statement of Affairs.” The Court of Appealsconcluded that the debtor’s listing of the second

defunct company showed “a clear awareness onhis part of the necessity of listing defunctcorporations.” United States v. Diorio, 451 F. 2dat 23.

Another approach to proving intent is to focusupon repeated omissions in the bankruptcyschedules. In United States v. Cluck, 143 F.3d174 (5th Cir. 1998), a debtor was convicted ofseveral counts of bankruptcy fraud. The gravamenof the allegations was that the debtor concealedassets, including accounts receivable and businessreceipts. The debtor argued that he lackedcriminal intent and that he was only careless incompleting the bankruptcy schedules. The Courtof Appeals rejected this argument:

In this case, it is manifestly clear thatCluck’s repeated omissions and history ofcoincidental and questionable transfersformed just the sort of “circumstances” thatthe Supreme Court had in mind in theReindeer case.

Cluck, 143 F.3d at 179-180.

D. The Recantation Argument

When confronted with a false oath of evidenceof concealment, a debtor will often amend hisschedules and then claim he merely made amistake. The general rule is that recantation does notalone cure a false oath. As stated by the SupremeCourt when it affirmed a perjury conviction:

The plain words of the statute and the publicpolicy which called for its enactment alikedemand we should hold that the telling of adeliberate lie by a witness completes the crimedefined by law.

United States v. Norris, 300 U.S. 564, 576(1937). However, the Supreme Court observedthat a recantation may impact upon the finding ofintent:

This is not to say that the correction of aninnocent mistake, or the elaboration of an


incomplete answer, may not demonstrate thatthere was no willful intent to swear falsely.

Id. at 576.

This general principle was applied in UnitedStates v. Diovio, 451 F.2d 21 (2d Cir. 1971).There, the Court of Appeals ruled that a jurycharge covering recantation was proper when itdistinguished between whether an honest discoveryof an earlier mistake, or the “realization that the jigwas up and that the falsity had already beenuncovered or was about to be uncovered byothers.” Diovio, 451 F.2d at 23. Therefore, a review should be made of thecircumstances surrounding the amendments toschedules. If the debtor amends schedules early inthe case before he is examined at a meeting ofcreditors, the recantation may have validity.However, amendments filed later in the case shouldbe scrutinized.

E. Direct Knowledge of Debtor

A debtor is not a passive observer of hisbankruptcy case. At each stage of a case, hereceives information about the rules he mustfollow. At the meeting of creditors, a trusteeexamines the debtor. Before the examinationbegins, the trustee gives the debtor a copy of aninformation sheet prepared by the United StatesTrustee. This sheet states in part: It is important tolist all your property and debts in yourbankruptcy schedules. Other times, the trustee or her counsel willremind the debtor of his obligations. In UnitedStates v. Grant, 971 F.2d 799 (5th Cir. 1992), adebtor was convicted of concealing artwork in abankruptcy case. The Court of Appeals affirmedthat conviction and concluded that the debtor knewthat he was without authority to take artworkbelonging to the estate. The Court of Appealshighlighted that trustee’s counsel had informed thedebtor of the “legal consequences of the Chapter 7conversion” including the right of the trustee totake possession of assets. Grant, 971 F.2d at 808. The bankruptcy court may also impartknowledge of the bankruptcy requirements to a

debtor. In United States v. Christner, 66 F.3d 922(8th Cir. 1995), a debtor was convicted ofconcealing assets in a bankruptcy case. On appealhe argued that there was insufficient evidence ofhis intent. The Court of Appeals affirmed andrecited that the bankruptcy court had “informedthe defendant that the Bank has a right to knowthe location of its collateral.” Christner, 66 F.3dat 926. Instead of following the directive of thecourt, the debtor sold the collateral and divertedthe proceeds. The personal characteristics of the debtor mayalso influence the determination of intent. InUnited States v. White, 879 F.2d 1509 (7th Cir.1988), a husband and wife were convicted ofbankruptcy fraud. On appeal, the wife’sconviction was reversed and the case against thehusband was remanded. However, the Court ofAppeals found that the husband had sufficientknowledge of the bankruptcy requirements:

He was an experienced businessman whohandled all the financial affairs of hishousehold. It was not a case of a singleoversight.

White, 879 F.2d at 1511.

Conclusion Proof of intent is fact-specific. However,courts have reviewed circumstances that support afinding of intent to support bankruptcy fraudconvictions. These patterns provide a templatethat may be used to establish intent. Transactionshidden by debtors show intent to defraud. Triggersfor the finding of intent could be the formation ofnew businesses directly before the bankruptcyfiling or the more pedestrian fabrication ofrecords. The documents filed by the debtor in thebankruptcy case are another source of evidencewith which to establish intent. Often a comparisonof the assets listed on the debtor’s schedules withthe assets the debtor failed to list will point tointent to defraud. If the debtor has filedamendments to his schedules, prosecutors shouldexamine the timing and completeness of theseamendments.


The bankruptcy proceedings should also bereviewed. The panel trustee will usually inform thedebtor of the requirements to list all assets. Othertimes the court may comment to the debtor. Areview of the transcripts of the meeting of creditorsor court hearings may be helpful. These transcriptscould provide support for the view that the debtorknew about the requirements of the BankruptcyCode. ò

ABOUT THE AUTHOR ë Dean P. Wyman is the Senior Attorney-Advisorwith the United States Trustee’s office inCleveland, Ohio. He is also the Regional CriminalReferral Coordinator for Region 9 and a SpecialAssistant United States Attorney. Hereceived his undergraduate degree from MiamiUniversity of Oxford, Ohio; his law degree fromthe University of Toledo College of Law; and hisMasters in Business Administration from theWeatherhead School of Management of Case-Western Reserve University. He is the author ofseveral bankruptcy articles, including “A 707(b)Sampler,” which appeared in the May 1994 issueof Norton’s Bankruptcy Law Adviser, and “May IHave My Balance Please? Allocation of PaymentsIn Bankruptcy Cases,” which appeared in theCommercial Law Journal, Summer 1995 edition.He is Vice-President of the Northern District ofOhio Chapter of the Federal Bar Association and amember of the Cleveland Bar Association and theAmerican Bankruptcy Institute. a


Flight and Fugitive Issues inBankruptcy Fraud Cases

Angela J. DavisAssistant United States AttorneyCentral District of California

Recent experiences in the Central Districtof California suggest that individualswho conceal assets will often try toconceal themselves as well. Consider,

for example, the case of Robert Masket, aSouthern California businessman who commencedChapter 11 proceedings after a divorce decreerequired him to pay over $2 million to his formerwife. Masket’s bankruptcy schedules identifiedseveral income-producing properties, but onlyscanty liquid assets. Amidst rumors of a concealedSwiss account, Masket refused to produce hisbooks and records to his bankruptcy trustee. Afterthe bankruptcy court issued a contempt order,Masket sailed his luxury fishing boat to Mexicoand was apprehended only six months afterMexico’s issuance of the provisional arrestwarrant, as requested by the United StatesAttorney’s office.

In another case, Dan Young, the former CEOof a for-profit hospital chain, was charged withbankruptcy fraud and money laundering in October1997. When civil proceedings against him reachedtheir peak, Young vanished, leaving one Mercedesat his residence and another at the airport. Youngremains at large and is thought to be in China.

In other bankruptcy fraud cases, defendantswho have remained in the country have eludedarrest by simply using multiple names and movingfrequently. Others have vanished after enteringguilty pleas. Recently, one bankruptcy frauddefendant failed to report for a 15-month sentenceand two other bankruptcy fraud defendants failedto report for “split” sentences. Another defendant,Michael Knighton, failed to appear at a sentencinghearing in which the Probation Office hadrecommended a 24-month sentence. AlthoughKnighton was ultimately apprehended, he remained

at large for several months and committed anotherfraud scheme while in flight. All but one of theseindividuals had no criminal history.

Although it is impossible to say, definitively,why so many bankruptcy fraud defendants flee,certain hypotheses come to mind. The mostcommon form of bankruptcy fraud, concealment ofassets under 18 U.S.C. § 152(1), is, by definition,a crime of “hiding.” For an individual who hidesan offshore account or a secret corporation, theconcept of hiding himself may not be such a greatmental leap. In addition, people who commitbankruptcy fraud are frequently in the midst offailed or failing relationships. Individuals who filebankruptcy frequently do so in response to adivorce decree, the dissolution of a financialpartnership, or the demise of a business plan.These events are certainly of a character to weakenone’s “community ties.” Smaller scale bankruptcyfraud defendants are also frequently engaged incrimes of “hiding” and breaking community ties.One of the individuals who failed to report for his“split sentence,” for example, had engaged in ascheme of living “rent-free” by signing a series oflease agreements under false names and falsesocial security numbers.

The end result in these and other cases is thatjustice is delayed and too often completely denied.In many instances, agents and AUSAs are forcedto devote precious resources to tracking downconvicted individuals.

What Can Be Done to Prevent Flight inBankruptcy Fraud Cases?


One cannot assume that a first-time offenderwho is facing a “light” sentence does not pose aflight risk. AUSAs prosecuting bankruptcy fraudshould carefully consider what bond, if any, isappropriate given the defendant’s fullcircumstances. In this regard, AUSAs shoulddirect case agents investigating bankruptcy fraudto investigate the extent to which the target poses aflight risk. In particular, the following areas shouldbe explored:

ë How long has the target lived in his/herneighborhood? Does s/he rent or own? Is s/hecurrent on the rent/mortgage?

ë How many times has the target moved in thelast ten years?

ë Is the target working? How long has s/hebeen at the current job?

ë Is the target speaking to his/her parents?(Many are not and Pretrial Services sometimesrecommends a signature bond because “thedefendant was born here and his wholefamily lives here.”)

ë Is the target married? Happily married? Ifthe target is in divorce court (many bankruptcyfraud targets are), find out from the lawyer onthe other side whether or not the target hasmade all court appearances and whether or notthe target has cooperated with efforts to takehis deposition, participate in “meet and confer”sessions, etc. Find out also who has childcustody and how often the target sees hischildren. (Again, if Pretrial Services opines adefendant won’t flee because his/her childrenare in the district, find out whether or not s/hehas visited the children in the last year or so.)Is the target current on alimony and childsupport obligations?

ë The above comments also apply to a targetinvolved in any other civil proceedings.

ë Verify the target’s citizenship. If the targetis a naturalized citizen, consider the

possibility that s/he may have more than apassport.

ë Do the target’s travels suggest s/he hasforeign assets or foreign residences? (e.g., atarget who spends summers in Acapulco mayhave a Mexican bank account and a furnishedresidence that his creditors have not yetmanaged to seize.)

In any case involving substantial losses, anAUSA should consider seeking a third-party bondwith a justified affidavit of surety and deeding ofproperty. In a case involving both substantiallosses and serious risk of flight, an AUSA shouldconsider seeking detention.

Plea agreements should also advise thedefendant that the government will onlyrecommend a credit for “acceptance ofresponsibility” if the defendant demonstrates suchacceptance by virtue of his or her conduct andcomplies with all of the terms of his or her bond.

Remedies After a Defendant Flees

Forfeiture of Bond

If a defendant flees after the initial appearancebut before sentencing, the AUSA should seekrevocation of the conditions of bond, forfeiture ofbail, and final judgment against the surety, if any.Federal Rule of Criminal Procedure 46 sets forththe procedure for forfeiture and provides that ifthere is a breach of condition of a bond, the districtcourt “shall” declare a forfeiture. Fed. R. Crim. P.46(e)(1). The court has wide discretion, however,to set aside a forfeiture if a defendant issubsequently surrendered or if it otherwise appearsthat justice does not require such a forfeiture. Fed.R. Crim. P. 46(e)(2). Interpreting the rule,appellate decisions have found that while forfeitureis “mandatory,” the district court has widediscretion in determining whether or not to grantrelief from the forfeiture. See, e.g., United Statesv. Stanley, 601 F.2d 380, 381 (9th Cir. 1979).

Multiple Sentencing Enhancements


A defendant who flees following a release onbond should be denied any point reduction foracceptance of responsibility pursuant to U.S.S.G.§ 3E1.1 and should receive an enhancement forobstruction of justice pursuant to U.S.S.G. § 3C1.1. Both of these sentencing adjustments areapplicable in cases where a defendant has fled, andthe adjustments should ordinarily be made even ifthe defendant previously entered a guilty plea.Application Note 3(e) to U.S.S.G. § 3B1.1 provides unambiguously that theobstruction enhancement is applicable where adefendant “escape[s] or attempt[s] to escape . . . orwillfully fail[s] to appear, as ordered, for a judicialproceeding.” Application Note 4 to U.S.S.G. §3E1.1 provides that “conduct resulting in anenhancement under § 3C1.1 . . . ordinarilyindicates that the defendant has not acceptedresponsibility for his criminal conduct.” Ininstances of flight following a guilty plea, appellatecourts have affirmed district court rulings denyingthe point credit for acceptance of responsibility andassessing the additional enhancement forobstruction. See, e.g., United States v. Loeb, 45F.3d 719, 721 (2d Cir. 1995) (“It iswell-established that by willfully failing to appearfor sentencing, a defendant fails to acceptresponsibility for the offense, regardless of whetherthere was a plea agreement stipulating credit forthe adjustment.”). The Loeb decision also noted,“intentional flight from a judicial proceeding isgrounds not only for a sentencing court to deny anadjustment for acceptance of responsibility, butalso for the court to impose an offense levelenhancement for obstruction of justice.” Id.;accord United States v. Thompson, 80 F.3d 368,369 (9th Cir. 1996) and cases collected therein(obstruction enhancement and denial of acceptancecredit proper for defendant who flees following aguilty plea).

In instances where a defendant flees andengages in further fraud schemes while on bond,AUSAs should also consider seeking an upwarddeparture on the ground that the defendant’scriminal history category is understated. U.S.S.G.§ 4A1.3 specifically endorses upward departureswhere a defendant’s criminal history category“does not adequately reflect the seriousness of the

defendant’s past criminal conduct or the likelihoodthat the defendant will commit other crimes.” Asthe Ninth Circuit found in United States v. Segura-del Real, 83 F.3d 275, 277 (9th Cir. 1996), indetermining whether a defendant’s criminal historycategory adequately reflects the seriousness of hispast conduct or likelihood of recidivism, this courtmay consider the defendant’s repetition of the sameor similar offenses, and may base an upwarddeparture on this circumstance: “‘[t]he recidivist’srelapse into the same criminal behaviordemonstrates his lack of recognition of the gravityof his original wrong, entails greater culpability forthe offense with which he is currently charged, andsuggests an increased likelihood that the offensewill be repeated.’” Id., quoting United States v.Chavez-Botello, 905 F.2d 279, 281 (9th Cir.1990). A defendant’s post-conviction conduct mayalso be properly considered as justification for anupward departure of his criminal history category.United States v. Myers, 41 F.3d 531, 533 (9th Cir.1994).

Application of these multiple sentencingenhancements may dramatically impact thesentence a defendant ultimately receives. In thecase of Michael Knighton, for example, thedefendant’s sentencing range prior to his flight was24-30 months. Consistent with the foregoingauthorities, the district court denied Knighton thecredit for acceptance of responsibility, assessed a2-point enhancement for obstruction, and alsoenhanced Knighton’s criminal history by onecategory. Knighton’s resulting sentencing rangewas 51-63 months, and the court found themaximum sentence was appropriate. Thus, thedefendant more than doubled his sentence byfleeing the jurisdiction and engaging in a furtherfraud scheme while on bond.

Indictment for Flight

In some instances— particularly when adefendant has already been sentenced and then failsto report to serve that sentence— AUSAs may bewell-advised to consider indicting a defendant for


flight. A defendant’s failure to appear before acourt following release on bond or failure to reportto serve a sentence is a violation of 18 U.S.C. §3146. The penalty for a violation of § 3146, as setforth in § 3146 (b)(i)-(iv), is tied to the maximumpenalty for the underlying case from which thedefendant fled. In the case of bankruptcy fraud, forwhich the maximum penalty is five years, themaximum penalty for flight or failure to appear isalso five years. 18 U.S.C. § 3146(b)(ii). Notably,any prison sentence for violation of § 3146 mustbe consecutive to any other prison sentence. 18U.S.C. § 3146(b)(2). The applicable sentencingguideline, U.S.S.G. § 2J1.6, also ties the penalty tothe maximum sentence for the underlying offense.In the case of a failure to appear (or report forservice of sentence) in a bankruptcy fraud case, adefendant’s combined offense level is 17. U.S.S.G.§§ 2J1.6(a)(2) and (2)(B).

Notably, the statute provides thatcircumstances beyond a defendant’s controlconstitute an affirmative defense. 18 U.S.C. § 3146(c). The sentencing guidelines also providefor a 5-level downward adjustment where adefendant voluntarily surrenders within 96 hours ofthe time s/he was originally scheduled to report.See U.S.S.G. § 2J1.6(b)(1)(A).

Limitations on Use of the Grand Jury

AUSAs should familiarize themselves with theUnited States Attorneys’ Manual (USAM)provisions regarding use of the grand jury to locatea fugitive. Section 9-11.120 of the USAMprovides, “[i]t is improper to utilize the grand jurysolely as an investigative aid in the search for afugitive in whose testimony the grand jury has nointerest.” However, if the grand jury has alegitimate interest in the testimony of a fugitive, itmay subpoena other witnesses and records in aneffort to locate the fugitive. Id. The USAM furtherprovides, “[i]f the present whereabouts of afugitive is related to a legitimate grand juryinvestigation of offenses such as harboring, 18U.S.C. §§ 1071, 1072, 1381, misprision of felony,18 U.S.C. § 4, accessory after the fact, 18 U.S.C. § 3, escape from custody, 18 U.S.C.§§ 751 and 752, or failure to appear, 18 U.S.C.

§ 3146, the grand jury properly may inquire as tothe fugitive's whereabouts.” Section 9-11.120 ofthe USAM goes on to state, “unless such collateralinterests are present, the grand jury should not beemployed in locating fugitives in bail-jumping andescape cases since, as a rule, those offenses relateto the circumstances of defendant's disappearancerather than his or her current whereabouts.”

Conclusion

The recent experiences of the Central Districtsuggest that bankruptcy fraud defendants may poseelevated risks of flight. Agents investigatingbankruptcy fraud subjects should be alert to anindividual’s ruptured community ties, overseasassets, and other factors suggesting risk of flight.AUSAs prosecuting bankruptcy fraud should bemindful that an individual who is facing a “light”sentence and has no criminal history may,nevertheless, be subject to other circumstancesincreasing risk of flight. Although detention is onlyrarely appropriate in bankruptcy fraud cases, thirdparty secured bonds (with deeding of property)should always be considered and plea agreementsshould reserve the government’s right to seekappropriate adjustments to a defendant’s offenselevel in the event s/he violates the terms of a bond.A defendant who does flee should be assessedmultiple sentencing enhancements and may also bea worthy candidate for another prosecution. ò


ABOUT THE AUTHOR ë Angela Davis has been practicing in the area ofbankruptcy, corporate and banking litigation, andfinancial fraud since 1986. She has been with theDepartment of Justice since 1993, and currentlyserves as an Assistant United States Attorney andCoordinator of the Bankruptcy Fraud Task Forcefor the Central District of California. She hastaught at various DOJ programs, including theOLE program on advanced bankruptcy. Recently,she received a Director’s Award from theExecutive Office for United States Trustees. a

Many Hands Make Light Work— ABankruptcy Fraud Concealment CaseAudrey G. FleissigAssistant United States AttorneyEastern District of Missouri

Last year, I received a phone call from apanel bankruptcy trustee, who told methat he was working on a Chapter 7personal bankruptcy in which creditors

were told that there appeared to be no assets fordistribution. He also told me that he just received acall from the debtor’s daughter, who told him thatthe debtor had more than $100,000 in cash hiddenin a safe and that the debtor had transferred otherreal and personal property to others. The paneltrustee also told me that he called the United StatesTrustee (UST). The panel trustee’s referral to mewas consistent with his duties under 18 U.S.C. §3057 and 28 U.S.C. § 586.

