Fake bankruptcy is not very easy to detect. Bankruptcy is said to be “fraudulent” when the “bankrupt” declares himself bankrupt while concealing part of the assets for his benefit and/or for the benefit of other persons, or if he is found to be a debtor of sums he should not have.
The bankrupt can be a legal person under private law or a commercial entity, such as a group of craftsmen, a manager, an officer, a liquidator, head(s) of an agricultural cooperative, a firm, an industrial group or even a company, multinational or one of its subsidiaries, etc.
Committing fraud before, during bankruptcy or committing fake bankruptcy can also result in serious consequences, including a denial of discharge, fines, or even criminal penalties.
Legally, we can only speak of bankruptcy when a reorganization or judicial liquidation procedure has been opened beforehand.
Fraudulent bankruptcy can be accompanied by other scams (e.g. insurance scam) or insider trading.
Hidden asset or concealed asset
In finance, a hidden asset is an asset that is not shown on a balance sheet. An example of such an asset is the US$15 billion that United Airlines’ frequent flyer program, MileagePlus, was estimated to be worth when it filed for Chapter 11 bankruptcy (United States Code).
Myths and facts: what are the consequences of bankruptcy?
There are many myths about the consequences of bankruptcy. Some say that when you go bankrupt, you lose everything. This is totally wrong! Every situation is different, but often people who go bankrupt do not lose their homes or cars.
In addition, bankruptcy is not the only solution. There are alternatives. The role of a financial recovery advisor is to help you determine the most appropriate one for you. It will inform you of all the possible solutions, their advantages and disadvantages.
If you find that bankruptcy is the best option for you, it will simply be an opportunity for a fresh start.
What are the consequences of bankruptcy in the United States?
By going bankrupt, most of your debts will be erased and this is what your creditors fear the most. This is the reason why they are willing to negotiate and often agree to be paid much less than what you owe. Better a little than nothing at all.
If you have lost your job, if your business is losing, you can no longer pay the mortgages on your house, which has lost a lot of value anyway, if you have fallen ill without medical insurance and you couldn’t pay the hospital bills, if your creditors are getting seriously impatient, you should probably consider bankruptcy.
Don’t feel guilty, society has built this loophole that will allow you to start over. You won’t be the only one.
The white collar equivalent of a bank robbery is probably a fraudulent bankruptcy. Basically, here are the steps to achieve this fake bankruptcy:
- An entrepreneur creates or, better still, takes control of a company endowed, preferably, with an excellent credit rating.
- She/He begins to build up stocks by taking advantage, at the start, of the credit granted to him by suppliers.
- At first, business seems to be going normally, enough in fact for the entrepreneur to be able to obtain, in addition to the growing credit granted to him by suppliers, a bank loan.
- The entrepreneur is rapidly increasing her/his stocks.
- She/He sells them in cash on the black market, hides the money and then declares bankruptcy, passing on his losses to the suppliers or the bank, or both.
- Read also: Embezzlement is Type of Financial Fraud
Example of this modus operandi:
- Many recruiters have also invested;
- Recruiters used their personal and business connections to solicit investors;
- Investors received bogus monthly reports that attested to transactions;
- Company went so far as to declare annual sales of $2 billion and assets of $500 million in a certain year when in reality, the value of its annual transactions never exceeded $300 million and that of its assets, $100 million;
- Investors from xxxx or who were on vacation could visit the facilities to see the warehouses full of goods and the trucks coming and going;
- Early investors enjoyed very high rates of return from the money that came in from new investors.
Ultimately, investable funds totaling nearly $500 million were accumulated. That being said, even a cursory investigation of the arbitration industry would have established that no amount of business, no matter how large, could have generated a 60% gross return in an area where ( unlike arbitrage of financial securities or commodities) operating costs related to transportation, warehouses, computer systems, etc., are very high and profit margins range from 2 to 3%.
Then, when the company solidified its foundations, the investors were invited to send the funds to the suppliers. This allowed Premium to temporarily control investor funds when those funds were disbursed to it. She could then delay payment or redirect them as she pleased.
Premium asked investors to electronically transmit money directly into its accounts to pay for the transactions, it shipped the products, it received the payments and it then proceeded to send money back to the investors.
The number of phony transactions increased, but investors could reassure themselves by phoning one of the fifteen “confirmers”, some of whom worked for Premium while others had bribed employees of wholesale distributors. But a good part of these transactions were legitimate: Premium still bought and sold products, and the financial operations had to be linked to transactions, real or imagined.
