The Volokh Conspiracy - How Much Bankruptcy Fraud is There?

Although most of the debate over the bankruptcy reform legislation has focused on the means-test and the problem of bankruptcy abuse, the bulk of the consumer provisions are dedicated to the much more mundane, uncontroversial, and damaging problem of bankruptcy fraud. The biggest problem, as one might expect, is simply hiding assets from creditors and the court. Tom Blumer at Bizzyblog has nonetheless suggested that perhaps the bankruptcy fraud problem is minor. Here's a quick roundup on the estimates of bankruptcy fraud I have been able to find with a moderate degree of searching:

The FBI estimated a decade ago that about 10% of consumer bankruptcy cases have some sort of fraud:

Bankruptcy laws were put in place to protect businesses and individuals from losing everything they owned in the event of financial failure. But who protects us from those who use this system to defraud their creditors and actually get rich through bankruptcy? Some people duped the bankruptcy courts with fabricated petitions and testimony resulting in unpaid debts and money in their pockets. Bankruptcy fraud costs businesses and taxpayers billions every year.

A wider acceptance of bankruptcy in this country, as well as a changing economic climate, has led to a 500 percent rise in bankruptcy filings since 1973. About 10 percent of all bankruptcies involve fraud. So in 1995 alone, almost 250 fraudulent bankruptcies were filed every day. Bankruptcy fraud schemes include the hiding of assets, false statements, multiple filings, forged petitions and petition mills that crank out phony information. Two-thirds of all bankruptcy fraud involves hidden assets.

A few years ago the IRS endorsed the 10% figure:

The Bankruptcy Reform Act of 1978 restructured the bankruptcy court system and overhauled the nation's bankruptcy laws to more closely conform to modern commercial transactions. Since these changes liberalized debtor access to bankruptcy relief, annual bankruptcy filings have increased from approximately 300,000 in 1980 to approximately 1.4 million in FY2001. The increasing number of bankruptcy petitions filed has been accompanied by a correlative increase in bankruptcy fraud.

Industry experts estimate that 10% of all bankruptcy petitions contain some elements of fraud. This results in serious consequences which undermine public confidence in the system, taint the reputation of honest citizens seeking protection under the bankruptcy statutes, and have a negative impact on voluntary compliance in our income tax system. With so much at stake, the detection and prosecution of bankruptcy fraud continues to be a priority for the IRS, as well as the Department of Justice.

A recent analysis by SMR Research states that this probably underestimates the extent of fraud in the system. (Note: This is a summary of a bankruptcy fraud study which is for sale, and which I haven't purchased, so this is from the summar on the SMR Research website):

We gathered a random sample of Chapter 7 petitions in 24 states, all filed the same day: June 5, 2002. It was the day in the middle of the worst year for filings. Our sample size was about 7.9% of all the Chapter 7 filings of that day.

All the cases we studied were successfully discharged.

We created a database of asset, debt, income, and living expense numbers and looked at the statistical results. We also did something judges don't always do: We read some of the petitions carefully.

The FBI estimates that 10% of bankruptcy filings involve fraud of some kind. But fewer than 0.1% of filers are convicted. And our statistical analysis suggests that even the 10% fraud estimate is probably low.

For people who are in bankruptcy because of poor financial planning skills, apparently some bankruptcy filers can make some pretty accurate calculations:

9.5% of filers claim that, in a wild coincidence, their bankruptcy fees of about $1,000 were their last cash, down to the penny. Nearly one-third of filers claimed they were nearly penniless after paying these fees.

And SMR notes some interesting case studies:

Among individual petitions, one after another stretched credibility to its limits. We illustrate with 30 case studies, all pretty clear stuff. Check James, who had $800,000 of unsecured debt but claimed the assets he acquired were gone after being struck by lightning. Russ in California had no job, no income, and no cash but somehow maintained his monthly gym membership. Brian owed money on a hot tub he claimed was stolen (by a gang of patient thieves, apparently; it takes hours to drain one and at least six large men to lift the shell.)

Bob and Susan had $120,000 of annual income but couldn't pay their debts for one big reason: $826 per month they spent on a SeaRay boat. Still, they reaffirmed the boat loan. Alexis filed, owing only $2,088 in total debt, even though she had a good job and could have paid half the debt with what she spent on lawyer and filing fees.