There is an identity of interests in a criminalproceeding and a bankruptcy proceeding whenfraudulently concealed assets are at issue. This isbecause fraud victims are frequently bankruptcycreditors, and the goal of finding the concealedassets and distributing them to the victim-creditorsis shared. This identity of interests poses unique

opportunities for cooperation and assistance duringall phases of the case.

Shortly after speaking with the panel trustee,we assembled a team consisting of the paneltrustee, an Assistant United States Trustee(AUST), and an FBI agent. The trustees brought acopy of the bankruptcy schedules and the tape ofthe 341 First Meeting of Creditors. Thebankruptcy schedules revealed that the debtorclaimed to have only $525.00 in assets. Theschedules also contained several entries thatcorroborated the daughter’s story. For example,the debtor scheduled more than $167,000 inliabilities, consisting entirely of credit card debtfrom approximately 33 different credit cards. Healso claimed that he did not pay rent for the homein which he was living, and claimed it belonged tohis sister. At his 341 Meeting, the debtor statedthat he had no other assets and had made notransfers.

The Chapter 7 trustee’s powers includedseeking a turnover order from the bankruptcycourt, or injunctive relief under 11 U.S.C. § 105 and Bankruptcy Rule 7065. The trusteecould also seek an order permitting him to enterand secure the debtor’s residence with securityguards. However, each of these options posed


problems. Most bankruptcy judges would hesitateto grant a temporary restraining order, or whatwould amount to a search and seizure based solelyon the daughter’s word, without notice to thedebtor. Any notice would give the debtor time tohide the cash. Moreover, entering the premisesposed security risks to the trustee and could provecostly to the bankruptcy estate.

We elected to seek a search warrant for thedebtor’s residence because it was the safest andmost expeditious means of discovering andsecuring the evidence and assets. In a telephoneinterview, the debtor’s daughter told us that thedebtor’s visited her and told her that he had morethan $100,000 in cash hidden in a large safelocated inside his home. He also told her that hehad transferred some real property into her name.After arguing about the propriety of his actions,the debtor left. The daughter called the trusteeshortly after that.

The debtor’s daughter told us that she had seena large, free-standing, 1000-pound vault in herfather’s kitchen, which contained approximately$50,000 in cash and several firearms. She also sawmany tools and equipment and a Buick Regalautomobile that her father “babied.” In previousconversations, her father told her that when hebegan having some legal problems a year or twoago, he transferred the car to a relative, and thetitle to the home to his sister in Florida.

With the help of the AUST and the paneltrustee, we assembled the public records regardingthe transferred assets by the next day thatcorroborated the transfers. These showed that thedebtor owned the home in which he had beenliving, but transferred it to his sister in Florida overa year ago, for no consideration. The recordsconfirmed that within one year of the filing of thebankruptcy, the debtor purchased real property andretitled it in the daughter’s name. Lending credenceto the daughter’s story that this was done withouther knowledge or consent, the title records showedthat the grantee had not signed the deed, theaddress listed was the debtor’s home address, andthe tax bills were also sent to the debtor’s homeaddress. Because we used the grand jury only toobtain certain bank records, we shared most of ourinformation freely.

The court determined that there was probablecause to search the debtor’s home and issued asearch warrant. During the execution of the searchwarrant, we found the house and garage filled withfurniture and other items, which still bore pricetags. We also found the Buick Regal and manydocuments evidencing the debtor’s illicit propertytransfers. Finally, we found the vault, whichcontained more than $120,000 in cash and 14firearms.

We quickly indicted the debtor on one count ofbankruptcy fraud (a false statement), but continuedto investigate the unlawful transfers. We alsolearned that the debtor had a previous convictionfor felony assault, leading to a felon in possessionof a firearm charge. The Chapter 7 bankruptcytrustee filed adversary proceedings in thebankruptcy court, including proceedings againstthe third-party transferees.

We needed to decide how to proceed withrespect to the seized assets and the property in thehands of third-parties. We again had a shared aimof returning the assets to the victims/creditors. Wedecided that the assembly, liquidation, anddistribution of the real and personal property wasbest handled by the bankruptcy trustee. If thedebtor/defendant would not cooperate, it could bedone through a turnover order in the bankruptcycourt or through criminal forfeiture. A turnoverorder would clearly be the most expeditious, butwe would also need to preserve the evidence forany future criminal trial. While criminal forfeiturewas an option, the bankruptcy trustee wasattempting to obtain the agreement of each of thethird-party transferees to turn over the assets.

The debtor pled guilty to a supersedingInformation charging him with two counts ofbankruptcy fraud (concealment and falsestatements) and one count of being a felon inpossession of a firearm. In the stipulation and pleaagreement, the debtor admitted the concealmentand transfers in contemplation of bankruptcy andagreed to relinquish any interest he had in theproperty. The debtor also agreed to pay fullrestitution for his bankruptcy liabilities.

Rather than administer the restitution throughthe criminal case, we found it more expeditious torely on the bankruptcy process. In the plea


agreement, the debtor agreed to cooperate with theUnited States Attorney and the bankruptcy trusteeto identify all assets at the time of filing, turn overall assets other than the firearms to the bankruptcytrustee, and use his best efforts to have third-parties turn over any transferred assets. Thefirearms would be destroyed or, at the option of theUnited States Attorney, turned over to thebankruptcy trustee. The plea agreement stated thatthe trustee would administer the assets. Thebankruptcy trustee would liquidate the assets,identify the creditors and report to the criminalcourt regarding the amount received by thevictims/creditors. The defendant agreed that the netamount received by the trustee from liquidating theconcealed assets would be credited toward hisrestitution obligation. To help maximize therecovery, the Chapter 7 trustee agreed to reducehis normal fee.

By the date of the sentencing, the bankruptcytrustee was close to completing the liquidation ofthe concealed assets. The debtor was sentenced to57 months’ imprisonment (the high end of theSentencing Guideline range) and ordered to payrestitution in the full amount of his bankruptcyliabilities. ò

ABOUT THE AUTHORë Audrey Fleissig has served as an AssistantUnited States Attorney for the Eastern District ofMissouri since 1991. She is the bankruptcy fraudreferral coordinator for her district and handleswhite collar crime cases. Before joining the UnitedStates Attorney’s office, she was a partner with aSt. Louis law firm, specializing in financiallitigation. She graduated from WashingtonUniversity School of Law in 1980 and currentlyserves as an adjunct professor in Trial Advocacy.a

Tracking Down a Trailer BustoutJoseph F. McGonigal, Attorney-AdvisorUnited States Trustee ProgramIndianapolis, Indiana

The bustout co-conspirator wanted to talkin a bar. So, on a Friday afternoon inMarch 1993, the Chapter 7 case trusteeand I picked him up and drove to a bar

in Indianapolis. Anthony Cummings had beenparticipating in a bustout scheme involving QualityMark Manufacturing, Inc. (QMI) for the pastseveral months. He and his partner, however, had afalling out over the distribution of the anticipatedproceeds. QMI filed for Chapter 7 relief inJanuary. Earlier that Friday, Cummings hadapproached the Chapter 7 trustee, stating that hewanted to explain his role in concealing assetsbelonging to QMI’s bankruptcy estate.

At the bar, I told Cummings that we could notgive him immunity or special treatment fordisclosing incriminating information. Nonetheless,

Cummings told us that for many years he andanother person involved in QMI had been creatingbusinesses to bust out with the assets. He admittedthat they had recently formed QMI’s “successor”company, Trailer Marketing Inc. (TMI), to useQMI’s assets at the expense of QMI’s creditors.Cummings said QMI funds were used to renovateTMI’s facility, and QMI assets were transportedfrom QMI’s plant to TMI property.

In February, Cummings, his QMI businessassociate, and QMI shareholder and legal counselAndrew Mittower developed a plan to throw theChapter 7 trustee off the trail of TMI operations inSalt Lake City, Utah. They decided to bring QMIassets to a storage facility in Elkhart, Indiana, andthen placed an “anonymous” call to Mittowerdisclosing the assets’ location. Mittower laterfalsely testified to the bankruptcy court that hereceived an anonymous call leading him to theassets.


Cummings said TMI’s Salt Lake Cityoperation used QMI funds to pay startup expensesand to pay certain QMI creditors to obtain a goodcredit record, which would help TMI buy materials, build trailers, default on payments tocreditors, and create another trailer company— inother words, to carry out another bustout scheme.

Background

In the typical bustout, the perpetrator buysgoods, sets up a business, sells the goods for cash,pockets the money, and then liquidates the businesswithout paying suppliers and other creditors.Bustouts are often sequential, with the perpetratorfolding up one business and immediately startinganother one in another location— far from theoriginal unpaid creditors.

Here is the background to Cummings’ bustoutstory. QMI manufactured trailers, with businessoffices in Indianapolis and plants in Elkhart,Indiana, and Salt Lake City. Late in 1992,Mittower and other QMI officials devised ascheme to form TMI, transfer the assets of QMI toTMI, and close down QMI operations withoutpaying creditors. Accordingly, QMI purchasedlarge amounts of manufacturing equipment andsupplies on credit. Cummings rented five largeRyder trucks and hired drivers. All of the QMIassets were transported from the Elkhart plant tothe TMI facility in Bargersville, Indiana. Mittowerprepared several documents relating to TMI’sincorporation, TMI’s alleged purchase of QMIassets, and TMI’s purchase of the Bargersvillefacility.

On Friday, January 8, 1993, QMI creditors inUtah obtained a pre-judgment writ of attachmentagainst certain Utah assets. Mittower suggestedthat, to avoid the writ, QMI file a bankruptcypetition in Indianapolis. The following Monday, hefiled a Chapter 7 petition for the company.

QMI’s creditors contacted the Chapter 7trustee, who moved for turnover of assets andsought to have Mittower examined under oath. Inthe resulting deposition, Mittower lied about thefalse signatures, the concealed assets, and othermatters. The group’s subsequent attempts to getthe trustee “off their back” led to the anonymous

call scheme, which was followed by several moreinstances of false testimony by Mittower.

Cummings’ information led to Mittower’sindictment and subsequent guilty plea on chargesof bankruptcy fraud and perjury. On January 15,1999, the District Court for the Southern Districtof Indiana sentenced Mittower to 33 months’imprisonment and ordered him to pay more than$150,000 in restitution. In addition, Mittowerresigned from the practice of law in July 1997.

Cummings plead guilty to one count of perjuryin January 1998. He was sentenced in July 1998 tothree years probation, including four months homedetention.

Developing the Case

Here, the United States Trustee’s office(USTO) provided assistance to the United StatesAttorney (USA) in many ways, including:

ë Participating at an early stage in abankruptcy court hearing where witnessesgave material responses supporting a chargeunder 18 U.S.C. § 152.

ë Interviewing co-conspirator Cummings,which led to the discovery of QMI assets.

ë Conducting an on-site visit with the trustee,trustee’s counsel, and local law enforcement tofind concealed assets.

ë Summarizing extensive transcripts of courthearings and the Bankruptcy Rule 2004examination, and providing an index of actualand contradictory testimony.

ë Participating in a preliminary interview ofMittower with the Assistant United StatesAttorney (AUSA) and the Federal Bureau ofInvestigation Special Agent, and a detaileddebriefing of Mittower with the Special Agent.

ë Participating in strategy meetings with theAUSA regarding the theory and direction ofthe case.


ë Helping the AUSA and the probation officerin determining the appropriate sentence underthe Sentencing Guidelines, considering factorssuch as the loss, the existence of more thanminimal planning, and violation of judicialprocess.

ë Locating and coordinating evidence andexhibits such as bankruptcy pleadings, trusteefinal reports, a videotape of the site visit, andtranscripts of the Section 341 meeting and theRule 2004 examination.

While the USTO did not do so here, programpersonnel have served as government witnesses toexplain the bankruptcy process to a jury or grandjury. Because our duties under 28 U.S.C. § 586include attending Section 341 meetings, Rule 2004examinations, and adversary proceeding, the USTscan help AUSAs by identifying conflicting andfalse statements made under oath. In addition,AUSAs and other law enforcement agents shouldconsider contacting us when investigating anyfraudulent behavior, because the targetedindividual may have filed for bankruptcysomewhere in the country. Even if the target didnot fill out all bankruptcy documents truthfully,bankruptcy schedules frequently contain a wealthof information because they identify the target’sassets and potential victims of the underlyingfraud. (Such exchanges of information among lawenforcement agencies are already the norm indistricts with Bankruptcy Fraud Task Forces;Region 10 has three task forces, in the Northernand Southern Districts of Indiana and the SouthernDistrict of Illinois.)

Case trustees and their attorneys can alsoprovide crucial assistance in bankruptcy fraudprosecutions. Significant credit in breaking thiscase should go to the Chapter 7 trustee, andparticularly to his counsel, who doggedly pursuedQMI’s assets after being contacted by thecompany’s creditors. Their knowledge provedhelpful to the development of the case.

Conclusion

In the QMI case, using the combined skills andexperience of the United States Attorney’s office,USTO, FBI, Chapter 7 trustee, and trustee’scounsel, we succeeded in identifying thebankruptcy fraud, preventing future bustouts, andbringing an unethical attorney to justice. The USTProgram can offer the same kind of assistance toyour office in many bankruptcy fraud cases. ò

ABOUT THE AUTHORë Joseph F. McGonigal is an Attorney-Advisorfor the United States Trustee’s office inIndianapolis, and is designated a Special AssistantUnited States Attorney for the Southern District ofIndiana. Before he joined the United States TrusteeProgram in 1988, he was an FBI Special Agentspecializing in white collar crime and publiccorruption. He received his law degree fromIndiana University Law School in 1992. a


Environmental Issues in BankruptcyCases: Protecting the Public Interestfrom Overzealous DebtorsAlan S. Tenenbaum, Senior Attorney Environment and Natural Resources Division Environmental Enforcement SectionU.S. Department of Justice

Reconciling the conflicting goals ofenvironmental and bankruptcy law is adifficult process. Environmental lawslike Superfund (the Comprehensive

Environmental Response, Compensation andLiability Act ("CERCLA"), 42 U.S.C. § 9601 etseq.) provide a comprehensive framework for bothimmediate and long-term solutions to seriousenvironmental and public health issues. They seekto hold companies accountable for what they havedone in the past. However, many contaminatedsites throughout the country, that do not qualify forthe highest priority under the National PriorityList, 42 U.S.C. § 9605, are not presentlyaddressed through the Federal Superfund process.State governments or private parties may beinitiating cleanup activities at such sites. Also, forsome sites, no one may be addressingcontamination problems because businesses haveignored or are unaware of the problems, and theyhave not come to the attention of the government.In the future, the clean up of these sites may fall tothe United States.

Bankruptcy, in contrast, focuses on givingdebtors an immediate fresh start free from its pastproblems. The idea underlying the BankruptcyCode is to permit all of the debtor’s creditors toshare in the debtor’s current assets in return forgiving the debtor a fresh start. A fresh start mayeven maximize the value of the debtor’s assets forthe benefit of existing creditors, including thegovernment. The tension between a statute thatseeks to hold companies liable for their pastactions, and one that seeks to give them a fresh

start free from their past, is thus inevitable anddifficult to reconcile.

This article reviews the case law at theintersection of bankruptcy and environmental law,including: When do environmental claims arise andbecome dischargeable in bankruptcy? Do debtors’have ongoing responsibilities for property that theycontinue to own? Are environmental injunctiveobligations dischargeable in bankruptcy? Thisarticle concludes by describing recent proposedchanges in the law by the National BankruptcyCommission and the Advisory Committee onBankruptcy Rules, and providing somesuggestions for spotting illegal proposals bydebtors, for Plans of Reorganization or propertysales that violate the governing rules forreconciling the goals of environmental law andbankruptcy law.

When do Environmental Claims Arise andBecome Dischargeable in Bankruptcy?

Many debtors contend that they should get adischarge and fresh start from all liability relatingto any pre-petition act. This rule of law wouldmean that polluters could entirely avoid providingthe government any fair opportunity to ever holdthem responsible for their acts, especially if theyfile for bankruptcy where the government hasinsufficient knowledge or information to pursuethem while they are in bankruptcy. It would beunfair to shield debtors from all responsibility forthe cleanup of their polluting activities when thegovernment could not participate with othercreditors because it did not know about thedebtor’s contamination.

Such a result would be inconsistent withimportant purposes of both environmental andbankruptcy law. Environmental law seeks to makethose responsible for contamination assume


responsibility for its cleanup. Bankruptcy lawseeks to permit all creditors, includingenvironmental creditors, to share in the distributionof proceeds through the bankruptcy case. If somecompanies succeed in using bankruptcy to shedunknown environmental liabilities associated withindustrial activities, this may influence the debtors’competitors to file for reorganization, to obtain thesame business advantage.

Governments, on the other hand, oncecontended that cost recovery claims do not ariseuntil incurrence of the particular costs. Theproblem that courts found with this approach isthat the government could, in theory, control whena claim arose and became dischargeable bycontrolling the timing of cleanup activities. The courts have adopted a middle ground.Under the prevailing case law, where there has notyet been any response action or environmentaltesting, or where the government has not yet tied adebtor to a site, the government's CERCLA claimhas not arisen. In In re Jensen, 995 F.2d 925 (9thCir. 1993), the Ninth Circuit held that, indetermining when an environmental claim ariseswithin the meaning of the Bankruptcy Code, thepolicy goals of both the bankruptcy laws and theenvironmental laws must be considered,harmonized, and balanced. If a claim is not withinthe fair contemplation of the parties, so that thereis a fair opportunity to adjudicate it in thebankruptcy case, it would be unfair andinconsistent with the environmental laws to bar allrecovery on the claim. Similarly in In re Chicago,Milwaukee, St. Paul & Pacific R.R., 3 F.3d 200(7th Cir. 1993), the Seventh Circuit held that aCERCLA claim arises when the claimant can tiethe bankruptcy debtor to a known release that theclaimant knows will lead to CERCLA responsecosts, and also when the claimant has conductedtests about the contamination problem. See also Inre Crystal Oil Co., 158 F.3d 291 (5th Cir. 1998)(adopting the Seventh Circuit’s test); In reNational Gypsum Co., 139 B.R. 397 (N.D. Tex.1992). But see In re Chateaugay Corp.,(LTV),944 F.2d 997 (2d Cir. 1991) (discharge of costrecovery claim can occur if there were pre-petitionreleases or threatened releases of hazardoussubstances). Whether sampling or testing of a

contaminated site has occurred is important underthis standard, because without testing, thegovernment would not have a fair opportunity toparticipate in the bankruptcy case, as debtorswould object to an environmental claim asspeculative.