The whole affair turned into a pure fraud. Nine times out of ten, the vendors allegedly involved in the reported transactions did not exist. At that time, seven Premium employees were assigned to the preparation of false invoices that were attached to the daily faxes or emails sent to investors.
We will never know the exact total since some investors placed funds they had deposited in secret accounts abroad in order to thwart the tax authorities and were therefore unable to file an official complaint. But in the end, this fraud cannot be attributed to the inefficiency of the legislative apparatus.
Part of the blame for this mess lay with the auditors and other professionals who had done the job poorly by letting themselves be fooled by Premium’s fine words and then convincing investors of the quality of this business opportunity. A superficial examination of the activities of the arbitration company would however have established that it was simply impossible to obtain such rates of return. But it is the blindness of investors, dazzled by the prospect of a miraculous return, which represents the main error committed in this affair. Indeed, it raises the fundamental difficulty of establishing to what extent, in such a case, people who are looking for fantastic deals do not only become the victim of the venality of the party which, apparently, lese, but also of their own greed, a phenomenon that could not be countered by any law.
Detection, evaluation for fake bankruptcy
Under the aegis of laws and standards and authorities linked to the countries (Autorité des marchés financiers or AMF in France; Securities and Exchange Commission or “SEC” in the United States), it is generally a court that confirms the reality or the fraudulent character of a bankruptcy.
For this, and in addition to the professions traditionally dedicated to the judicial investigation in the field of financial or commercial malfeasance, he can call upon (especially in North America, where this profession is in full expansion) a new profession that has emerged for prevent, detect or assess various types of accounting malfeasance: the “forensic accountant” to detect fake bankruptcy.
Investigators and courts can rely on data from tax or customs services, on the company’s accounts and sometimes on alerts or denunciations (coming from aggrieved creditors for example) or on various accounting indices or abnormal behavior (a player potentially benefiting from the bankruptcy visibly seeking to defeat a conciliation procedure after cessation of payments, for example). To proceed with a judicial liquidation, a court can intervene at the request of the company, on the basis of a complaint, or a request from the public prosecutor. In certain countries, including France, it can also take up the case ex officio and the “works council or, failing that, the staff representatives can communicate to the president of the court or to the public prosecutor any fact revealing the cessation of payments of the debtor”, in order to detect fake bankruptcy.
Anticipatory and precautionary measures
Some regulations seek to better protect investors from this type of financial risk (systemic financial risk in times of crisis), including in Europe the Directive on markets in financial instruments.
In certain sectors of the economy (particularly the mining sector, via the mining codes, the law sometimes provides (depending on the country) that companies must make provisions, which will be used if they do not honor their commitments. This is intended in particular to avoid bankruptcies that are fraudulent or belatedly justified by the depletion of a deposit, a change in the economic conditions of exploitation (lower profitability) Operators are thus – in certain countries – forced to constitute during their activity, in a blocked account controlled by the State, the “financial provision” necessary to finance this rehabilitation, and bio-indicators can be imposed or proposed for the evaluation of the effectiveness of an environmental rehabilitation in progress or completed.
The case of multinationals and their subsidiaries
Even in the presence of cost accounting, the fraudulent character of a bankruptcy or a fake bankruptcy can be difficult to prove in the case of subsidiaries of certain multinationals whose strategies are not transparent, and in which participations, mergers and acquisitions, the use of offshore accounts in “tax and legal havens” can greatly complicate liability searches.
In order to escape the obligation to repay their commercial, tax, social debts, etc., unscrupulous managers or managers could, for example, legally detach themselves from a subsidiary, then allocate to it (directly or indirectly):
- the impossible management of toxic loans;
- an ecological debt whose costs will be unbearable for the subsidiary. It may, for example, be a property that is known to be seriously degraded (e.g.: polluted soils and pollution sequelae on a groundwater table) involving high costs of risk assessment, maintenance and site protection, then treatment (depollution) and ecological restoration, even compensation for local residents, etc.);
- orders that cannot be fulfilled, possibly in the context of a market that they would manipulate in such a way as to create “market anomalies” (for example by artificially increasing the price of the raw material, which is possible if the multinational is in hegemonic or dominant position in the market or acts within the framework of a “cartel” or price fixing). They could also and on the contrary make sure to deprive this subsidiary of control, so as to then present it as economically unprofitable and start a vicious circle leading to bankruptcy; such a cycle can be initiated by assigning large orders to other factories or companies, competing or linked to the same multinational;
- deprive this subsidiary of necessary secondary resources, in order to cause a bankruptcy which allows them to discard their social responsibilities (reclassification, etc.) and financial (debt repayment).
