Types of Bankruptcy Frauds

In the previous article, we have learned about how corporations use bankruptcy as a strategic tool. However, it is important to emphasize the point that the application of those strategies is 100% legal. This is not the case with all bankruptcy-related strategies.

Bankruptcy provides a corporation with substantial relief from the amount it owes. It is for this reason that bankruptcy law has seen various types of fraud over the years. It needs to be understood that unlike corporate strategy, these frauds are illegal. Over the past years, many people have been convicted of bankruptcy fraud, and some have even been sent to prison for the same.

In this article, we will explain the common types of bankruptcy frauds.


Bankruptcy provides the incumbent firm with significant relief from creditors. Short term debts are restructured to create long term debts. The interest rates on debts are also reduced. In many cases, the interest charges are simply wiped out. However, the government requires the company to disclose a list of all the assets that they own. This is done because a trustee appointed by the court takes possession of all assets listed by the company. These assets may then be liquidated to pay off the creditors. The balance debts may be discharged depending upon the circumstances.

In such a scenario, if a company decides to conceal the assets that they have, then such concealment amounts to bankruptcy fraud. This is because they are fraudulently trying to keep assets with themselves even though they owe money on such assets. Many times companies sell their assets to sister concerns for inadequate consideration. This is done to deceive the court about the assets that the company has. It is for this reason that courts have now started asking details about the sale of assets for a certain period prior to bankruptcy as well.


Bargaining is another common strategy to defraud creditors using bankruptcy law. In order to do so, the firm first picks up large amounts of unsecured debt without having any intention to pay it back. The same firm later files a petition for bankruptcy.

Now unsecured creditors are aware that their interests can be adversely affected if the company actually files bankruptcy. This is the reason why they agree to settle for a much smaller amount in return for immediate payment. The company then settles with almost all creditors and ends up paying only a fraction of the amount as compared to what it originally owed.

Once all the debts have been settled, the company then withdraws the bankruptcy petition. Sometimes, the company may just continue business as usual. Other times, the company winds up the operation in a particular area without damaging its credit and then repeats the same scam in a different geographical location.

Bust Out

A bust out is a kind of bankruptcy fraud wherein the company which faces bankruptcy has been designed to fail from the very outset. The company is first created and runs a genuine business for some time. This is done in order to increase credit ratings and develop a credit profile with suppliers.

Once the credit profile has been created, the company suddenly starts increasing its orders and then rapidly rakes up huge bills. The merchandise procured on credit is sold for cash, usually at a bargain. This means that the company has the cash to pay its outstanding bills. However, it uses accounting tricks to stall the payment of the debt. In the meanwhile, this debt is embezzled using a complex web of companies. Later, the company files bankruptcy. The end result is that the money is embezzled by the promoters. These types of bust-outs have happened in various industries like consumer goods industries, travel agencies, and even retail establishments.

Bleed Out

A bleed out is another type of bankruptcy fraud. It is quite similar to the bleed out. The characteristic feature of a bust out is that it happens over a relatively short period of time. On the other hand, a bleed out happens over a prolonged period of time, sometimes even decades.

Using this strategy, the insiders of the company purposely deplete the assets of the company over a long period of time. The transactions are designed to be confusing. They often have many layers and are spread out over a large time frame. This is what makes the forensic investigation of a bleed out very expensive and difficult.

There are many forms in which bleed outs occur. For instance, in some cases, companies are paid for invoices against which no goods or services were received. These firms are owned by the insiders of the company.


Regulating agencies have now become wary of the various types of frauds that are perpetrated nowadays. Hence, instead of directly filing for bankruptcy, many companies work in hand in glove with certain creditors and ask them to file bankruptcy on their behalf. This is done to conceal the fraud and mislead the investors into thinking that the company is actually facing an involuntary bankruptcy. This is also considered to be a fraudulent activity since the intention of such an activity is to deceive people and cause monetary harm.

The bottom line is that bankruptcy laws are often misused by certain firms to commit fraud. It is the job of the regulators and the investors to stay wary of such frauds. Also, the companies themselves need to be aware that with the help of technology, catching such frauds has become much easier.

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