The emerging “fair contemplation” test, forwhen environmental claims arise in bankruptcy, isconsistent with non-environmental mass tort caseswhere bankruptcy courts have also, on grounds offairness, limited the reach of the Bankruptcy Code.See In re Fairchild Aircraft Corp., 184 B.R. 910,922-27 (Bankr. W.D. Tex. 1995) (Courts "findthemselves having to reconfront the competingconcerns of [fresh start] and of assuring that theentire process is fair. . . Not every conceivableobligation finding its source in the debtor's pre-bankruptcy past is necessarily an obligation thatcan be fairly handled by the bankruptcy process."),vacated on other grounds, 220 B.R. 909 (Bankr.W.D. Tex. 1998). A contrary rule of law, assought by many debtors, would effectively deprivevictims of wrongdoing with any fair opportunityfor a day in court. Such a result would furtherweaken the legitimacy of the bankruptcy systemfrom the viewpoint of a populace which mayalready view the system as unfairly skewed infavor of debtors.

What Ongoing Responsibilities Do DebtorsHave for Property They Continue to Own?

Even if an environmental claim for acontaminated site has arisen, a debtor andreorganized debtor (or buyer of a debtor’sproperty) still have an ongoing responsibility fortheir property for ongoing releases that can causean environmental claim to spring anew. This isbased on the debtor’s (or buyer’s) post-bankruptcyownership (or operation) of property. See In reCMC Heartland Partners, 966 F.2d 1143 (7thCir. 1992). For response costs incurred during thebankruptcy case, the Government would have anadministrative priority claim. See Pennsylvania v.Conroy, 24 F.3d 568 (3d Cir. 1994); In reChateaugay Corp. (LTV), 944 F.2d 997 (2d Cir.1991), In re Smith-Douglass, Inc., 856 F.2d 12(4th Cir. 1988); In re Wall Tube & Metal


Products Co., 831 F.2d 118 (6th Cir. 1987).Further, a reorganized debtor or buyer of propertywould be discharged only for response costsincurred pre-bankruptcy. A new claim arises forpost-bankruptcy response costs. The rationale forthis rule is the long held rule of law that no one canmaintain a nuisance. A current property ownermust deal with ongoing problems on his property,even if caused long before filing a bankruptcypetition. See 42 U.S.C. § 9607(a) (providing thatcurrent owners of facilities are liable for cleanup oftheir property).

Are Environmental Obligations Dischargable inBankruptcy?

Another important issue in environmentalbankruptcy cases is whether a debtor can use itsbankruptcy as a shield against having to complywith legal obligations, as opposed to monetaryclaims, under environmental law. The BankruptcyCode defines a "claim" to include a “right to anequitable remedy for breach of performance if suchbreach gives rise to a right to payment, whether ornot such equitable remedy is reduced to judgment,liquidated, fixed, contingent, matured, unmatured,disputed, legal equitable, secured, or unsecured.”11 U.S.C. § 101(5).

Plainly prohibitory injunctions do not fallwithin this definition. As to mandatory injunctionssuch as cleanup orders, the key question is whethera breach of a cleanup order gives rise to a right topayment within the meaning of this definition.Governments have, with some success, contendedthat a breach of a cleanup order does not give riseto a right to payment within the meaning of thisdefinition. A refusal to perform a cleanup actiondoes not give rise to an alternative right of paymentinstead of dealing with the pollution. In otherwords, a polluter may not pay the governmentinstead of cleaning up the hazards for which it isresponsible. Accordingly, in In re TorwicoElectronics, Inc., 8 F.3d 146 (3d Cir. 1993), theThird Circuit held that New Jersey's equitableremedy for requiring the cleanup of contaminatedproperty was not a “dischargeable claim” inbankruptcy, and that such injunctive obligationssurvive. The debtor's liability for cleanup of its

formerly leased property was an ongoingregulatory obligation, which did not run with theland, but run[s] “with the waste.” Id. at 151; seealso Ohio v. Kovacs, 469 U.S. 274 (1985)(injunction to clean up a hazardous waste site gaverise to a right to payment against the former siteowner, where a receiver had been appointed pre-petition to take control of the site, therebydispossessing the owner, and where the State ofOhio was found to be seeking money to clean upthe site); In re Chateaugay Corp. (LTV), 944 F.2d997 (2d Cir. 1991) (cleanup obligations would notbe considered claims just because they required theexpenditure of money and would not be consideredclaims if intended to deal with ongoing pollution);In re Industrial Salvage, Inc., 196 B.R. 784, 787-88 (S.D. Ill. 1996) (debtor must comply withenvironmental closure obligation wheregovernment has taken no action to transformclosure obligation to a right to payment); RoxseHomes, Inc. v. Roxse Homes Ltd. Partnership, 83B.R. 185 (D. Mass. 1988) (debtor must complywith pre-petition order for specific performance).

This argument has had greatest success understatutes such as the Resource Conservation andRecovery Act ("RCRA"), 42 U.S.C. §§ 6901 etseq., where the government generally does not haveany right to a monetary recovery. Even where thegovernment may have an independent preexistingright to clean up the pollution and seek recovery,as under CERCLA, that independent right does notarise from a breach of the cleanup order. Thepolluter may not avoid complying with a CERCLAcleanup order by offering money, just as sellers ofreal estate cannot avoid specific performance bypaying damages or penalties after a breach. Theuse of bankruptcy law should not provide asubstantive right that does not exist under non-bankruptcy law. If non-bankruptcy law providesfor requiring polluters to remedy theircontamination, as opposed to paying money,bankruptcy law should not provide a haven forpolluters to avoid these responsibilities.Nevertheless, it should be kept in mind that thecase law on when environmental obligations areclaims is much more favorably developed forstatutes like RCRA than CERCLA-like statutespermitting cost recovery.


Proposal of the National BankruptcyCommission on Future Claims

The existing law does not dischargereorganized debtors from liabilities that do not yetexist during their bankruptcy case. 11 U.S.C. § 1141(d)(1)(A). The reason for this is, if a claimhas not yet arisen, providing a fair opportunity forthe claim holder to prove his or her claim and sharein the proceeds distributed in the bankruptcyproceeding is usually impossible.

The National Bankruptcy Commission hasproposed to Congress that it change this long-standing feature of bankruptcy law by permittingdebtors and buyers of debtors’ property orbusiness to obtain a discharge of certain types ofmass future claims that are capable of estimation.National Bankruptcy Review Commission FinalReport at 315-51 (1997). A future claimsrepresentative would be appointed to protect theinterests of the future claim holders. The rationalebehind the Commission's proposal is that, incertain cases, it is in the future claim holders' bestinterest to permit a business to continue operationby providing some relief from the prospect offuture suits. Continued operation may maximizethe return for both existing and unknown futureclaimants in circumstances where an otherwiseprofitable business could not continue in operation.On the other hand, permitting treatment anddischarge of future claims in bankruptcy, withoutthe actual participation of the affected claimholders, is at odds with concepts of due processand fundamental fairness. There is a significantrisk that debtors might abuse a future claimprovision to try to obtain liability baths while inbankruptcy without adequately providing for thedischarged future claims of unknown absent claimholders.

The Commission's Report recognizes the needto balance these competing considerations and limitthe application of its proposal to limited factualcontexts involving only certain mass tort and masscontract claims. However, for reasons beyond the

scope of this Article,^ the Commission's actualproposal is much broader than claimed orwarranted, and falls short in adequately protectingthe rights of future claim holders.

Any change in the law, with respect to futureclaims, would potentially have drastic impacts onthe government’s ability to protect against publichealth and the environmental threats caused bycorporate debtors which are ongoing dangersunfairly contemplated at the time of a debtor’sbankruptcy. The Commission's Report doesappropriately recommend that mass future claims“not encompass police and regulatory causes ofaction” or interfere with the "obligation to complywith applicable laws nor the Government’s abilityto act in its police and regulatory capacity,[because] police and regulatory causes of actionare of a different nature than mass future claims.”National Bankruptcy Review Commission FinalReport at 329.

A clear police and regulatory exception to thedefinition of mass future claim is essential to theprotection of public and health safety, wherecontinuing unsafe conditions or public nuisances

^ The Department of Justice hasrecommended to Congress that any future claimslegislation provide appropriate safeguards to the rightsof future claim holders, including that (1) in order fora plan of reorganization to be confirmed in a chapter11 case treating future claims, the future mass claimsrepresentative must vote for the Plan and the Courtmust specifically find that the Plan’s funding of futureclaims is adequate to ensure that future claims will befairly treated; (2) provision of a binding treatment offuture claims should not be permitted unless the debtorhas made available or disclosed to the future claimsrepresentative and all known holders of future claimsall non-privileged information that it has or is awareof that may relate to a fair estimation of future claims;(3) treatment of future claims should be permitted onlywhere a court finds that advance resolution of massfuture claims is the only alternative if the debtor is tobe able to reorganize or sell the company as anongoing concern; and (4) the debtor's plan mustdedicate at least 51 percent of future profits or 51percent of the reorganized debtor’s stock to paypresent or future mass claimants.


may predate a debtor’s emergence frombankruptcy. Unlike unidentified future mass tortvictims, the government is known, and can act witha debtor to protect its own mutual interests ifnecessary and appropriate. Without an expressexception for actions or proceedings by agovernmental unit to enforce its police orregulatory power, adding future claims to thescope of the Bankruptcy Code would createpotentially gaping loopholes in many federal andstate environmental and non-environmentalregulatory programs, including worker safety laws,housing laws, aviation and motor vehicle safetylaws, consumer safety laws, labor laws, health careprovider laws, mining laws, civil rights laws,farming laws, food and drug laws, pension laws,immigration laws, admiralty laws, and export andtrade laws.

Thus far, Congress has not taken any action onthe Bankruptcy Commission’s recommendation onfuture claims. They have rejected or substantiallychanged many of the Bankruptcy Commission’sother significant proposals.

Rules Committee Proposal to Improve Debtors’Environmental Disclosure

The Advisory Committee on Bankruptcy Rulespreliminarily approved a proposal requiring thatbusiness debtors provide information onenvironmental matters on their bankruptcyschedules. Under the proposal, new question 25 onthe Official Form Statement of Financial Affairsprovides disclosure by all site business debtors forwhich the government notified, in writing, ofpotential liability or violations of law; all sites thatdebtors have notified the government of releases ofhazardous material; and all of the debtor’s judicialor administrative environmental cases^. In addition,Exhibit C to the Debtor’s Petition provides for the disclosure of allproperty owned by the debtor that poses a threat ofimminent and identifiable harm to public health or

safety. Final approval will follow a publiccomment process. Although these proposals fail toseek information about some categories of debtors’potential environmental liabilities, the proposalwould be a significant and welcome improvement.The new information would enable United StatesAttorneys’ offices (USAOs), which are oftenserved with bankruptcy papers without beinginformed of the nature of any potential federalinterest, to identify bankruptcy cases that shouldbe monitored to protect the public interest underthe environmental laws.

Identifying Objectionable Proposed Plans ofReorganization and Sales of Property inEnvironmental Bankruptcy Cases

The Environment Division receives copies ofvery few proposed Plans of Reorganization orproperty sales under the Bankruptcy Code, 11U.S.C. § 363, and relies on the EPA and theUSAOs to identify illegal proposals that threatenthe public’s interest in a clean environment.Sometimes United States Attorney’s Offices arethe only recipients. Too often, overzealous debtorsbury improper proposals in the middle ofvoluminous documents that, not surprisingly, mayescape anyone’s attention. Carefully scrutinize thelegality of any Plan or 363 Motion in a caseinvolving a debtor with industrial activities thatmight involve releases of contamination orenvironmental regulation. Some tips for findingimproper proposals follow:

1. Look for language referring to discharge,release, or sales free and clear of claims. Whilesome discharge and sale free and clear is oftenappropriate, check the language to make sure it isnot broad. One debtor went as far as to propose aspart of a Section 363 sale of property that there bea court-ordered moratorium on environmentalenforcement at the property for three years! Ofcourse, it claimed that such a moratorium wouldenhance the value of the estate to creditors. If wehad not successfully objected, the buyer wouldhave contended that it was the only entity in thecountry that did not have to comply with the CleanAir Act, Clean Water Act, and other important

Â separate proposal will require debtors toindicate in their notices to United States Attorney’soffices the specific agencies that are creditors of thedebtor.


environmental statutes protecting public health andsafety.

2. As discussed above, the Debtor or buyer ofdebtor’s property is not entitled to be relieved ofliability as the owner or operator of property. Thatliability springs anew based on a reorganizeddebtor or buyer’s post-acquisition ownership oroperation, although the debtor may have causedcontamination long ago. In every case which wehave identified a possible improper attempt tosecure such a release of liability, the movants haveagreed to clarify language along the followinglines: “Nothing in [the Court’s Order approvingPlan or Sale] shall be construed as releasing orrelieving any entity of any liability or responsibilityunder any environmental law as the owner oroperator of property that the entity owns oroperates after the effective date of this Order.”Look for language that tries to release a debtor ofall liability relating to its “past conduct” or “pastacts.” Such language is improper, because theBankruptcy Code only releases claims that arise bythe date of confirmation of a Plan. A Plan may notrelease claims that have not arisen such asenvironmental claims that are not within the faircontemplation of the parties. Likewise, a Plan canonly discharge claims (rather than injunctiveobligations) to comply with the law, such ascleanup orders. Plans that purport to discharge all“liability” may be illegal. Look for any attempt toenjoin the government. Injunctions areextraordinary remedies that may not be appropriateagainst the government. Look for language thatattempts to release non-debtors (such as officers,directors, employees, parents, affiliates, lenders,other creditors) as part of a Plan ofReorganization. The Bankruptcy Code’s dischargeprovisions do not apply to non-debtors. See 11U.S.C. § 524(e).

ABOUT THE AUTHOR ë Alan S. Tenenbaum is a Senior Attorney withthe United States Department of Justice'sEnvironmental Enforcement Section (EES). He hasbeen with EES since 1988 and supervises orhandles many of DOJ’s environmental bankruptcycases for the Environmental Protection Agency(EPA) and other client agencies. He works withEPA’s Bankruptcy Workgroup and is theEnvironment Division representative on theDepartment of Justice Bankruptcy Workgroup,which comments on proposed bankruptcylegislation. He is a 1981 graduate of Harvard LawSchool. a


For $800 and the Deed to YourHome— Bankruptcy Foreclosure ScamsTarget Distressed Home OwnersJane Limprecht, Public Information OfficerExecutive Office for United States Trustees^Washington, D.C.

Attention Home Owner: Save yourhomes— Stop foreclosure now! Beforeyou file bankruptcy call me first. Werefinance mortgages regardless of your

credit history! Unless your home has been listed for

foreclosure, you have probably never received anadvertisement like this in your mailbox, but youmay have seen similar solicitations printed in thelocal newspaper or posted on the grocery storebulletin board. These solicitations may signal that alucrative type of fraud–-the bankruptcy foreclosurescam–-has established a foothold in yourcommunity.

In May 1998, the Bankruptcy ForeclosureScam Task Force of the United States BankruptcyCourt for the Central District of California issuedits final report^^ describing several bankruptcy

foreclosure scams operating in the region;explaining how they hurt bankruptcy courts,lenders, and homeowners; and recommending waysto combat them in the Central District ofCalifornia.

Bankruptcy foreclosure scams, however,should not be dismissed as solely “an L.A.problem.” The most complex and lucrativebankruptcy foreclosure scams have arisen in majormetropolitan areas on the West Coast; in August,one Los Angeles area perpetrator was sentenced to71 months’ imprisonment and ordered to pay morethan $72,000 in restitution for running a scaminvolving more than 200 fraudulent bankruptcyfilings. However, Mom-and-Pop operations areappearing even in mid-size Midwestern cities.Some perpetrators are not only reaching acrossstate lines to recruit local “customerrepresentatives,” but are also seeking referralaffiliations with local consumer bankruptcyattorneys.

Reports from United States Trustee Programpersonnel around the country make clear thatbankruptcy foreclosure scams are geographicallywidespread, and varied in their methodology.

Types of Foreclosure Scams

“For the cost of a bankruptcy filing fee, adebtor can immediately obtain one of the mostpowerful injunctions available under Americanlaw: the automatic stay,” the foreclosure scam taskforce pointed out. The task force report describedbankruptcy foreclosure fraud as the practice offiling for bankruptcy to delay or defraud creditors,

^This article is reprinted here with thepermission of the American Bankruptcy Institute(ABI). For regular updates of bankruptcy legislativeactivity and other insolvency news, as well as ABImembership information, visit ABI World athttp://www.abiworld.org. All views expressed in thisarticle are the author’s and do not necessarily representthe views of, and should not be attributed to, theUnited States Department of Justice or the UnitedStates Trustee Program. The author wishes to thank allof the United States Trustee Program employees whoprovided invaluable information and assistance in thedevelopment of this article.

^^Final Report of the Bankruptcy ForeclosureScam Task Force, United States Bankruptcy Court,Central District of California, May 1998 (“Task Force

Report”). The text of the report is posted on theAmerican Bankruptcy Institute’s web site atwww.abiworld.org.


without intending to comply with the requirementsfor obtaining a bankruptcy discharge or completinga repayment plan.

The foreclosure scam most commonlyassociated with the West Coast is the fractionalinterest transfer. Typically, a partialinterest— perhaps 5 or 10 percent— in propertyheld by a homeowner facing foreclosure istransferred to a real or fictional entity already inbankruptcy. Because a bankruptcy debtor thenholds the property interest, the original owner’screditor cannot foreclose until the bankruptcy courtlifts the automatic stay.

Some scams involve fractional intereststransferred with the knowledge of the originalproperty owner. Often, however, the original ownerfirst transfers the property to the perpetrator of aforeclosure scam, who then transfers the fractionalinterest without the original owner’s knowledge.Sometimes a property is moved from case to caseas the stay is lifted; one residential property waslinked to 24 different bankruptcy cases.^

The task force report explained how onehomeowner facing foreclosure was persuaded by ascam perpetrator to sign deeds of trust and grantdeeds transferring fractional interests in herproperty. The homeowner paid the foreclosureconsultant several hundred dollars per month so shecould stay in her home. The fractional interestrecipients included apparently fictitious individualsand homeless persons recruited for a fee toparticipate; eight recipients filed for bankruptcyone after the other. Each filing stayed foreclosureon the property, causing a 10-month delay betweenthe first filing and the completed foreclosure.