In all these cases, the subsidiary can be sacrificed with regret, or be a subsidiary which one already wanted to get rid of; which becomes possible as soon as the conditions are in place for this subsidiary to be led despite itself to a situation of cessation of payments, with a recovery which would appear to be manifestly impossible, resulting in a judicial liquidation. This type of action, considered unethical by many charters or codes of good practice, is legally illegal in many countries, but it is facilitated by certain contexts that are not very transparent, and when the majority managers or administrators involved are at the head of many companies of the same group, even of competing companies or that they occupy an influential position in the board of directors as a shareholder or as an “independent” member (this is one of the possible situations of conflict interest in a company) and can lead to fake bankruptcy.
List of Bankruptcies that make a lot of Noises
Here are 10 spectacular bankruptcies… and sometimes tinged with scandal.
1. Bre-X — November 6, 1997
In 1997, the Canadian mining company announced the discovery of the largest gold deposit of the century. The stock climbs to US$280. But the samples were wrong: the stock crashes and investors lose US$ 10 million.
2. Pacific Gas and Electric Company — April 6, 2001
In the late 1990s, deregulation of the energy sector hit California’s main supplier of natural gas and electricity. Collapsed under a debt of US$ 9 billion, the company is placed under the protection of the bankruptcy law. A restructuring allows it to be reborn in 2004.
3. Enron — December 2, 2001
A darling of the political class, the energy conglomerate is experiencing rapid growth. But in 2001, CEO Kenneth Lay suddenly sold his shares. The American authorities open an investigation: Enron inflated its results and concealed immense debts. The action collapses, more than US$ 65 billion is lost and some 4,000 people are left jobless.
The Enron scandal, or Enron affair, is a case of fraud and financial manipulation discovered in 2001, which resulted in the bankruptcy of the Enron company, a time seventh capitalization of the United States, and in the dismantling and the de facto (in fact) disappearance of their financial auditor Arthur Andersen. On June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron, resulting in the Enron scandal. Although the Supreme Court reversed the firm’s conviction, the impact of the scandal combined with the findings of criminal complicity ultimately destroyed the firm.
4. WorldCom — July 22, 2002
The telecommunications company shines during the tech bubble. But an investigation launched in 2002 leads to falsified accounts to hide losses and inflate income. It is one of the biggest frauds in US history, for which former CEO Bernard Ebbers will be sentenced to 25 years in prison.
5. Lehman Brothers — September 15, 2008
The subprime mortgage crisis infects the financial sector in 2007. Lehman Brothers, which was hiding its debt, is short of cash. The unthinkable happens: the investment bank that we thought was “too big to fail” collapses, dragging the global economy with it.
6. Washington Mutual — September 26, 2008
Once the largest savings bank in the United States, Washington Mutual was swept away by the mortgage crisis of 2008. Despite assets of US$ 330 billion, it was forced to close the books. JPMorgan Chase bought the whole thing for US$ 1.9 billion.
7. Nortel — January 14, 2009
Canadian jewel of the communications, its action is worth 124 dollars in September 2000; two years later, it is only worth US$ 47 cents. A series of accounting scandals lead to the firing of CEO Frank Dunn. Despite the settlement of the lawsuits and several restructurings, the losses accumulate until bankruptcy.
8. Chrysler — April 30, 2009
Debt-ridden, Chrysler is negotiating at length with the Italian manufacturer Fiat to get out of the slump. Lost effort: the Obama administration forces the manufacturer to place itself under the protection of the bankruptcy law. The decision benefits Fiat, which gets its hands on 20% of its shares for a pittance. The governments of Canada and Ontario are providing US$2.9 billion.
9. General Motors — June 1, 2009
Seeing its sales weighed down by the 2008 crisis, unable to support an astronomical debt, the company placed itself under the protection of bankruptcy law. The US Treasury came to its rescue, as did Ottawa and Ontario. GM suspended production, closed factories and dealerships, then returned to the stock market in 2010, freed from its debts.
10. American Airlines — November 29, 2011
While the airline industry is in crisis, the American flagship takes a nosedive and places itself under the protection of bankruptcy law. It will take two years – and a merger with US Airways – to take off again… in force: it is now the largest airline in the world. And the most profitable.