Suppose that you have a valid judgment, or at least a claim against a party for damages but the debtor is insolvent. How do you recover any assets in this scenario? These methods require qualified legal advice and support from professional investigators skilled in the specific area of asset recovery. Let’s take a look at some strategies which can provide pathways to recovery or seizure of funds and assets in this situation.
If the individual or entity has already filed a bankruptcy petition and the case is still in process, there are a few methods for a creditor to obtain a more favorable outcome. Using the “fraudulent transfers” provisions of the US Bankruptcy Code, creditors can assist the trustee to reclassify assets as debtor assets even if they are presently titled or held by other parties. The debtor may have intentionally transferred funds or other assets to nominee third parties for the purpose of placing them outside the reach of creditors or the trustee. These are discovered by through qualified investigative methods, and can be presented to the trustee for consideration when located. Provisions for recovering from improper transfers can be found in the Code at 548(a)(1).
Even if the debtor did not intentionally transfer assets fraudulently, creditors can use the theory of constructive transfers to reel in assets. In these instances, the transfer is made without receiving something of reasonably equivalent value in exchange for the transfer. These outbound assets or funds can be identified for possible clawback. Less obvious asset transfers can be in often overlooked forms, such as a promissory note held by a debtor. A loan which is forgiven by the debtor, or offered with below market terms can be made part of a claim to recover assets. Specific mechanisms for identifying constructive fraudulent transfers is in the US bankruptcy code at 548(a)(1)(A).
Going even further, a creditor can make the argument that the date of insolvency was when the debtor began operating a fraud or Ponzi scheme. This can open up an entirely new set of assets for recovery. For example, suppose a debtor began operating at a loss for several years while continuing to receive revenue from clients or investors. During this period the debtor continues to pay salaries to principals and executives. At the same time there are preferential payments to entities such as closely held management companies, principally owned real estate leases, or selected payables vendors. A financial forensics investigation can pinpoint the instant in history which the debtor became technically insolvent so that outflows of assets beyond that date can be assessed. An analysis of payments will reveal which payees received preferential treatment and which were paid late or not at all. Preferential payees including principals or executives may be a source or clawback.
Third Party Liability
If the fraud was extended due to the actions of third parties, vicarious liability can extend to those individuals or entities as well. A bankrupt debtor may have been able to continue its enterprise because of lax oversight of its bank accounts, continued recommendation by investment advisers or preparation of positive financial statements by accountants. In one example, a company opens a bank account with the stated purpose of operating a local retail store. The account is used to collect payments from investors around the country. Instead of expected account activity showing merchant deposits and cash entries, the account statement shows large volume of ACH and wire transfers from out of town banks. A review of the policies and procedures of the bank who holds the account, compared with the actual activity in the account will reveal whether the financial institution followed its own internal or regulatory requirements in monitoring the client. If it can be demonstrated that according to policy the account should have been reviewed or even closed, a claim can be made that the institution enabled the fraudulent debtor to operate longer than it would otherwise would have, and therefore expanded losses to creditors.
If a third party prolonged the life of an otherwise defunct corporation a claim can be made that the third party carries some liability for losses to the entity. Consider an example where a contract salesperson brings in new business or investors to an insolvent company. If the company was able to continue to operate for a longer period of time, the contractor may have enabled the deepening of the fraud. It may have been unwittingly, but not if the contractor knew or should have known that the corporation was not viable. An area of investigation in this scenario would be to analyze communications, emails, voice mails, or other correspondence to see if there were any suggestions made to the salesperson to “just get a few more sales to cover payroll.” This could indicate that the sales were being made simply to temporarily delay the discovery of the insolvency. An investigation would look at whether a professional overlooked obvious red flags of fraud, or did not look into doubtful representations made by a client or vendor. Creditors who incurred losses which were enabled by information furnished by such a third party may be able to claim against that person or firm. A separate legal theory for connecting third party liability is “foreseeable injury,” where the professional had a reasonable expectation for a party to be damaged, even if there was no contractual relationship with the client.
The actions which created the debt to a particular creditor can also be scrutinized to determine if related parties contributed to the liability. For example, suppose a bankrupt company owes money to a creditor due to an unpaid invoice for services. Were all of those services provided exclusively to the debtor? Did any benefit company principals individually, or other entities?
A formal bankruptcy petition filing allows greater powers for discover of a debtors finances and activities. Prior transactions can be scrutinized for indications of fraudulent transfers or third party liability. If a debtor is insolvent, but not formally in bankruptcy there may be a benefit of using the strategy of an involuntary filing by creditors to obtain this ability. On the other hand, it has the consequence of prioritizing claims which may not favor one particular creditor.