Many other variations of bankruptcyforeclosure fraud are surfacing around the country.Probably the most widespread involves the use offoreclosure notices to identify individuals facing theloss of their homes. The scam perpetrator contactsthe homeowner, advertising “mortgage assistance”or “foreclosure counseling.” The scam promises towork out the homeowner’s problems with the

mortgagee or to obtain refinancing for an up-frontfee typically ranging from $250 to $850. Theperpetrator may direct the home owner to “fill outsome forms,” including a blank bankruptcypetition, or may collect the information needed tocomplete a petition later. The perpetratorsubsequently files a bankruptcy petition in thehomeowner’s name. The bankruptcy petitioninvokes the automatic stay, the imminentforeclosure is postponed, and the homeowner stopsreceiving collection calls and letters.

Usually, the perpetrator does not tell the homeowner about the bankruptcy petition, insteadconvincing the homeowner that foreclosure activityhas ceased because mortgage problems have beenworked out. The perpetrator may tell the homeowner to ignore any notice from the court. Thehome owner may even be told that the perpetratorhas gone to court on the homeowner’s behalf.When no one appears at the Section 341 meeting,the case is dismissed, the foreclosure goes forward,and the home is lost.

Permutations of this scam include theperpetrator’s collecting monthly mortgagepayments from the homeowner, falsely stating thatthey will be forwarded to the mortgagee. Eachdefrauded homeowner pays not only the up-frontfee for “services,” but also hundreds or thousandsof dollars in mortgage payments.

In another increasingly common alternative, thescam perpetrator convinces the homeowner to quit-claim the residence to the perpetrator or to sell theresidence for a nominal fee such as $1. The homeowner agrees to transfer title because he or she haslittle or no equity in the property. The perpetratorcharges the homeowner “rent,” a “consultant’sfee,” or “management fee” to stay in the residencewhile the mortgage problems are worked out, afterwhich the homeowner will be able to “apply forrepurchase” of the property or share the profits ifthe perpetrator sells the property.

It costs money for the perpetrators to file thesebankruptcy cases. To avoid bankruptcy filing fees,some perpetrators transfer an interest of the homeowner’s quit-claimed property into the name of anexisting bankruptcy debtor— perhaps a Chapter 11business debtor across the country— in a variationof the fractional interest scam. Typically, the

^ “The Foreclosure Must Go On; L.A.Bankruptcy Judges Give the Hook to ‘Artful Dodger’Debtors,” 84-May A.B.A.J. 32.


debtor learns that a property interest has beentransferred into its bankruptcy estate when it iscontacted by counsel for the property owner’ssecured creditor, who has learned it cannotforeclose because a bankruptcy debtor owns theproperty.

Detecting and Reporting Scams

Bankruptcy foreclosure scams can beexceptionally difficult to detect because the casesare usually dismissed for failure to participate,leaving no sign of the defrauded home owner.Many cases go no further than the Section 341meeting, so Chapter 7 and 13 trustees form the“front line” of foreclosure scam detection.

Warning signals include: a proliferation of prose petitions filed with no schedules; a series ofdebtors with similar petitions or schedules; debtors’failure to show up at the Section 341 meeting;multiple debtors represented at the meeting by abankruptcy petition preparer or other non-attorney;debtors who attend the meeting but are confusedabout whether they are in bankruptcy; and a rash ofdebtors who clearly lack sufficient income to funda Chapter 13 repayment plan.

Bankruptcy judges are another valued sourceof information. Nationwide, judges have flaggedsuspicious cases. One judge noticed that anattorney was filing many cases that were not beingproperly serviced. This can suggest that a scamperpetrator is either referring home owners to anattorney to help them in filing bankruptcy, orsending completed bankruptcy papers to theattorney to file in court with or without the homeowners’ knowledge. Scam perpetrators use thelatter method to avoid liability for violating 11U.S.C. § 110's restrictions on bankruptcy petitionpreparers.

In addition, secured lenders can flagforeclosure scams because they have unique accessto relevant documentation. A secured lenderreceives all of the bankruptcy cover sheets on aparticular piece of property. These documents mayshow that different debtors are all linked to theproperty. The secured lender may be the only entity that can pull together thisrevealing information.

Consumer bankruptcy attorneys can also helpidentify foreclosure scams. A home owner whosebankruptcy case is filed by a scam perpetrator anddismissed for lack of participation may have to filefor bankruptcy again. A client’s story told to abankruptcy attorney may reveal that the client isthe victim of a bankruptcy foreclosure scam.

Debtors’ counsel should be aware thatperpetrators seek out attorneys— sometimesinexperienced attorneys without a well-developedreputation in the bankruptcy community— and offercase referral. Frequently, the attorney is expectedto kick back part of the legal fee to the perpetratorin exchange for the referral.

Victimized homeowners report some scams,although many homeowners never realize they weredefrauded. A victim who complains to theperpetrator after foreclosure occurs— assuming theperpetrator is still operating in the area— may betold that the mortgage problems were too serious towork out or the homeowner’s credit was too bad toobtain refinancing. Sometimes, however, receipt ofnotice from the bankruptcy court prompts thehomeowner to call the court, the United StatesTrustee, the case trustee, or a bankruptcy attorney.Homeowners who apply for credit have broughtother complaints and discover a bankruptcy filinglisted on their credit records.

Foreclosure scams are most likely to flourishand least likely to be detected in judicial districtsinundated with bankruptcy filings. If the privatetrustee can quickly identify a case as improperlyfiled and obtain its immediate dismissal, avoiding a6- to 12-month delay in foreclosure, a homeownermay be more likely to complain about a “mortgageconsultant’s” poor service. However, with highbankruptcy case loads causing substantial delays inrelief from the stay, some defrauded homeownersdecline to report the scams, apparently decidingthat the extra months of living in their homes offsettheir losses.

The most dramatic method of detectingbankruptcy foreclosure scams is throughundercover investigations like “Operation Churn‘N Burn,” a 1995 sting that resulted in sevenconvictions. In Churn ‘N Burn, fictitiousforeclosure actions were filed in the county court.Scam perpetrators zeroed in on two apparently


distressed homeowners, unaware that the “spouses”were FBI agents and their “home” was provided bythe United States Department of Housing andUrban Development.^

Nevertheless, undercover operations targetingbankruptcy fraud are rare. In combatingbankruptcy foreclosure fraud, the United StatesTrustee Program relies upon tipoffs fromparticipants in the bankruptcy system— thetrustees, bankruptcy judges, bankruptcy clerks,secured lenders, and attorneys.

Who Are the Victims?

Bankruptcy foreclosure scams claim manyvictims, but the one that suffers the greatest harmis the bankruptcy system. The task force reportnoted that bankruptcy cases filed solely for delayrequire more clerical and judicial time and attentionbecause they usually involve more relief from staymotions, orders to show cause, and motions andorders to dismiss. Nationwide, foreclosure scamsmay cause the inappropriate filing of thousands ofbankruptcy cases.

Lenders also suffer from foreclosure scams,receiving no payments for months or years whilethe repeated transfers and bankruptcy filingsinvoke the automatic stay. When the case involvesa federally insured mortgage loan, such as aVeterans Affairs or Federal HousingAdministration loan, the government is ultimately avictim of bankruptcy fraud because it must coverthe mortgagee’s loss.

Homeowners, who place their trust in scamperpetrators, can end up financially devastated.“We’ll help you keep your piece of America,”promised advertisements distributed by Dallas“consultant” Musu Cuch Ketter, who wassentenced to 24 months’ imprisonment and ordered

to pay $58,000 in restitution for bankruptcy andbank fraud. Defrauded homeowners paid Ketterfrom $2,000 to $15,000 in fees and mortgagepayments; around 30 homeowners are believed tohave lost their homes due to her activities.

Varied Remedies

Foreclosure scams look like easy money andoften reach huge proportions. A successful criminalprosecution sends the message that scams will notbe allowed to flourish. Gilfert Jackson of LosAngeles was sentenced to 71 months’ imprisonmentand ordered to pay more than $72,000 in restitutionfor operating a massive bankruptcy foreclosurescam involving more than 200 fraudulentbankruptcy filings.

Attorneys and analysts from the United StatesTrustee Program work closely with federal, state,and local prosecutors in cases involving bankruptcyforeclosure scams. United States Trustee Programpersonnel not only put together the initial referrals,but also assist in the investigation and developmentof the case. Criminal cases frequently involvecharges under 18 U.S.C. § 157, which permitsfines and imprisonment for the use of thebankruptcy system as part of a scheme or artificeto defraud. Alternatively, state and local authoritiesmay bring charges under state anti-fraudprovisions.

Bankruptcy fraud rarely ranks first amongcriminal prosecution initiatives because of limitedinvestigative and prosecutorial resources. Thebankruptcy foreclosure fraud task force asserts that“the criminal process is too slow and too limited tobe the primary line of defense against bankruptcyfraud.” The amount of loss per case is small,witnesses often move without leaving forwardingaddresses, paper trails are hard to follow, andpositive identification can be elusive.

Thus, exploring other ways to fight bankruptcyforeclosure scams is crucial. United States Trusteeshave successfully litigated civil actions againstforeclosure scam perpetrators under 11 U.S.C. §110. In addition, active enforcement of stateunauthorized practice of law provisions, and avigilant state bar, can create an inhospitable

^ “Nine Indicted by U.S. for BankruptcyFraud; Foreclosures Key to Alleged Scam,” ChicagoTribune, May 19, 1995, 1995 WL 6208323; “NineCharged in Bankruptcy Fraud Case,” Chicago Sun-Times, May 20, 1995, 1995 WL 6654358; “JusticeAnnounces Indictments of Nine, Including Lawyer,For Bankruptcy Fraud,” BNA’s Bankruptcy LawReporter, May 25, 1995, p. 607.


atmosphere for petition preparers and lawyers whowould engage in unlawful or unethical behavior.

The bankruptcy foreclosure fraud task forcemade several suggestions for combatingbankruptcy foreclosure scams, including amendingSection 362 explicitly to authorize the bankruptcycourt to enter an “in rem” order— that is, an orderstating that a lift-stay order will remain effective asto a particular property in any future bankruptcycase, without the creditor’s seeking further relieffrom the stay. The National Bankruptcy ReviewCommission made a similar recommendation in itsfinal report,^ and both major bankruptcy reformbills^^ pending before the 105th Congress containlanguage to this effect. This position is not withoutcontroversy, however; despite the task force’s view,even some bankruptcy judges in the CentralDistrict of California believe they lack jurisdictionto issue such orders.

The task force also advocated amendingBankruptcy Rule 5005 to let the bankruptcy clerkreject a bankruptcy petition if the filer does notprovide identification. This recommendation wasintended to prevent scam perpetrators from filingpetitions without the named debtors’ consent orwith the use of false names or Social Securitynumbers. The United States Trustees are alsoconsidering steps they may take to protect againstthese abuses, including requiring identification atthe Section 341 meeting.

Conclusion

Bankruptcy foreclosure fraud is a growingproblem that threatens the integrity of thebankruptcy system as it takes advantage of familiesin distress. The United States Trustee Program isworking hard to identify bankruptcy foreclosurescams around the country and to act throughcriminal referrals and civil suits, but we need helpfrom members of the bankruptcy community.

The United States Trustee Program welcomesinformation that will help detect bankruptcyforeclosure scams, and is indebted to those trustees,judges, clerks, secured lenders, bankruptcyattorneys, and private citizens who reportsuspicious fact patterns. We also appreciate theefforts of federal and state law enforcementauthorities who target these operations. We willcontinue to coordinate with all participants in thebankruptcy system to eradicate this destructiveform of fraud. ò

ABOUT THE AUTHORë Jane Limprecht has served as the PublicInformation Officer for the Executive Office forUnited States Trustee since September 1997.Before that, she worked as a legal editor andreporter for BNA’s Bankruptcy Law Reporter. Shereceived her Juris Doctor from the University ofWisconsin Law School in 1980, and worked forseveral years for the state legislature in Madison,Wisconsin, before moving to Washington, D.C. a

^Bankruptcy, the Next Twenty Years, NationalBankruptcy Review Commission Final Report, October20, 1997, pp. 281-87.

^^HR 3150 at § 121; S 1301 at § 303.


Civil Remedies for Bankruptcy FraudAntonia G. DarlingAssistant United States TrusteeSacramento, California

Estimates of the percentage of bankruptcycases that involve some sort of fraud,whether outright criminal fraud or themore ambiguous “abuse” of the

bankruptcy laws, range from 3 percent to 50percent. This disparity shows how hard it is topinpoint the actual number of fraudulent filings.However, serious fraud occurs in enough casesthat it must be addressed to maintain the integrityof the bankruptcy system. Criminal prosecution ofbankruptcy fraud is the preferred method ofaddressing the problem, but reality tells us that thecriminal system can only handle some of the casesuncovered.

For cases in which criminal prosecution willnot occur at all or will not occur until a later date,litigants can choose from any number of civilremedies. First, the objective of the fraud, orbankruptcy “prize,” should be identified. Then aremedy can be selected that will effectively denythe prize sought. Most of these remedies areeffective only against debtors who engage infraudulent behavior, not against creditors or otherparties who attempt to commit fraud through abankruptcy case. Creditors and others are harder toreach through use of the civil powers.

The most important prizes in bankruptcy are:(1) the automatic stays, which prevent a creditorfrom pursuing any action against the debtor or theproperty of the estate to collect or enforce a pre-petition debt; (2) the discharge, which removes thedebtor’s obligation to pay a debt; and (3) creditorinertia, which causes many creditors to write off adebt when they find a bankruptcy case is filed andto abandon collection efforts even if the case issubsequently dismissed. This article contains adiscussion of the major civil remedies availableand the types of fraudulent activities bestaddressed by each remedy.

Dismissal of the Case

This is the most simple and efficient remedy. Arequest for dismissal of a case is brought bymotion. The grounds are broad in all BankruptcyCode chapters, which require only a showing ofcause.^ The effect of dismissal, unless otherwiseordered by the court, is to put matters back as theywere before the filing.^^ The court can also dismissthe case with prejudice or make a specific findingthat the debts listed cannot be discharged even in asubsequent Chapter 7 case.^^^

This remedy can be especially effective in thefollowing instances: (1) where the fraudulentconduct is aimed at obtaining a discharge beforepermitted by law or at using the automatic stay tothwart an otherwise proper purpose outsidebankruptcy, such as to avoid paying judgments,alimony or child support or to stop evictionproceedings or lawsuits; (2) when the case wasfiled without the knowledge or consent of one orboth debtors; or (3) when the debtor refuses tocooperate or provide information.

Objection to Dismissal

Conversely, objecting to a debtor’s attempt todismiss a case can also be an effective tool incombating certain types of fraud. A debtor mayattempt to dismiss the case when someone isgetting too close to the truth or is about to discoverinformation that might reveal fraudulent activities.The debtor hopes that a dismissal will diminishinterest in pursuing the matter. A debtor in aChapter 13 case has an absolute right to dismissthe case, if the debtor has not previously converted

^ 11 U.S.C. §§ 707, 1112, 1208, and 1307

^^11 U.S.C. § 349

^^În re Leavitt, 209 B.R. 935 (Bankr. 9th Cir1997); In re Walker, 102 B.R. 612 (Bankr. N.D. Ohio1989)


the case. If there is good evidence of fraudulentbehavior, however, some judges are willing to takecreative action such as entering an orderconverting the case to Chapter 7 and making theconversion nunc pro tunc to a date before theattempted voluntary dismissal.

Denial or Revocation of Discharge

The discharge is most frequently the object ofdesire in cases of concealed or fraudulentlytransferred assets. An objection to or revocation ofthe discharge must be pursued by filing anadversary proceeding, which is a lawsuit within thebankruptcy case. Unless the court extends thedeadline, an action to deny a discharge must beinitiated within 60 days from the first date set forthe 341 meeting. The court strictly follows thisdeadline, so it must be watched carefully. Thegrounds for a denial of discharge are quite broadand include not only the debtor’s fraudulentconduct in this case or a related case, but also thedebtor’s failure to keep adequate books andrecords, failure to explain the loss or diminution ofassets, failure to turn over records to the trustee orUnited States Trustee, destruction of books andrecords or assets of the estate, and refusal to obeya court order.

In contrast, an action to revoke the dischargein a Chapter 7 case must be filed within one yearof the entry of the discharge. The information thatforms the basis of the action must not have beenknown before the entry of the discharge. Thegrounds to revoke a discharge are much morelimited than the grounds to deny a discharge.Grounds for revocation are that the debtor eitherused fraud to obtain the discharge, came intopossession of estate assets and failed to turn themover to the trustee, or failed to obey an order of thecourt.

Since the discharge is what the debtor usuallywants, simply moving to extend the deadline toobject to the entry of discharge is an effective wayto keep the pressure on a debtor to cooperate andreveal assets that might not have been scheduled.

In a Chapter 11 case the only way to revokethe discharge is to move to revoke confirmation ofthe reorganization plan. The order revoking plan

confirmation also serves to revoke any dischargegranted.^ An adversary proceeding to revoke planconfirmation must be brought within 180 days ofthe entry of the confirmation order,^^ and the onlybasis for the action is that the order was obtainedthrough fraud.

Adversary proceedings can be complexlitigation involving heated discovery battles andtrials lasting several days to weeks. However, ifthe United States Trustee or any other party bringsan adversary proceeding to deny the discharge orrevoke plan confirmation, discovery will often leadto a wealth of information to support criminalprosecution.

United States Trustees have expressed theconcern that success in obtaining denial of adebtor’s discharge can rule out any chance ofcriminal prosecution, as the case will becomeunappealing to a jury. This should not be the case.A successful action for denial or revocation ofdischarge will have fleshed out the evidence and allprobable defenses, making it easy for the AssistantUnited States Attorney to assess the merits of thecase. Denial of discharge does not put money backin the hands of creditors, who will probably nevercollect what they are owed. Criminal prosecutionof these cases serves as an effective deterrent forall debtors who think they can keep a “littlesomething extra,” be it a car, house, officebuilding, or business. Criminal prosecution alsohelps dispel the public perception that everyone inbankruptcy hides assets and gets away with it.

Relief from Stay In Rem

Generally, when a creditor wishes to take anaction against a debtor that the automatic staywould normally prohibit— such as foreclosing onreal property in which the debtor has noequity— the creditor moves the bankruptcy courtfor relief from the automatic stay. Essentially thecreditor must prove that the asset has no value for

^ 11 U.S.C. § 1144(2)

^^ FED. R. BANKR. P. 7001(5)


the estate or that the creditor’s action will not harmthe estate.^

A new fraud scheme that uses bankruptcy fordefrauding a creditor is called “dumping.”Typically this scheme involves a property ownerwho wishes to stop a pending foreclosure actionbut does not want to file for bankruptcy. Theowner, either directly or through an intermediary,transfers a fractional interest in the property to anunrelated person who is already in bankruptcy,usually without the knowledge of the third person.The quit claim deed is either recorded or a phonyrecording notice is made up and sent to theforeclosing creditor, typically via fax. Theproperty owner thereby “borrows” the realbankruptcy debtor’s automatic stay.

The creditor must seek relief from theautomatic stay to proceed with the foreclosure.While the creditor always wins, the property ownercan repeat this scheme often, in multiplebankruptcy cases and judicial districts. Thecreditor is forced to spend thousands of dollars inlegal fees, and experience months of delay, becausemortgage payments go unpaid and the property’svalue declines.

