Can You Spot the Signs of Bankruptcy Fraud?

Imagine that your company landed a lucrative new account, and the customer placed a few small orders, paying on time. Now they want to place a larger order, if you’ll expand their credit line. Watch out! This customer may be planning a “bust-out” — a common bankruptcy-related scam.

Bogus bust-outs

In a bust-out, fraudsters create a bogus company — often with a name resembling an established, reliable business — to order goods they have no intention of paying for. In fact, they plan to sell the products for fast cash, file for bankruptcy and leave you, the supplier, holding the empty bag.

Another version of the scheme involves bogus operators who buy an existing company and use its good credit to order the goods. They sell the products they order below cost, for cash, and then file for bankruptcy, writing off the supplier’s bill.

To protect your business against a bust-out, carefully vet prospective customers that are new businesses. Also be wary of established companies with new ownership — particularly if the new owners want to keep their involvement under wraps. Other possible red flags:

• Warehouses stuffed with high-volume, low-cost items
• Disproportionate liabilities to assets
• No corporate bank account
• Principals previously involved with failed companies

Fraudulent conveyances

The most common type of bankruptcy fraud isn’t a bust-out; it’s concealing assets, also called “fraudulent conveyance.” This scheme involves hiding or moving assets in anticipation of a bankruptcy. For example, the owner of a business on the brink of collapse may transfer property to a third party, such as a spouse, for little or no compensation. The third party holds the property until bankruptcy proceedings have concluded, then transfers it back to the business owner.

The business owner may also file for bankruptcy and then, with the court’s approval, sell property below value to a straw buyer. The owner’s relationship with the buyer isn’t disclosed, but the buyer holds the property until the owner is ready to reclaim it at a previously agreed-upon price.

In either case, the goal is the same: to keep money and property out of the hands of creditors.

Keep your eyes open

Once you’re aware of the most common types of fraud, you can design processes and internal controls to help protect your company. But after bankruptcy fraud occurs, you will most likely need professional legal and financial help to recover.

If you’d like to find out more about possible fraud prevention measures, or you suspect one of your customers is trying to pull a fast one, contact us.

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