Some judges have been willing to enter anorder for “relief from a stay in rem,” which statesthat relief from the stay is granted as to the pieceof property in any present or future bankruptcyfiled in that court or any other. An in rem ordercan be particularly effective in a “dumping” caseor a case where the debtor serially transfersproperty to cooperating parties who filebankruptcy cases. However, many judges arereluctant to enter an order for in rem relief fromthe stay, because the language of the order must beextremely broad to give the creditor anymeaningful relief and because there is no specificlegal authority for such an order.

In cases where the judge will not grant in remrelief, it may take other creative lawyering toaddress the harm, such as obtaining very detailedfindings in the first case and asking all subsequentjudges to adopt the findings. Some creditors haveeven continued with foreclosure without a relief

from stay order after obtaining a writtendeclaration from the real debtor stating that thedebtor has no interest in the property.

Motion to Appoint Trustee/Examiner

A trustee is not usually appointed in a casefiled under Chapter 11. Instead, the debtor ischarged with the duties of a trustee and is calledthe “debtor in possession” or DIP. Of course, thisis heaven for the unscrupulous debtor who wishesto use a bankruptcy to further some scheme. Whilethe United States Trustee monitors Chapter 11cases more directly than other cases, questionableactivities can take place unless the fraud is obviousor a knowledgeable creditor reports the problem tothe court or the United States Trustee. A Chapter11 bankruptcy can provide the perfect opportunityfor a debtor to bleed out any value in a companywhile ostensibly trying to work on a plan ofreorganization, or to transfer all the business to aparallel company, leaving nothing but the debt inthe debtor’s company.

A party in interest or the United States Trusteecan, upon motion, appoint a trustee or examiner,based upon a showing of “cause” such as fraud,deceit, or misconduct by the debtor, or a showingthat the appointment would be in the best interestsof creditors.^^ A trustee steps into the shoes of thedebtor and has all the powers of the debtor plus afew additional ones. This means the trustee canhire, fire, review all the books and records andobtain access to all information regarding thebusiness. The attorney-client privilege frequentlypasses to the trustee as well.

An examiner has more limited powers. Thecourt usually directs examiners to perform aspecific task, such as reviewing the books andrecords and determining where the money is goingor if the business is viable. An examiner canpetition the court for expanded powers if he finds aproblem or needs to do something else to performhis tasks.

^11 U.S.C. § 362(d) ^^11 U.S.C. § 1104


When the debtor is attempting to siphon offassets, transfer funds, or continue a fraudulentscheme, the appointment of a trustee or examinercan stop the conduct dead or at least expose it.

Motion to Convert/Reconvert

A Chapter 7 trustee’s primary job is toliquidate the available assets of the estateexpeditiously. Trustees are aware that not allassets are listed, so they frequently conduct someindependent investigation or pursue leads given tothem by disgruntled creditors or ex-spouses toidentify and recover unlisted assets. Mostcommonly, the unlisted asset is an intangible suchas a claim against another entity or an interest in alawsuit. However, many debtors are foolishenough to fail to list easily traceable assets such asreal property and motor vehicles. Once the trusteefinds an unscheduled asset and begins to takecontrol of it, many a Chapter 7 debtor decides towrest that control away by converting the case toChapter 13 or Chapter 11.

While a debtor has an absolute right to convertto a reorganization chapter if he has neverconverted the case, many judges feel the debtorlacks the absolute right to stay in a reorganizationchapter when the conversion was made in badfaith. Under these circumstances, the remedy is tofile a motion to reconvert the case based on thebest interests of the creditors.

Similarly, if a Chapter 11 debtor ismisbehaving or engaging in fraudulent behaviorand the court is not inclined to appoint a Chapter11 trustee, a motion to convert to Chapter 7 maybe warranted. Upon conversion or reconversion aChapter 7 trustee is appointed; the trustee shouldthen take action to recover the asset or stop themisconduct.

Motion to Compel

Being in bankruptcy is a privilege, not a right.As such, the debtor must fulfill certain duties andobligations to stay in bankruptcy. These dutiesinclude cooperating with the case trustee, if one isassigned, and with the United States Trustee, andrevealing all pertinent information to any interested

parties. The debtor is also required to appear andbe examined at the meeting of creditors and to filecomplete and accurate schedules and statements offinancial affairs.

Sometimes a debtor who is using a bankruptcyto further some fraudulent scheme does not care ifthe case stays open once he has obtained the initialstay. This debtor has no desire to reveal all, muchless be examined under oath. Such a debtor willsimply fail to appear at the meeting of creditors,fail to file the schedules or statement of financialaffairs, or fail to perform duties such as filingmonthly operating reports for an ongoing business.The debtor hopes that the court will dismiss thecase and nothing more will come of it.

The best remedy for this situation is to makesure the case is not dismissed and to use thecourt’s power to compel the debtor to perform theavoided tasks. Failure to obey a court order canresult in sanctions and imprisonment, and denial ofdischarge. Best yet, the debtor can be ordered toattend the meeting of creditors; if he does not doso, the court can order the United States Marshalto find the debtor and bring him in for themeeting.^ A debtor trying to play this game isusually surprised to see his personal escort arriveto accompany him to the 341 meeting, and evenmore surprised to learn that he stays in custodyuntil the trustee arrives to question him.

Sanctions

A debtor’s failure to perform a duty or attemptto mislead the court or interested parties can alsoresult in sanctions.^^ The idea of levying sanctionsagainst a person in bankruptcy may seem strange.However, some debtors do have assets or money,which they filed for bankruptcy to protect. Oftenthe threat of sanctions is enough to obtain at leastminimal cooperation.

Petition Preparer Regulations

^ FED. R. BANKR. P. 2005

^^ FED. R. BANKR. P. 9011; 11 U.S.C. § 105


Bankruptcy petition preparers are people whoare not licensed to practice law but who preparebankruptcy papers for a fee. The Bankruptcy Coderegulates them and requires them to discloseinformation, such as their individual name,address, Social Security number, and fee.^

In many parts of the country a petitionpreparer operation is always the front for afraudulent scheme of some sort. In other places,such as California, petition preparers are as oftenreasonably legitimate. Any petition preparer whofails to comply with the disclosure requirementsfaces possible sanctions and ultimately apermanent injunction against future petitionpreparation. The burden is on the preparer tocomply, so enforcing compliance isstraightforward and is accomplished by motion.

Petition preparers can also be a wonderfulsource of information. Because they are notlicensed to practice law, their communications withthe debtor are not privileged. If subpoenaed, theymust tell everything the debtor said and providecopies of everything they obtained from the debtoror face personal penalties.

Permanent Injunction

As mentioned above, if a petition preparerviolates the Bankruptcy Code’s disclosurerequirements or engages in other improperconduct, a permanent injunction can be sought byfiling an adversary proceeding in bankruptcy court.Preparers who take money from debtors and neverdo any work create a dilemma: no action has beenfiled in bankruptcy court, so it might be arguedthat the bankruptcy court lacks jurisdiction overthe preparer. In such instances, the defraudeddebtors are usually referred to the district attorneyor small claims court. If, however, the preparerfiles just one bankruptcy case, the unfiled casescan be added to the adversary proceeding in thefiled case.

Civil Contempt

Contempt of court is another potential remedyfor fraudulent behavior in a bankruptcy. Becausean article on civil and criminal contempt appearselsewhere in this issue, I will merely point out that,like sanctions, contempt can be coercive andpunitive to the debtor or other party using abankruptcy to commit a fraud.

Conclusion

These varied civil remedies can be used mosteffectively in tandem with a vigorous criminalprosecution program to combat bankruptcy fraudand restore the public’s faith in the integrity of thebankruptcy system. Used alone, neither civil norcriminal remedies can be as effective as acoordinated system that addresses as manyimproprieties as possible. ò

ABOUT THE AUTHORë Antonia Darling has been the Assistant UnitedStates Trustee in Sacramento, California, since1990. From 1983 to 1990 she was an AssistantUnited States Attorney in Shreveport, Louisiana,and she served as senior trial counsel forDisciplinary Enforcement for the California StateBar from 1977 to 1983. Darling received her lawdegree from Golden Gate University School ofLaw in 1977. a

^ 11 U.S.C. § 110


Civil and Criminal Contempt inBankruptcy CourtClifford J. White, IIIAssistant United States TrusteeGreenbelt, Maryland

The number of bankruptcy filings hasexploded to reach more than 1.4 millionin fiscal year 1998. Although thenumber of Chapter 11 cases has dipped,

the volume of consumer cases continues to grow.The increased filings have triggered problemsassociated with keeping order in the court. In manyjurisdictions, overworked bankruptcy judges haveto cope with thousands of diverse cases, rangingfrom complex business reorganizations to smallconsumer cases that involve pro se debtors or,worse yet, non-attorney petition preparers whoseknowledge of and respect for the rules are oftenglaringly deficient. The need has never beengreater for bankruptcy courts to insist uponprompt compliance with judicial orders that protectthe integrity of the system and the rights of allparties to a bankruptcy case.

An important tool of bankruptcy courts is thepower to hold parties in civil, or even criminal,contempt of court. By holding recalcitrant debtors,creditors, lawyers, and other parties in contempt,bankruptcy judges may impose appropriatepenalties to vindicate the authority of the court, tocompensate victims of the contemnors’ acts ofcommission or omission, and to compelcompliance with lawful court orders.

Civil Contempt

Generally, bankruptcy judges have the powerto enforce their orders by finding violators in civilcontempt of court.^ The purpose of civil contempt

may be either coercive or remedial.^^ Civilcontempt penalties are not punishments, but aremeans by which to bring a party into compliancewith a court order or to force the contemnor tocompensate the victim of his acts committed indisregard of a court order.

A court considers two factors whendetermining whether to hold a party in civilcontempt: whether the alleged contemnor had noticeof the court order and whether that person compliedwith the order. Courts have held that thecontemnor’s intent or state of mind is irrelevant.Given the seriousness of the civil contempt findingand the penalties that may be imposed on theviolator, “clear and convincing” evidence that aparty has committed civil contempt should satisfythe court. Furthermore, the court may not impose acivil contempt penalty if the contemnor can provean inability to comply (e.g., an impecuniouscontemnor cannot pay a fine) or if the underlyingorder is later found invalid.

The Federal Rules of Bankruptcy Procedure(Fed. R. Bankr. P.) set out the procedures a courtmust follow in civil contempt matters. Althoughcontempt committed in the presence of the judgemay be summarily disposed of by the judge, otherinstances of contempt require more deliberate steps.Under Fed. R. Bankr. P. 9020(b), before finding aparty in contempt, the court must issue a writtennotice that provides specific details about thealleged acts of contempt, states the time and place

Â bankruptcy court’s authority to hold aparty in contempt derives from several sources,including the inherent authority of any court to

regulate the conduct of those appearing before it, 11U.S.C. §105 (the power to issue orders necessary orappropriate to carry out the Bankruptcy Code), 28U.S.C. § 157(b) (jurisdiction of bankruptcy courts tohear “core” matters), and FED. R. BANKR. P. 9020(discussed infra.).

^^For a concise overview of civil contempt in abankruptcy proceeding, see, e.g., In re Walters, 868F.2d 665 (4th Cir. 1989).


of the hearing on the charges, and allows areasonable response time. The judge is disqualifiedfrom hearing a contempt charge involvingdisrespect or criticism of that judge.

A bankruptcy court order of contempt does notbecome effective for 10 days. The contemnor mayobject to the finding by filing exceptions with thedistrict court that will consider the matter de novo.The district court may confine itself to the recordbelow or take additional evidence. If no one filesobjections, the bankruptcy court order “shall havethe same force and effect as an order of contemptentered by the district court.” Fed. R. Bankr. P.9020(c).

Although civil in nature, penalties for civilcontempt may be severe. Civil contempt penaltieshave been imposed for a variety of violations,including failure to attend Section 341 meetings,failure to disgorge fees, and violation of othercourt orders. Fines are commonly imposed. If,however, the court finds that the contemnor isunable to pay a monetary penalty, the court may becreative. For example, attorneys who fail todisgorge fees have been enjoined from practicingbefore the court that issued the disgorgement orderuntil the fees are refunded.

Since the purpose of civil contempt is to coercecompliance, the court may impose a regimen ofescalating penalties. For example, if the contemnorpays a fine but still disregards a court order, thecourt may impose additional fines. A contemnorwho continues to violate a court order may even beincarcerated. It is increasingly agreed thatbankruptcy judges may order the United StatesMarshal to take contemnors into custody and evento incarcerate them until they purge themselves ofcontempt. If the civil contemnor possesses the“keys to the jailhouse door,” he may remain incustody.^

Besides civil contempt, bankruptcy courtssometimes avail themselves of other similarremedies. For example: Fed. R. Bankr. P. 9011,

which is nearly identical to Fed. R. Civ. P. 11,provides for sanctions against parties who sign andfile court papers; some courts have used 11 U.S.C.§ 349 to penalize debtors whose cases aredismissed (such as by enjoining refiling for a periodor by denying the discharge of debts in any futurecases); and 28 U.S.C. § 1927 allows federalcourts^^ to sanction attorneys who “vexatiously”protract litigation.

Criminal Contempt

The power of a bankruptcy court to find aparty in criminal contempt of court remainsunsettled.^^^ Case law is evolving, however, topermit bankruptcy courts to impose sanctions thatmay be characterized as criminal in nature.

Criminal contempt differs from civil contemptin many material respects. The key distinctionbetween civil and criminal contempt is that criminalcontempt sanctions punish contemnors. Oncecriminal contempt has been committed, thedefendant cannot cancel the sanction by purgingherself of the contempt.

Contempt of court is a crime under 18 U.S.C.§ 401. Case law establishes at least three elementsof the crime: the court must have issued areasonably specific order; the contemnor must haveviolated the order; and the contemnor must haveacted willfully. Unlike in civil contempt, a criminalcontempt conviction will be upheld even if theunderlying order is later invalidated. The rationalefor this principle is that criminal contemptvindicates the authority of the court.

Âmong the earlier cases holding thatbankruptcy judges may impose incarceration as a civilcontempt penalty are In re Duggan, 133 B.R. 671, 673(Bankr. D. Mass. 1991), and In re Maxair AircraftCorporation, 148 B.R. 353, 359 (M.D. Ga. 1992).

^Ît is unsettled whether a bankruptcy courtqualifies as a “court of the United States” for purposesof imposing § 1927 sanctions.

^^^The leading cases on each side of thiscontroversy are In re Ragar, 3 F.3d 1174 (8th Cir.1993) (held attorney who represented a Chapter 13debtor after disqualification to be in criminalcontempt) and In re Hipp, Inc., 895 F.2d 1503 (5thCir. 1990) (held that bankruptcy court lackedjurisdiction to hold creditor in criminal contempt forviolating injunction against filing motions).


A final key difference between civil andcriminal contempt is that criminal contemptrequires the same “beyond a reasonable doubt”standard of proof required for any other criminalconviction.

Although some courts and commentators havecast doubt on the power of a bankruptcy court toventure into the arena of criminal contempt, theBankruptcy Rules clearly contemplate thatbankruptcy judges will exercise criminal contemptpowers. The notice requirement in Fed. R. Bankr.P. 9020(b) expressly requires that the allegedcontemnor be informed in writing of whether thecontempt charged is criminal or civil.

Those convicted of criminal contempt aresentenced under Sentencing Guideline § 2J1.1.Under that Guideline, the court is directed to applywhichever Guideline applies to an analogouscrime. This means, for example, that a judge maylook to Sentencing Guidelines covering suchmatters as obstruction of justice or frauddepending upon the nature of the acts committed.

No authority supports the power of abankruptcy judge to impose a criminal sentence ofincarceration. In In re Finney,^ the bankruptcycourt conducted the criminal contempt trial, foundthe defendant to be in criminal contempt, and thenreferred the matter to the district court forsentencing. Under Fed. R. Bankr. P. 9020(c), thedefendant also had 10 days within which to fileexceptions before the bankruptcy court judgmentwas final. This procedure has been followed in atleast one other case.^^

Criminal contempt proceedings present manyspecial issues. The defendant may be entitled to ajury trial, which only the district court can hold. Adefendant has a right to a jury trial before aconviction for any crime other than a petty offense(i.e., a crime carrying a penalty of six months orless). In addition, the defendant may be entitled to

court-appointed counsel. Moreover, because adefendant is protected against double jeopardy, thecourts and prosecutors should narrowly tailor thecontempt charge so that it is not used to defeat alater indictment on other related charges. Thedouble jeopardy problem might be more likely toarise for the unwary who convince a judge toimpose a civil sanction that is later found apunishment. In In re Power Recovery Systems,Inc., the United States Court of Appeals for theFirst Circuit stated expressly that a bankruptcycourt’s label on its own judgment does not bind ahigher court. 950 F.2d 798, 802 (1st Cir. 1991).

There are effective alternatives to seekingcriminal contempt sanctions in bankruptcy court.For example, the government could ask thebankruptcy court to conduct an evidentiary hearingand to certify its findings to the district court for denovo consideration. In addition, the wrongdoer canbe separately indicted for his contumacious acts.

United States Trustee (UST) attorneys areinstructed to consult with the United StatesAttorney’s office before initiating or evenparticipating in any criminal contempt proceedings.Furthermore, because of the minefield of specialissues that attach to any contempt action, USTattorneys are well-advised to consult with theirUnited States Attorney counterparts about civilcontempt actions and potential sanctions as well.

Conclusion

Debtors ranging from large financial servicescompanies to consumers who have reached the endof their financial ropes walk through the doors ofbankruptcy courts each day. With a full plate ofissues before them on matters as diverse as taxliability and curing arrearages on home mortgages,bankruptcy judges play a crucial role in both thecommercial and consumer realms of our economy.Given these broad responsibilities, bankruptcycourts should fully exercise their powers as federalcourts.

United States Attorneys, United StatesTrustees, and other prominent litigants in thefederal bankruptcy system should, in appropriateinstances, ask bankruptcy courts to use the powerof contempt to effect the purposes of the

^167 B.R. 820 (E.D. Va. 1994).

^În re Darenda Downing, 195 B.R. 870(Bankr. D. Md. 1996) (after conviction andsentencing, and while the case was on appeal, thedefendant was indicted for criminal contempt and forother crimes).


Bankruptcy Code and to do justice. Federalgovernment lawyers, in particular, have aresponsibility to help the court in bringing andprosecuting contempt actions. As just described,the use of the contempt powers can inure to thebenefit of the courts, and of the vast majority ofdiligent and honest litigants who rely upon thebankruptcy court to provide a “fresh start” fordebtors and an efficient means for repayingcreditors. ò

ABOUT THE AUTHORë Clifford J. White, III is the Assistant UnitedStates Trustee for the District of Maryland -Southern Division. He joined the United StatesTrustee Program in 1991. White served as aDeputy Assistant Attorney General from 1986 to1991 and as counsel in the United StatesInformation Agency and Office of PersonnelManagement. He graduated with honors fromGeorge Washington University Law School. a


Prosecuting Bankruptcy Fraud:Meeting the Advice of Counsel DefenseCraig Peyton GaumerAssistant United States AttorneyDistrict of South Dakota

Bankruptcy fraud cases may be unlikemost other matters handled by anAssistant United States Attorney orCriminal Division Trial Attorney.

While it is common for many targets anddefendants to blame others for their criminal acts,the targets and defendants in bankruptcy fraudcases may actually have a plausible defense whenthey attempt to shift the blame.

Because almost every debtor and creditor isrepresented by counsel in bankruptcy cases, andmay have acted in good faith upon the advice ofcounsel to protect their statutory rights,Department attorneys must try to rule out theadvice of counsel or good faith defenses beforeindicting a debtor or creditor. Each of these closelyrelated defenses negates the mental state needed toobtain a bankruptcy fraud conviction. Because theprinciples of federal prosecution instruct that aprosecutor should only “initiate or recommendfederal prosecution if he or she believes that theperson's conduct constitutes a federal offense andthat the admissible evidence probably will besufficient to obtain and sustain a conviction,”USAM at § 9-27.220, it is critical to eliminate theadvice of counsel/good faith defense.

If the prosecution can establish that the clientdid not rely on counsel, or hid information from theattorney, such a course of conduct will constituteexcellent evidence of fraudulent intent.The goal of this article is to provide guidance tobankruptcy fraud prosecutors on how to acquire the information they need from the target’sattorney.

Scope of the Problem

Two primary bankruptcy fraud statutes, 18U.S.C. § 152 and §157, require the government toprove an elevated mens rea. Section 152 requiresthe government to prove that any crimes chargedunder its various subsections were committed“willfully and knowingly.” Similarly, Section 157convictions require evidence beyond a reasonabledoubt of fraudulent intent. A defendant who canestablish a colorable claim to have relied on theadvice of counsel before engaging in the conductcharged has a strong chance of convincing a jurythat he or she had no wrongful intent, and the casecan be lost on that basis alone.

A defendant’s reliance upon counsel can beraised as one of two closely-related defenses,namely either the “good faith” or “advice ofcounsel” defense. While both are discussed below,prosecutors should take care to review the distinctelements of these defenses within the jurisdictionsin which they practice. See generally, Maggs,Consumer Bankruptcy Fraud and the “Relianceon Advice of Counsel” Argument, 69 AM. BANK.L. J. 1 (WINTER 1995).

According to Devitt, Blackmar, Wolff, &O'Malley, Federal Jury Instructions (§ 19.06), thegood faith of a defendant is a “complete defense”to those offenses that require proof of the “intent todefraud” or the “intent to obtain money or propertyby means of false or fraudulent pretenses,representations, or promises.” “A person who acts,or causes another person to act, on a belief or anopinion honestly held is not punishable under thisstatute merely because the belief or opinion turnsout to be inaccurate, incorrect, or wrong. Anhonest mistake in judgment or an honest error inmanagement does not rise to the level of criminalconduct.” Id. “The burden of proving good faithdoes not rest with the defendant because thedefendant does not have any obligation to proveanything.” Id. It is the government's burden to


prove beyond a reasonable doubt that thedefendant acted with the required mental state. Ifthe evidence in the case leaves the jury with areasonable doubt about whether the defendantacted with the required mental state, or in goodfaith, the jury must acquit.

The defendant's good faith is a factual matterfor the jury to decide. United States v. Turner, 799F.2d 627, 629-30 (10th Cir. 1986). A good faithinstruction is not required unless the defendantintroduces sufficient evidence to support it. UnitedStates v. Scherer, 653 F.2d 334, 337 (8th Cir.1981). In United States v. Levine, 970 F.2d 681(10th Cir. 1992), the court stated that “if a personacts strictly according to the attorney's advice'relying upon it and believing it to be correct, onlyintending his or her acts to be lawful’ then thatperson cannot be convicted.”

DEVITT, BLACKMAR, WOLFF, & O'MALLEYalso discusses the “advice of counsel defense.”(§ 19.08):

If, before (taking any action) (failing to take anyaction), Defendant . . . while acting in good faithand for the purpose of securing advice on thelawfulness of (his) (her) possible future conduct,sought and obtained the advice of an attorneywhom (he) (she) considered to be competent, andmade a full and accurate report or disclosure to(his) (her) attorney of all important and materialfacts of which (he) (she) had knowledge or hadthe means of knowing, and acted strictly inaccordance with the advice (his) (her) attorneygave following this full report or disclosure, thenthe defendant would not be willfully ordeliberately doing wrong in (performing)(omitting) some act the law (forbids) (requires), asthose terms are used in these instructions.

Id. Whether the defendant acted in good faith, whether the defendant made a full and completereport or disclosure to counsel, and whether thedefendant acted strictly in accordance with theadvice received, are all questions for the jury todetermine.” Id. The advice of counsel defense is amore specific form of the defense of good faith.See also Pattern Jury Instructions of the DistrictJudges Association of the Eleventh Circuit,Criminal Cases, Special Instruction No. 14 (1985).

The most credible witness to establish whethera defendant acted in good faith and upon the adviceof counsel is the bankruptcy attorney. Thus, beforemaking the charging decision, prosecutors shouldengage in a two-step process: 1) get an interviewwith the defendant to see if he or she places theblame for the bankruptcy fraud on his or herattorney; and 2) if the defendant does raise thesedefenses, get an interview with, or grand jurytestimony from, the bankruptcy attorney. If thebankruptcy attorney takes responsibility, the casemay be over. If not, the case is probably strongerfor having eliminated the best defense.

Dealing With the Attorney-Client Privilege

The primary problem prosecutors will face ineliciting an interview or testimony from thedefendant’s bankruptcy attorney will, of course, bethe attorney-client privilege. Consideration of thescope and limits of this privilege reveal that it issurmountable, and that several grounds exist thatwarrant allowing the bankruptcy attorney totestify.

Federal Rule of Evidence 501 establishes thatfederal law controls the scope and availability ofany claim of privilege that a party may exercise. Infull, the rule states:

Except as otherwise required by theConstitution of the United States orprovided by Act of Congress, or in rulesprescribed by the Supreme Court pursuantto statutory authority, the privilege of awitness, person, government, state, orpolitical subdivision thereof shall begoverned by the principles of the commonlaw as they may be interpreted by thecourts of the United States in the light ofreason and experience.

(Emphasis added). Thus, Rule 501 establishes thata debtor/defendant or creditor/defendant may onlyclaim as privileged discussions with his or herattorney if federal law supports such a claim. Under federal common law, the attorney-clientprivilege only applies if the following conditionsexist:


(1) the asserted holder of the privilege is orsought to become a client;

(2) the person to whom the confidentialcommunication was made (a) is a member ofthe bar of a court, or his subordinate and (b) inconnection with the communication is acting asa lawyer;

(3) the confidential communication relates to afact of which the attorney was informed (a) byhis client (b) without the presence of strangers(c) for the purpose of securing primarily either(i) an opinion on law or (ii) legal services or(iii) assistance in some legal proceeding, andnot (d) for the purpose of committing a crimeor tort; and

(4) the privilege has been (a) claimed and (b)not waived by the client.

Diversified Industries Inc. v. Meredith, 572 F.2d596, 601-02 (8th Cir. 1977); In re Campbell SixtySix Express Inc., 84 B.R. 632, 633 (Bankr. W.D.Mo. 1988) (holding federal law governs the extentto which confidential communications are withinthe scope of the attorney-client privilege). See alsoUnited States v. (Under Seal), 748 F.2d 871,874-75 (4th Cir. 1984) (discussing federalprivilege).

In bankruptcy cases, the question of whether acommunication is privileged hinges upon whetherthe information involved is confidential. As amatter of federal law, pre-petition informationconcerning a debtor's assets and liabilities is notconfidential information. Federal Rule ofBankruptcy Procedure 1007 requires the fulldisclosure of this information (b), which reads inrelevant part as follows . . . the debtor . . . shallfile schedules of assets and liabilities, a schedule ofcurrent income and expenditures, a schedule ofexecutory contracts and unexpired leases, and astatement of financial affairs, prepared asprescribed by the appropriate Official Forms.(Emphasis added). See also FED. R. BANKR. P.9009 (Forms). To guarantee the truthfulness of thepetitions and schedules, the

debtor is required to verify the accuracy of them byunsworn declaration.

Because all of the debtor's assets and liabilitieson the date the bankruptcy was filed are propertyof the bankruptcy estate under 11 U.S.C. § 541,every debtor has a duty to disclose thisinformation. It follows that any discussionsbetween the debtor and counsel about assets thathad to be disclosed relate to public information andcannot be characterized as deliberations concerningconfidential data.

The Seventh Circuit addressed the question ofwhether information used in preparing a debtor'spetition and schedules is confidential in UnitedStates v. White, 950 F.2d 426 (7th Cir. 1991). InWhite, a paralegal employed by the debtor’sattorney prepared the debtor’s petition. Theattorney did, before filing the petition andschedules, review the documents. After thegovernment began investigating the debtor forfailing to disclose assets in his bankruptcy case,the local United States Attorney contacted thedebtor's attorney for information. The attorneyagreed to share non-privileged information abouthow the petitions and schedules were prepared.The information provided was used to convict thedebtor of bankruptcy fraud. On appeal, theSeventh Circuit addressed the propriety of thedisclosures.

The White Court instructed that theattorney-client privilege is to be narrowlyinterpreted because it is in "derogation of thesearch for truth." Therefore, the burden of provingevery element of the attorney-client privilege fallson the party seeking to invoke it. The claim ofprivilege cannot be a blanket claim; it must bemade and sustained on a question-by-question ordocument-by-document basis. Applying theseprinciples to both the underlying bankruptcy caseand the prosecution, the Seventh Circuit held that"information . . . transmitted to an attorney withthe intent that the information will be transmittedto a third party. . . is not confidential."

The Seventh Circuit rejected the debtor-defendant's claim of confidentiality: "Wheninformation is disclosed for the purpose ofassembly into a bankruptcy petition and supportingschedules, there is no intent for the information to


be held in confidence because the information is tobe disclosed on documents publicly filed with thebankruptcy court." Since the information was notconfidential, it was not subject to theattorney-client privilege, and the debtor's attemptto challenge the use of evidence on grounds ofconfidentiality was rejected.Footnote two of the White case also providesuseful clarification related to the issue of what isand is not confidential. The court noted thatinformation not contained in a debtor's petitionsand schedules is actually a "lack ofcommunication" and not a "confidentialcommunication." Thus, there is no ruleprohibiting an attorney from discussing what heor she has not been told by the client.

The Sixth Circuit followed the White approachin United States v. Hubbard, 16 F.3d 694 (6th Cir.1993) (the information elicited from Hubbard'sattorney was not protected by the attorney-clientprivilege because what Hubbard communicated tohis attorney was to be conveyed to the bankruptcytrustee and the court via written pleading and thuswas not protected by the privilege: the privilegeextends only to confidential communications, notall communications.”).

The White decision was followed by the UnitedStates Bankruptcy Court for the District of SouthDakota in In re French, 162 B.R. 541 (Bankr D.SD. 1994). The Bankruptcy Court ordered aparalegal employed by debtor's counsel to answerquestions about what she had been told about thedebtor's assets when she helped him prepare theschedules. The debtor's schedules failed to disclosethat he had $50,000 in the bank on the date offiling. When questioned about this omission at a2004 Exam, he blamed the omission on theparalegal. When the government took theparalegal's deposition, she refused to answerquestions about how the schedules were preparedon the grounds of attorney-client privilege. Thegovernment filed a motion to compel her to answerthe questions. The court permitted the discoveryfor two reasons: 1) The court held that theinformation was not privileged because the debtorwas required to disclose such data; and 2) even if it were confidential, the debtor hadimplicitly waived the privilege by attacking the

assistance rendered by the paralegal and heremployer. The debtor was later convicted of fourbankruptcy crimes and had his Chapter 12 caseconverted to a Chapter 7 due to fraud.

Though both White and French address theconfidentiality of information contained in adebtor's schedules, the rule they follow is notnecessarily limited to information related to theschedules. Arguably, the full scope of informationthat should be disclosed in monthly reportsrequired by the United States Trustee or in areorganization plan are also within the scope of theWhite/Hubbard/French analysis, as would beinformation underlying a creditor’s proof-of-claim.

The Ninth Circuit, however, has not lookedupon the White/Hubbard/French rule with favor.In United States v. Bauer, 132 F.3d 504 (9th Cir.1997), the Ninth Circuit reversed a defendant’sbankruptcy fraud conviction because it consideredthe privilege to have been violated when theprosecutor elicited testimony from the debtor-defendant’s attorney about advice “recommendingdisclosure of all assets on petition and explainingperjury implication of falsifying petition.” At issuewas not what Bauer told or gave to his attorney (asin White/Hubbard/French), but what his attorneyexplained to him about the disclosure requirementsof the bankruptcy system.

Although there was nothing discretionaryabout it, and Bauer could have learned the sameinformation simply by reading the forms he signedand filed under the penalty of perjury, the Courtconsidered the attorney’s explanation of theobligation to disclose assets to be “legal advice.”The Bauer Court was not persuaded that theattorney was acting as a “conduit for transmissionof a message” from the bankruptcy court. Thisholding makes little sense, because the FederalRules of Bankruptcy Procedure, which the UnitedStates Supreme Court promulgates, require debtorsto file the schedules and statement of financialaffairs, and to verify the information in them underoath. Comprehending how the attorney was notacting as a conduit of information is difficult. Hiscomments were not advice— they were a statementof the debtor’s unquestionable duties. In asentencing context, several circuits have held that


the bankruptcy rules are judicial orders,^ so theattorney was simply passing on court ordered rulesto his client. There was nothing advisory about theinformation conveyed.

The Ninth Circuit distinguished the holding inWhite by claiming that the Seventh Circuit’sholding was limited to the disclosure ofdocumentary information. The Bauer Courtoverlooked the fact that the attorney in White notonly provided documents to the prosecution, but hetestified about the documents, as well. The Courtdid not identify any reason to draw a distinctionbetween information given to an attorney indocumentary form and data given in verbal form, ifeach was intended to be used in the preparation ofrequired disclosures.

Bauer is a poorly-reasoned decision thatcounsel can probably get around if they focus onthe information the client provided to the attorneyfor disclosure in the schedules, the statement offinancial affairs, and other documents, which eventhe Bauer Court recognized as non-privileged,rather than trying to elicit testimony concerningspecific advice given to the debtor by his counsel.

The prosecution in Bauer may have made atactical error, as well, though it is difficult to tellfrom the decision. The prosecution did not need toelicit this testimony concerning Bauer’s knowledgeof the disclosure requirements in its case-in-chief.Introduction of the signed schedules, which containclear instructions and a penalty of perjury warning,would have established that Bauer was informed ofhis duty. The same data may have been availablein a tape or transcript of the First Meeting ofCreditors (341 meeting). The only way Bauercould have rebutted this evidence of his knowledgewould have been to take the stand and blame hisattorney for not explaining the disclosurerequirements to him. Once Bauer did this, theattorney would have been free to testify as arebuttal witness to defend the charges against him,

and could also have testified due to the impliedwaiver of the attorney-client privilege made whenBauer testified. See Greenberg, Klingsberg &Mulligan, Attorney-Client Privilege, 30 AM.CRIM. L. REV. 1011 (Spring 1993); Hellerstein, AComprehensive Survey of the Attorney-ClientPrivilege And Work Product Doctrine, 540PLI/LIT 589 (FEB. 1996) (litigation andadministrative practice course handbook series ofthe Practicing law Institute).

Besides arguing that the privilege does notexist or has been waived, prosecutors can alsoargue, if the facts fit, that communications betweenan attorney and his client fall within the “crime-fraud” exception to the privilege. See UnitedStates v. Sabbeth, — F. Supp. 2d — ,1999 WL 52368 (E.D.N.Y. 1998) . As a result,"all Courts agree that the lawyer-client privilegedoes not extend to [such] communications" whichare said to fall within the crime-fraud exception.WEINSTEIN ON EVIDENCE, Section 503.31[1] at503-91.287, 292 (5th Cir.1986). For thegovernment to establish the applicability of theexception it "must demonstrate that there is afactual basis for a showing of probable cause tobelieve that a fraud or crime has been committedand that the communications in question were infurtherance of the fraud or crime." Id. Thegovernment does not need to prove that theattorney knew of the scheme to defraud; it mustonly establish that the client used the attorney’sservices to plan or engage in an unlawful scheme.In re Grand Jury Proceedings, 87 F.3d 377 (9thCir. 1996).

How to Obtain the Necessary Information

Once the bankruptcy fraud prosecutor hasdetermined during the investigation that he or sheneeds information from the debtor-defendant’s orcreditor-defendant’s bankruptcy attorney, the nextquestion is how to obtain the information. Whilemultiple methods may exist, a few tactics may beamong the best.

See Craig Peyton Gaumer, Protecting TheBankruptcy Process: The Propriety Of Enhancing ABankruptcy Criminal’s Sentence For Abuse OfJudicial Orders Or Process, 16-Sept. Am. Bankr. Inst.J.12 (1997)


First, the prosecutor can simply invite theattorney to be interviewed, and explain in detailwhy the privilege does not exist, or why anexception applies. Some attorneys may be willingto talk if the prosecutor can make strongarguments concerning these points.

Second, the prosecutor can ask the defendantto waive the attorney-client privilege so that the case agent can verify the accuracy of the advice ofcounsel/good faith defense. This method shouldonly be used where the defendant has criminaldefense counsel, or else the prosecutor runs therisk of being accused of prosecutorial misconductfor taking unfair advantage of the defendant (SixthAmendment issues might also be implicated). Inbusiness Chapter 7 and Chapter 11 cases, thetrustee can waive the attorney-client privilege.Commodity Futures Trading Commission v.Weintraub, 471 U.S. 343, 353 (1985). Defensecounsel can simply be told that if the privilege iswaived and the attorney supports the defense, thecriminal case will likely be declined.^ After all, theDepartment is not in the business of indictinginnocent persons. Third, the prosecutor shouldconsider bringing the bankruptcy attorney beforethe grand jury. Case agents conducting aninterview may not be able to elicit the preciseinformation that the prosecutor wants or needs, ormay not recognize the need to ask importantfollow-up questions. Obtaining the testimonybefore the grand jury gives the prosecutor morecontrol of his case, and allows the prosecutor achance to assess the veracity and demeanor of thebankruptcy attorney as a potential witness.

Most bankruptcy attorneys, if not all, maymove to quash the grand jury subpoena based uponthe privilege. However, they cannot invoke theprivilege wholesale, and must first refuse to answerspecific questions based on the privilege. At thatpoint, the prosecutor should proceed to the DistrictCourt with a Motion to Compel, and must prove tothe Court why the information is not privileged orwhy it comes within an exception. Prosecutorsemploying this method should make sure that they

have the required prior Department approvalbefore they subpoena an attorney. The requestform is reproduced at the end of this article.

Conclusion

Bankruptcy fraud cases have attorneyseverywhere. The trustee is typically an attorney oris represented by one. The Assistant United StatesTrustees are attorneys. Debtors and creditors haveattorneys. Consequently, the attorney-clientprivilege issue is likely to arise in most bankruptcyfraud investigations and prosecutions, andprosecutors should plan and develop a concisestrategy to address these issues. ò

ABOUT THE AUTHORë Craig Peyton Gaumer is an Assistant UnitedStates Attorney in the District of South Dakota,and has served in that capacity since 1991. Hechairs the South Dakota Bankruptcy Fraud TaskForce and is a member of EOUSA’s BankruptcyFraud Working Group. He has served as the Chairof the American Bankruptcy Institute CommercialFraud Task Force. He obtained his law degree in1989 from Washington University. a

Ôf course, this negotiating tool should not beused if other charges would remain outstanding.


Sentencing Bankruptcy CrimesJoe B. BrownUnited States Magistrate JudgeMiddle District of Tennessee^

Even as the Justice Departmentprosecutes bankruptcy crimes withincreased frequency, some criminalsescape with a lighter sentence than the

guidelines call for because courts and prosecutorslack experience in sentencing these crimes. Thisarticle highlights some special considerations thatapply to bankruptcy crimes that may not apply toother cases of fraud, theft, or perjury.

The most common bankruptcy crime isconcealment of assets by a debtor in bankruptcy.The debtor seeks the benefit of the automatic stayto stop his creditors in their tracks. He may alsoseek a discharge of all dischargeable debts at theclose of the bankruptcy process. The corruptdebtor attempts to conceal assets so there will beno distribution of his non-exempt assets tocreditors. This scenario can result in severalguideline applications that do not occur in theaverage white collar crime case.

Most bankruptcy crime prosecutions arebrought under 18 U.S.C. §§ 152 through 157. Infact, § 152 and its nine subparagraphs cover about90-percent of all possible bankruptcy crimes.Appendix A to the Sentencing Guideline Manualcontains three different guidelines that can apply to§ 152— Guideline 2B4.1 for theft, Guideline 2F1.1for fraud, and Guideline 2J1.3 for perjury. Any orall of these can apply in a particular prosecution.

Guideline Applications

Many bankruptcy fraud cases involvemultiple violations that can be brought underseparate counts of § 152. As part of the

bankruptcy process, the debtor must file, under thepenalty of perjury, a petition and schedules of allassets and liabilities. Shortly after the case is filedand the debtor has obtained the benefit of theautomatic stay, the first meeting of creditors (or“341 meeting” is held, where the debtor is placedunder oath and questioned about his financialaffairs by a United States Trustee, a standingtrustee, or a case trustee. Creditors may alsoappear and ask questions. The corrupt debtor oftencommits separate offenses, such as concealingassets under Paragraph 1 of § 152 when he fails tolist assets on the appropriate schedules, andperjury under Paragraph 2 of § 152 when he signsthose schedules under the penalty of perjury. Thispattern is repeated when the debtor lies under oathabout his assets at the 341 meeting.

If a violation of only Paragraph 1 of § 152 ischarged, Guideline 2F1.1 applies. Under thisguideline, loss is a major consideration. (How tocalculate loss will be discussed later in this article.)Other issues, however, are also relevant underGuideline 2F1.1. First, the enhancement for morethan minimal planning under Guideline 2F1.2(b)(2)(A) normally applies. Bankruptcy involves aprocess that takes some preparation and time. Thedebtor must file the petition, schedules and otherdocuments, and appear at the section 341 meetingand other proceedings. Therefore, bankruptcyfraud is not a spur of the moment, one-shot crime.

Even if the court is not convinced that there ismore than minimal planning, there are usuallymultiple victims as provided under Guideline2F1.2(b)(2)(B). Case law seems settled that eachcreditor is a victim, and most cases involve abankruptcy trustee as well. See United States v.Nazifpour, 944 F.2d 472 (9th Cir. 1991); UnitedStates v. Saacks, 131 F.3d 540 (5th Cir. 1997).Some defendants have tried to argue that thetrustee is the only victim, but the trustee clearlyrepresents all unsecured creditors. Securedcreditors are also defrauded in many cases. Thus, unless you have a rare case with only a singlecreditor, this two-level adjustment should apply.

^ The comments in this article are my ownand do not necessarily represent the opinion of anyoneelse.


Violation of Judicial Process

Another potential upward adjustment iscommonly missed. Guideline 2F1.1(b)(4)(B)directs a two-level increase for “violation of anyjudicial or administrative order, injunction, decree,or process not addressed elsewhere in theguidelines.” If the resulting level is less than level10, the guidelines direct an increase to level 10.Thus, under this guideline section, any bankruptcycrime will be at least a level 10 despite the lossamount.

Almost every court to consider the issue hasheld that this increase applies to a debtor whoconceals assets by providing false information onhis bankruptcy petition and schedules. See thecases collected in United States v. Messner, 107F.3d 1448 (10th Cir. 1997); United States v.Saacks, 131 F.3d 540 (5th Cir. 1997); and UnitedStates v. Mohamed, 161 F.3d 1132 (8th Cir.1998). As a caution, if you are in the First orSecond Circuit, look at United States v. Shadduck,112 F.3d 523 (1st Cir. 1997) and United States v.Carrozzella, 105 F.3d 796 (2d Cir. 1997), whichquestion the automatic application of this increasewithout specific findings by the district court aboutthe exact order or process violated.

The majority interpretation of this adjustmentis very reasonable. Bankruptcy fraud is aparticularly egregious type of fraud because itdirectly involves the federal court system. By filingfor bankruptcy, the debtor invokes the automaticstay and receives the protection of the BankruptcyCode. The debtor abuses the judicial process in afundamental way if he provides false informationin the bankruptcy process.

Expenditure of Substantial Resources

In cases involving high dollar loss, theguideline applicable to fraud or theft will usuallybe higher than the guideline applicable to perjury.However, the perjury guideline— Guideline 2J— isuseful if the dollar loss is uncertain or relativelysmall. Guideline 2J1.3 has a base level of 12despite the amount of loss. Obtaining a three-levelenhancement under 2J1.3(b)(2) may even bepossible if you can show that the perjury or false

statements under § 152 caused “[u]nnecessaryexpenditure of substantial governmental or courtresources.”

The United States Trustee’s Office can helpyou decide whether the case in question caused“substantial” expenditure of governmental or courttime. A lie that is quickly caught and corrected willnot trigger this enhancement. Commonly, however,unraveling complicated dealings engaged in by adebtor to hide assets requires substantial effort andtime by the United States Trustee and many courtproceedings. AUSAs should not overlook thisguideline application since it will bring the case toa level 15, regardless of the money involved.

It may be possible to secure an additionalone-level enhancement by charging a fraudviolation for filing false schedules and a false oathoffense for lying at the section 341 meeting.Arguably, these are separate violations that shouldnot be grouped and another level under Guideline3D1.4 should be added.

Professionals

Debtors and creditors trying to beat thesystem frequently use attorneys, accountants, andother professionals to aid them in their efforts. Thetwo-level increase under Guideline 3B1.3 for useof a special skill should be sought in all casesagainst professionals. Moreover, a Chapter 11bankruptcy debtor usually remains in control of hisor the company’s assets as a debtor in possession(DIP). The DIP has all the authority of a casetrustee and acts by operation of law as a fiduciaryto the creditors of the bankruptcy estate. As such,the DIP seems to hold a position of private orpublic trust under Guideline 3B1.3, although thisapplication of the guideline has not been widelyargued.

Always seek an enhancement for use of aspecial skill or abuse of a position of trust in casesagainst a trustee or a trustee’s professional agentsuch as an accountant or an auctioneer. Such anindividual either has a professional license or is appointed to that position and can act only with theapproval of the bankruptcy court.

Valuation of Loss


Determining the loss is critical under bothGuidelines 2B and 2F. Bankruptcy crimes presentseveral unique issues relating to loss valuation. Formost bankruptcy offenses, the money involved isthe single most important factor that affectssentencing. The guidelines look to the greater ofthe gain to the defendant or the actual or intendedloss to the victim or victims.

In bankruptcy cases involving theft orembezzlement, loss is calculated as in non-bankruptcy theft and embezzlement cases: lossequals the property or money stolen. Still,valuation of loss is often more complicated inconcealed assets cases. A defendant who givesfalse information with intent to conceal assetsintends to deprive the creditors of the value of thatasset, so the value of the asset sought to beconcealed is one proper measure of loss. UnitedStates v. Beard, 913 F.2d 193, 196 (5th Cir.1990). If the property concealed has a clearlyestablished value, such as a bank account or a car,valuation is simple. In other cases, the time for thevaluation may be a consideration. The court held inUnited States v. Smithson, 49 F.3d 138 (5th Cir.1995), that a stock option should be valued as ofthe date the bankruptcy case was filed, not the datethe concealed stock option was later exercised.

A good general discussion of valuation can befound in United States v. Anderson, 68 F.3d 1050(8th Cir. 1995). The debtor in Anderson, who haddebts of about $1.35 million, listed assets of$446,000 when he actually had assets sufficient topay all debts in full. He settled with his creditorsfor some $590,000 before his case was closed. Thecourt calculated the intended loss as the differencebetween the listed liability and the listed assets— alittle over $900,000. The court gave the debtorcredit for the $590,000 he paid before his case wasclosed and held him responsible for an intendedloss of $400,000. The court considered, butrejected, valuing the creditors’ loss atapproximately $250,000, which was the amountby which the creditors reduced their claims basedon the false asset amount listed.

How much liability a debtor tries to dischargeacts as a cap upon both actual and intended loss. Itis hard to argue that the loss is more than the debtssought to be discharged. If a debtor undervalued

property by $200,000 but owed only $50,000, losswould clearly be limited to $50,000. United Statesv. Waller, 29 F.3d 908 (5th Cir. 1994). There area number of cases on valuation, including UnitedStates v. Edgar, 971 F.2d 89 (8th Cir. 1992);United States v. Levine, 970 F.2d 681 (10th Cir.1992); United States v. Nazifpour, 944 F.2d 472(9th Cir. 1991); and United States v. Dolan, 120F.3d 856 (8th Cir. 1997); see also United States v.Saacks, 131 F.3d 540 (5th Cir. 1997).

Intended Loss: Amount Sought to beDischarged

I have argued occasionally that the intendedloss should ordinarily be the amount of debt soughtto be discharged. The best case on this point isUnited States v. Holland, 160 F.3d 377 (7th Cir.1998), where creditors held $454,000 in judgmentsagainst the debtors who, in turn, concealed$32,284 in an undisclosed bank account when theyfiled for bankruptcy. The district court valued theloss at the amount of debt sought to be discharged,not the value of the hidden bank account. TheSeventh Circuit said:

Since the evidence showed that the acts ofbankruptcy fraud were committed to obtain adischarge of the $454,000 in default judgments,the district judge was justified in finding that theloss was $454,000, thus increasing the offenselevel pursuant to United States SentencingGuidelines § 2F1.1(b)(1)(J). Shirley's reliance onUnited States v. Gunderson, 55 F.3d 1328, 1331(7th Cir. 1995), is misplaced, because the courtthere explicitly refused to choose between theprosecution's and defendant's methods ofcalculating intended loss. The Hollands' failureto disclose the assets of the bankruptcy estate wasmotivated to obtain a discharge of $454,000owed to Joe's and HEC's creditors. Consequentlythat is the intended loss.

Holland, 160 F.3d at 381. A bankruptcy debtor seeks to discharge alldischargeable debts. The Bankruptcy Codeprovides very short deadlines for revoking adischarge, even if obtained by fraud. The argumentthat the intended loss is the amount of debtintended to be discharged is entirely reasonable and


consistent with the theory of intended loss. TheFifth Circuit used this approach in United States v.Saacks, 131 F.3d 540 (5th Cir. 1997).

This argument can also be made with respectto a debtor who is ineligible to file for bankruptcy.I once successfully argued this theory before thedistrict court in a case involving a debtor who wasineligible for Chapter 7 because he had filed underthat chapter within the past six years. In his secondbankruptcy case, he lied about the prior filing. Thedistrict court valued the loss at all the debt hesought to discharge.

United States v. Cobleigh, 75 F.3d 242 (6thCir. 1996), also supports this theory. TheCobleigh court used the listed liabilities as a startin calculating the intended loss, although itultimately reduced the loss by 50 percent after thedebtor claimed he inflated his liabilities to ensurehe received a discharge. Bankruptcy Schemes

Another very effective statutory provision is18 U.S.C. § 157, enacted by Congress in 1994 tocover a wide range of fraud cases in which thebankruptcy system was used to help carry out thefraudulent scheme. Section 157 tracks, in largepart, the language of the mail and wire fraudstatutes, 18 U.S.C. §§ 1341 through 1344.

The Sentencing Commission has not yetdesignated the guideline sections that apply to thisstatute in Appendix A of the Guideline Manual.However, using the guideline section applicable tomail and wire fraud statutes appears reasonablebecause the language of those statutes is so closeto that of Section 157.

Conclusion

Bankruptcy crimes can affect a lonedefrauded ex-spouse or an entire class of swindledinvestors. Beyond that, they also damage theintegrity and credibility of the bankruptcy courtsystem. It is well worth examining a case’s specialcircumstances to ensure that the defendant receivesa sentence truly reflecting the serious harm that

bankruptcy crime inflicts upon the bankruptcysystem.^ ò

ABOUT THE AUTHORë Joe B. Brown was appointed United StatesMagistrate Judge for the Middle District ofTennessee in August 1998. From 1991 to 1998 heserved as Special Assistant United States Trusteein Nashville, with responsibility for coordinatingthe United States Trustee Program’s criminalprogram. From 1981 to 1991 he was the UnitedStates Attorney for the Middle District ofTennessee; for 10 years before that he was anAssistant United States Attorney. He chaired theSentencing Guidelines Subcommittee of theAttorney General’s Advisory Committee from1987 to 1991. a

^For additional materials on this subject,contact the United States Trustee in your district.Several members of the United States Trustee’sbankruptcy fraud working group are available forassistance on specific cases. The United StatesTrustee’s Office in each district has a manual onbankruptcy crimes that goes into great detail regardingwhat constitutes the various bankruptcy crimes and theelements of each crime. Assistant United StatesTrustee Sandra Rasnak of the Chicago office can assistin any national coordination needed with the UnitedStates Trustee Program. At the district level, your localUnited States Trustee’s Office can assist on proceduresinvolving the bankruptcy process and can provideexpert testimony at trial or sentencing. AssistantUnited States Attorney Craig Gaumer of the District ofSouth Dakota has also written several articles onsentencing bankruptcy crimes.


The Criminal Side of SearsMark J. BalthazardAssistant United States AttorneyDistrict of Massachusetts

On February 19, 1999, a subsidiary ofSears, Roebuck and Co. pleadedguilty to one count of bankruptcyfraud in violation of 18 U.S.C. § 157

and was sentenced to pay a record $60 million fine.Sears’ fraud involved its policy of not filingreaffirmation agreements with bankruptcy courtswhen Sears believed such agreements would berejected, and leading pro se debtors to believe theagreements were court-approved, legally-bindingobligations when in fact the underlying debts hadbeen discharged.

Background Information

To understand the fraudulent conduct fully, abrief description of bankruptcy discharge andreaffirmation agreements is necessary. When anindividual files a Chapter 7 bankruptcy, the mainbenefit he or she gets is a discharge of pre-bankruptcy debts. This means that he or she notonly gets rid of the debt, but that the creditor isenjoined from trying to collect on the debt. TheBankruptcy Code, however, permits debtors toreaffirm some of those debts rather than have themdischarged. To do so, the debtor and creditor haveto execute a written agreement that complies withall the requirements of the Code, including that theagreement be filed with the Bankruptcy Court.Also, when the debtor is acting pro se, theBankruptcy Court is required to hold a hearingduring which it must advise the debtor of theeffects of reaffirmation and determine if thereaffirmation would impose a hardship on thedebtor and is in the debtor’s best interest. Thepurpose of the filing and hearing requirements is sothe Bankruptcy Court can maintain oversight ofreaffirmation agreements reached by debtors andprotect debtors from being coerced into signingsuch agreements, and to assure that they fullyunderstand the consequences of doing so.

Despite the clear language of the BankruptcyCode requiring the filing of reaffirmationagreements, Sears’ written policy from 1985 until1997 was not to file such agreements when itbelieved the bankruptcy court would reject them,particularly when the debtor was acting pro se orif the debtor’s attorney refused to sign theagreement. During that time, Sears entered about180,000 of these agreements, which it did not filewith the courts, and obtained about $120 million inpayments to which it was not entitled.

Sears’ fraudulent reaffirmation practices beginin 1985. In response to an increase in bankruptcyfilings, Sears’ western United States operationsbegan an aggressive program to seek reaffirmationagreements in nearly all bankruptcy cases filed. Aspart of that program, credit and legal departmentpersonnel drafted a bankruptcy manual. Themanual stated that reaffirmation agreements had tobe filed and stressed that after a debtor received adischarge, Sears was permanently enjoined fromtrying to collect its debt or having any contact withthe debtor about the debt.

Nevertheless, the manual and subsequentversions went on to state that such agreementsshould not be filed with the court undercircumstances where it was likely the bankruptcycourt would reject them. Sears clearly understoodthat it was acting to avoid the Bankruptcy Court’slegitimate review of such agreements, since themanual recommended not filing when, for example,a bankruptcy judge regularly rejected suchagreements because the judge believed they werenot in the best interest of the debtor.

Sears was not concerned about losing moneyfrom this practice because it found that even whenthe agreements were not filed, debtors continued tomake their payments. This was not surprising sincethe Sears’ employees responsible for gettingdebtors to sign the agreements were neverinstructed to tell them that the agreement would notbe filed, that it was void and unenforceable andthat the debtor had no obligation to make anypayments. In fact, the agreements themselvessuggested that they would be filed in court and


were legally binding documents. The agreementswere in the form of bankruptcy court pleadings,with a standard heading used on bankruptcy courtpleadings. At the bottom of each agreement was asection entitled “Order Approving ReaffirmationAgreement” and a line for a bankruptcy courtjudge to sign where the debtor was acting pro se.The language of the agreement itself also reflecteda binding obligation. It stated that debtors“reaffirm, promise, and agree” to pay Sears; thatupon default of an installment, the entire balancewas due and payable immediately; and that thedebtor “promises, reassumes, and agrees to bebound by all the terms and conditions as set forthin the original security agreement” with Sears.

Debtors, particularly those unrepresented bycounsel, did not know that the agreement was notlegally binding and fully enforceable against them.Believing that it was, they made their payments.Furthermore, in direct violation of the dischargeinjunction, Sears sent those debtors monthly billsdemanding payment. When debtors did not pay,they received dunning phone calls from Sears.Sometimes, Sears even sued in state courts tocollect on pre-petition debts, relying on theassumption that the debtor would not know thereaffirmation agreement was not filed in court andtherefore unenforceable, and would not raise thatas a defense.

The fraudulent reaffirmation practices, whichwere begun at Sears’ west coast operations, wereexpanded nationwide by early 1987. A largeincrease in consumer bankruptcies fueled theexpansion of the program. In 1987 Sears receivedmore than 130,000 bankruptcy notices on activeaccounts, amounting to a balance of more than$100 million. In September 1990 the head ofSears’ credit department advised all creditmanagers in writing that bankruptcy recoverieswere an extremely high priority and that it was“imperative that every effort be made to maximizerecoveries.” He noted that the company’sbankruptcy losses were going to exceed $200million that year. Attached to that memo was aseries of questions and answers relating tobankruptcy, including the advice that if bankruptcyjudges routinely reject reaffirmations, they shouldnot be filed with the court, but instead kept in

Sears’ files and customers’ payments accepted. Sowhile credit managers were being told of the highpriority of increasing bankruptcy recoveries, theywere also being told to bypass the bankruptcyjudges that were getting in the way of thoserecoveries.

This conduct was perpetuated through thebankruptcy manual and by training sessionsconducted nationwide. Senior executives withinSears’ national credit department, as well asmembers of Sears’ legal department, knew andcondoned it. Sears engaged in this conduct despite legaladvice from inside and outside the company thatthe policy of not filing all reaffirmation agreementsand sending bills to debtors was, at best, highlyrisky and at worst illegal. In 1985, shortly after thefirst bankruptcy manual was put in use, Searsobtained a legal opinion on its bankruptcy manualfrom an outside attorney. He advised that if Searsdid not believe a court would approve a particularreaffirmation agreement, then the company shouldnot enter into it. He stated that if such agreementsever became known in a later legal proceeding,Sears might be liable for punitive damages foroperating outside the bounds of fairness asestablished in the Bankruptcy Code. Sears not onlydisregarded this advice, but its in-house counselresponded by criticizing bankruptcy judges who,he said, refused to approve such agreements“based merely on their own prejudices about whatis best for the debtor.” The issue was again raised with counsel in theearly 1990's, by a senior executive in Sears’Recovery Unit. He asked an in-house attorneywhether the company could send monthlystatements on non-filed reaffirmation agreements,knowing that was the regular practice at the time.The attorney replied that Sears could not send suchstatements, explaining that since the bankruptcycourt had discharged the debt, it would be aviolation of the Bankruptcy Code and the dischargeinjunction to send bills to collect on such debts.When that attorney was told that in fact such billswere being sent out, he advised that the practiceshould stop because it was against the law and thecompany could be subject to sanctions by the


bankruptcy court and civil suits. That advice wasalso ignored.

The executive later reduced his thoughts towriting in an e-mail sent to his superior— then thethird most senior person in Sears’ national creditdepartment— as well as a member of the legaldepartment. The memo stated that the policy ofsending the monthly statements on unfiledreaffirmation agreements was a business decisionmade after weighing the small likelihood of gettingcaught versus the large advantages of obtaininghundreds of reaffirmations without filing them withthe bankruptcy court. It stated that since thecustomer was obviously cooperating with Sears bysigning the agreements, the risk was low that theywould complain. It concluded that “probably thebiggest risk that [Sears] would have would be ifsome attorney happens to run across it and thinkshe might have grounds for a class action suitbecause of a bankruptcy code violation.” Thisdocument reflects clearly that the decision not tofile the reaffirmation agreements, and to continueto send monthly statements to customers, was abusiness decision made with the recognition thatsuch conduct was a violation of the law. CertainSears executives were willing to take that riskbecause of the substantial financial benefit to Searsand the small risk of getting caught. Moreover,Sears executives decided that even if they werecaught, that was the cost of doing business, withthe most severe repercussions being a possibleclass action suit in which they would have to repaytheir ill-gotten gains.

An in-house attorney to several senior creditdepartment employees also gave similar advice tostop sending such bills in 1996. The practice,however, continued despite this advice.

Sears’ fraudulent practices finally becameknown as the result of the actions of a pro sedebtor in Massachusetts who signed an unfiledreaffirmation with Sears, but later sought to get thebankruptcy judge to discharge that reaffirmed debt.When Chief Bankruptcy Judge Carol Kennerlearned that the reaffirmation agreement had notbeen filed, she summoned Sears into court andeventually learned that there were thousands ofsuch unfiled agreements relating to Massachusettsdebtors alone.

Judge Kenner’s discovery ultimately led toSears paying restitution and penalties to debtors ofmore than $180 million and civil fines of $40million to the fifty state attorneys general. Sears’senior management recognized the wrongfulness ofthe company’s conduct and cooperated fully withthe United States Attorney’s office in Boston.Sears waived the attorney-client privilege as to allhistorical matters, made witnesses available, andsorted through the documentary record to bring tothe government’s attention the most incriminatingmaterials.

The decision of the United States Attorney forthe District of Massachusetts to prosecute Searscriminally was appropriate and necessary. Formore than a decade, Sears engaged in a practice ofeffectively usurping the Bankruptcy Court’s role inthe reaffirmation process. Sears’ conduct was theresult of a conscious business decision made afterweighing what it considered was the small risk ofgetting caught versus the substantial benefit ofcontinuing to collect on debts. Sears’ actionsshowed contempt for the Bankruptcy Code, theBankruptcy Courts, and the entire bankruptcysystem. A criminal prosecution was necessary tovindicate the harm Sears caused to that system.

Congress contemplated prosecution ofcreditors for such conduct when it enacted 18U.S.C. § 157 in 1994. The Congressional recordstates that the law could "apply to creditors as wellas debtors. For example, if a creditor as part of ascheme to defraud a debtor or debtors, knowinglymade false statements to a debtor concerning thedebtor's rights in connection with a bankruptcycase, that creditor could be subject to this section." While the typical bankruptcy fraud iscommitted by debtors who conceal or lie abouttheir assets, the action of creditors such as Sears inpreying on debtors was as much an abuse andfraud on the system. In order for the system towork, all participants must comply with the lawand not abuse it for their own advantage. òABOUT THE AUTHORë Mark J. Balthazard has been with the UnitedStates Attorney’s office in Boston since 1989,where he works in the Economic Crimes Unit.From 1989 to 1992, he served as a Special


Assistant United States Attorney through theUnited States Trustee’s office in Boston and handled bankruptcy fraud cases. He has also beenin private practice and served as an attorney at theSecurities & Exchange Commission. In 1997, hereceived the Attorney General’s Award forDistinguished Service in connection with his workon the investigation and prosecution of DamonClinical Laboratories, Inc. He graduated fromBoston University School of Law in 1984. a

Summary of Sears’ Fines and Penalties

ë $60 million federal criminal fine;ë $40 million civil fine to the 50 state

attorneys general;ë Over $180 million in restitution; andë Federal Civil permanent injunction.

Involvement of the U.S. Trustee’s office

The United States Trustee’s office in Boston was instrumental in bringing to light the number ofMassachusetts debtors who were defrauded by Sears. The United States Trustee’s involvement led directlyto the opening of the criminal investigation by the United States Attorney’s office in Boston. The UnitedStates Trustee’s office also participated in negotiations resulting in Sears’ substantial civil settlements. ò


United States Attorneys’ Offices/Executive Office for United StatesAttorneys

Honors and Awards

1999 Arthur S. FlemmingAwards Program

Assistant United States Attorney Richard CraigSmith, Southern District of Texas, currentlyon detail to the Counsel to the Director’s

Staff, Executive Office for United StatesAttorneys, received the 50th Annual Arthur S.Flemming Award. This annual award recognizesoutstanding young men and women who have madeexceptional contributions to the FederalGovernment.

AUSA Smith received this award for hisoutstanding achievements as a federal prosecutor,exceptional dedication to the law, and commitmentto serving the public by reducing crime. Faced withlarge-scale law enforcement problems along theTexas Southwest Border, Mr. Smith representedthe government in many important publiccorruption cases, including a complex, high-profilecase in which he played a key leadership role incoordinating the investigation and prepared forseven trials, all of which he successfullyprosecuted. In his current position on detail to theExecutive Office for United States Attorneys, Mr.Smith contributes to the development of programsconcerning civil rights, immigration, narcotics,organized crime, human rights, and other vitalDepartment policies that shape and guide dailyprosecutions and litigation throughout the country.The award was presented to Mr. Smith on June 10,1999, in Washington, D.C. ò

Resignations/Appointments

District of ColoradoOn April 21, 1999, Thomas Strickland was

sworn in as the Presidentially-appointed UnitedStates Attorney for the District of Colorado. ò

District of Delaware

On May 17, 1999, Carl Schnee was sworn inas the Presidentially-appointed United StatesAttorney for the District of Delaware. ò

Northern District of IndianaOn June 25, 1999, David A. Capp was sworn

in as the AG-appointed United States Attorney forthe Northern District of Indiana effective June 28,1999. ò Southern District of Texas

On April 5, 1999, Mervyn M. Mosbacker wassworn in as the Court-appointed United StatesAttorney for the Southern District of Texas. ò

EOUSA Staff UpdateIn February 1999, the Executive Office of

United States Attorneys welcomed AssistantUnited States Attorney Mary Murguia, District ofArizona, as Principal Deputy Director of EOUSA. Ms. Murguia joined the United States Attorney’s


office for the District of Arizona in 1990. Since1994, Ms. Murguia has been the district’s DeputyChief of the Criminal Section, in charge of theViolent Crime Unit. Ms. Murguia obtained herJuris Doctorate in 1985 from the University ofKansas. She completed her undergraduateeducation with a B.S. in Journalism and a B.A. inSpanish, in 1982 from the University of Kansas. ò

In March 1999, the Executive Office forUnited States Attorneys welcomed James L.Santelle, an Assistant United States Attorney forthe Eastern District of Wisconsin, as a DeputyDirector of EOUSA. Mr. Santelle joined theUnited States Attorney’s office for the EasternDistrict of Wisconsin in 1985. Since 1993, Mr.Santelle has been the district’s Civil Chief. Mr.Santelle obtained his Juris Doctorate in 1983 fromthe University of Chicago Law School. Hecompleted his undergraduate education with a B.A.in English and History, in 1980 from MarquetteUniversity. ò

In February 1999, Assistant United StatesAttorney Kelly Shackleford, District of SouthCarolina, began a one-year detail with OLE as itsnew Deputy Director. She previously served OLEas an Assistant Director in charge of managementtraining and related areas. As Deputy Director, sheis responsible for assisting in the supervision of theseven teams that develop and facilitate the coursessponsored by OLE. ò

On February 1, 1999, Assistant United StatesAttorney Charlie Bourne began a detail with theOffice of Legal Education. He is from the SouthernDistrict of Georgia, where he served in theCriminal Section. He is working at the NationalAdvocacy Center. ò

In March 1999, Assistant United StatesAttorney Jon Gant of the Eastern District of Texas(Plano) completed an 11-month detail to LegalPrograms. During his detail, he served as anattorney-advisor to the Department of Housing andUrban Development’s (HUD) Enforcement Center.

In March, he accepted a permanent position withHUD. ò

On March 2, 1999, Assistant United StatesAttorney Janet Papenthien began a detail with theOffice of Legal Education. She is from theNorthern District of Iowa, Sioux City branchoffice, where she handled violent crime and whitecollar crime cases. She is working at the NationalAdvocacy Center. ò

On April 6, 1999, Assistant United StatesAttorney Pat Stout began a detail with the Officeof Legal Education. She is from the NorthernDistrict of Georgia, where she has handled avariety of civil cases with an emphasis in theemployment discrimination area. She is working atthe National Advocacy Center. ò

On April 26, 1999, Assistant United StatesAttorney Marialyn Barnard completed her detailwith the Office of Legal Education and returned tothe United States Attorney’s office for the WesternDistrict of Texas, where she is handling civilaffirmative and defensive cases. ò

In April 1999, Assistant United StatesAttorney Patricia A. Kerwin completed her detailwith the Office of Legal Education and returned tothe United States Attorney’s office for the MiddleDistrict of Florida. ò

On April 11, 1999, Assistant United StatesAttorney Pam Moine completed her detail with theOffice of Legal Education and returned to theUnited States Attorney’s office for the NorthernDistrict of Florida, where she is handling defensivecivil work with an emphasis in medical malpracticecases. ò

On April 21, 1999, Assistant United StatesAttorney Ann Dooley began a one-year detail withthe Counsel to the Director’s Office, EOUSA. Sheis responsible for monitoring issues on ViolenceAgainst Women, Indian Country, Child Support,Child Exploitation, and Obscenity. She is from theNorthern District of Oklahoma, where she servedas tribal liaison between the United States


Attorney’s office and eleven tribes in the district.ò

In May 1999, Kim Lesnak, Assistant Director,Law Enforcement Coordination/Victim Witness(LECC/VW) Staff returned to the United StatesAttorney’s office, Northern District of Illinois. Sheserved as the Assistant Director of the LECC/VWStaff for the past three and one-half years. She willcontinue to assist EOUSA in a number ofnationwide programs and initiatives until herdeparture. Barbara Walker, Deputy AssistantDirector of the LECC/VW Staff will serve as theActing Assistant Director during this transitionperiod. ò

In May 1999, Assistant United States AttorneyVirginia Howard of the Northern District of Texasbegan a detail with Legal Programs. She is servingas EOUSA’s liaison with the Civil Division and isworking on John Doe v. United States. Beforebeginning her detail with Legal Programs, she wason detail to EOUSA’s Legal Counsel’s office. ò

In May 1999, Assistant United States AttorneyMichael Cauley returned to the Middle District ofFlorida after completing a 14-month detail to LegalPrograms and the Department of Housing andUrban Development. ò

In May 1999, Assistant United States AttorneyJamie Mittet completed a 14-month detail to LegalPrograms and returned to the Western District ofWashington. During her detail, she served as anattorney-advisor to HUD’s Enforcement Centerand as EOUSA’s ACE Coordinator. ò

On May 3, 1999, Assistant United StatesAttorney Brian J. Quarles began a one-year detailwith the Legal Counsel’s Office, EOUSA. He isresponsible for providing guidance to USAO andEOUSA personnel regarding ethics matters such asconflicts of interest, recusals, outside activities,and request for representation. He also providesadvice to management on employee grievancematters and acts as agency counsel in personnelactions before the Merit System Protection Board.

He is from the Western District of Tennesseewhere he was assigned to the Civil Division. ò

On May 10, 1999, Assistant United StatesAttorney Samuel J. Louis began a one-year detailwith Legal Counsel’s Office, EOUSA. He isresponsible for providing guidance to USAO andEOUSA personnel regarding ethics matters such asconflicts of interest, recusals, outside activities,request for representation and is the point ofcontact for the USAO regarding Hyde matters. Healso provides advice to management on employeegrievance matters and acts as agency counsel inpersonnel actions before the Merit SystemProtection Board. He is from the Southern Districtof Texas where he was assigned to the OCDETFsection of the Drug Task force. ò

On June 1, 1999, Assistant United StatesAttorney Robert Troester of the Western Districtof Oklahoma began a detail with Legal Programs.He is serving as EOUSA’s ACE Coordinator. ò

On June 28, 1999, Suzanne Little began apermanent position with EOUSA as the AssistantDirector for the Freedom of Information Act Staff.She came to EOUSA from private practice whereshe was a respected criminal litigator whospecialized in federal and state criminal defense.She has also served with the Office ofAdministrative Law Judges in the Department ofLabor, the Department of Navy, and with theUnited States Attorney’s office for the District ofColumbia. ò

On June 28, 1999, Joseph Salama beganservice with EOUSA as the Assistant Director forthe Case Management Staff. He previously servedas the head of information technology for theOffice of Naval Research and brings considerabletechnological expertise to his new position. ò

On June 28, 1999, Siobhan Sperin beganservice with EOUSA as the Deputy AssistantDirector for the Case Management Staff. She camefrom the Department of Defense where she servedas the Deputy Director, Joint Chiefs of Staff Year2000 task Force. ò

On June 30, 1999, Assistant United StatesAttorney Carolyn Adams, Northern District ofGeorgia, completed her detail with the Office ofLegal Education. In August 1999, she will beginworking for the United States Attorney’s office forthe Middle District of Florida, where she willhandle criminal cases. ò

On July 6, 1999, Assistant United StatesAttorney Suzanne L. Bell began a one-year detailwith the Legal Counsel’s Office, EOUSA. She isresponsible for providing guidance to USAO andEOUSA personnel regarding ethics matters such asconflicts of interest, recusals, outside activities,and request for representation. She also providesadvice to management on employee grievancematters and acts as agency counsel in personnelactions before the Merit System Protection Board.She is from the Central District of California,where she served as an Assistant United StatesAttorney in the Civil Division. ò

On July 9, 1999, Assistant United StatesAttorney Kimberly A. Selmore, Middle District ofFlorida, completed her detail with the LegalCounsel’s Office. On July 12, 1999, she began adetail in the Professional Responsibility AdvisoryOffice. Her responsibility is to provide advice andguidance to Department attorneys on professionalresponsibility matters and the implementation ofSection 530B. ò

On July 25, 1999, Eileen Grady becameEOUSA’s new Employee Assistance Program(EAP) Counselor. EOUSA recently instituted itsown EAP program and looks forward to thecontinuity Ms. Grady will provide, since sheserved as one of the primary counselors for theUnited States Attorneys’ organization while atJustice Management Division. She is a licensedclinical social worker who knows EOUSA and itsemployees well and has done substantial trainingfor EOUSA in the past. ò

On July 30, 1999, Assistant United StatesAttorney Jennifer Bolen, Northern District ofTexas, completed her detail with the Office ofLegal Education. On August 16, 1999, she will

begin working for the United States Attorney’soffice in the Eastern District of Tennessee. ò

On August 27, 1999, Assistant United StatesAttorney Tim Wing will complete a 14-monthdetail with Legal Programs as EOUSA’s AssetForfeiture Coordinator. He will return to theDistrict of Maine. The new Asset ForfeitureCoordinator will be Larry Wszalek, an AssistantUnited States Attorney from the Western Districtof Wisconsin. ò

In September 1999, Janet Craig, Civil Chieffor the Southern District of Texas, will begin adetail with EOUSA to serve as the Legal Counsel.She has previously served with EOUSA as theDirector of the Office of Legal Education and asthe Acting Assistant Director for the EqualEmployment Opportunity Staff. She will bereplacing Marcia Johnson. ò

In September 1999, Marcia W. Johnson willcomplete her detail as Legal Counsel. She willreturn to the United States Attorney’s Office forthe Northern District of Ohio, where she will serveas the Chief, Civil Division. ò

Office of Legal Education

USABook Corner

The OLE Publications Staff has been busypreparing publications for Assistant UnitedStates Attorneys (AUSAs). Recently we

distributed the handbook Sentencing Guidelinesand Collateral Review. We are currently workingon a new Federal Criminal Practice Manual and aBrady/Giglio Handbook, and will also publish arevision of the Grand Jury Manual. Keep yoursuggestions coming. We’re listening! ò

UPCOMING PUBLICATIONSBelow you will find the current Bulletin publication schedule. Please contact us with your ideas and

suggestions for future Bulletin issues. Please send all comments regarding the Bulletin, and any articles, stories, orother significant issues and events to AEXNAC(NBOWMAN). If you are interested in writing an article for anupcoming Bulletin issue, contact Nancy Bowman at (803) 544-5158, to obtain a copy of the guidelines for articlesubmissions and publication deadline.

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