Note again that every debtor in the study received a discharge, even Brian, the unfortunate victim of hot tub theft.

In a positive note, the DOJ appears to be ramping up its efforts to rein in bankruptcy fraud. (See, for instance, Operation Silver Screen.")

Update:

Apparently my skepticism about the plausibility of hot tub theft was unwarranted. A reader writes: As for the hot tub theft, we get them fairly often in this neck of the woods. The thieves drive up to the back of the house with a pick-up. Jack up the side of the hot tub so the water runs out. Toss the hot tub on the back of the pick-up and drive off. A hot tub like the ones at SAMS can be stolen in less than five minutes and resold for at least $300.00.

	[Todd Zywicki, April 12, 2005 at 8:58pm] Trackbacks How Much Bankruptcy Fraud is There? Although most of the debate over the bankruptcy reform legislation has focused on the means-test and the problem of bankruptcy abuse, the bulk of the consumer provisions are dedicated to the much more mundane, uncontroversial, and damaging problem of bankruptcy fraud. The biggest problem, as one might expect, is simply hiding assets from creditors and the court. Tom Blumer at Bizzyblog has nonetheless suggested that perhaps the bankruptcy fraud problem is minor. Here's a quick roundup on the estimates of bankruptcy fraud I have been able to find with a moderate degree of searching: The FBI estimated a decade ago that about 10% of consumer bankruptcy cases have some sort of fraud: Bankruptcy laws were put in place to protect businesses and individuals from losing everything they owned in the event of financial failure. But who protects us from those who use this system to defraud their creditors and actually get rich through bankruptcy? Some people duped the bankruptcy courts with fabricated petitions and testimony resulting in unpaid debts and money in their pockets. Bankruptcy fraud costs businesses and taxpayers billions every year. A wider acceptance of bankruptcy in this country, as well as a changing economic climate, has led to a 500 percent rise in bankruptcy filings since 1973. About 10 percent of all bankruptcies involve fraud. So in 1995 alone, almost 250 fraudulent bankruptcies were filed every day. Bankruptcy fraud schemes include the hiding of assets, false statements, multiple filings, forged petitions and petition mills that crank out phony information. Two-thirds of all bankruptcy fraud involves hidden assets. A few years ago the IRS endorsed the 10% figure: The Bankruptcy Reform Act of 1978 restructured the bankruptcy court system and overhauled the nation's bankruptcy laws to more closely conform to modern commercial transactions. Since these changes liberalized debtor access to bankruptcy relief, annual bankruptcy filings have increased from approximately 300,000 in 1980 to approximately 1.4 million in FY2001. The increasing number of bankruptcy petitions filed has been accompanied by a correlative increase in bankruptcy fraud. Industry experts estimate that 10% of all bankruptcy petitions contain some elements of fraud. This results in serious consequences which undermine public confidence in the system, taint the reputation of honest citizens seeking protection under the bankruptcy statutes, and have a negative impact on voluntary compliance in our income tax system. With so much at stake, the detection and prosecution of bankruptcy fraud continues to be a priority for the IRS, as well as the Department of Justice. A recent analysis by SMR Research states that this probably underestimates the extent of fraud in the system. (Note: This is a summary of a bankruptcy fraud study which is for sale, and which I haven't purchased, so this is from the summar on the SMR Research website): We gathered a random sample of Chapter 7 petitions in 24 states, all filed the same day: June 5, 2002. It was the day in the middle of the worst year for filings. Our sample size was about 7.9% of all the Chapter 7 filings of that day. All the cases we studied were successfully discharged. We created a database of asset, debt, income, and living expense numbers and looked at the statistical results. We also did something judges don't always do: We read some of the petitions carefully. The FBI estimates that 10% of bankruptcy filings involve fraud of some kind. But fewer than 0.1% of filers are convicted. And our statistical analysis suggests that even the 10% fraud estimate is probably low. For people who are in bankruptcy because of poor financial planning skills, apparently some bankruptcy filers can make some pretty accurate calculations: 9.5% of filers claim that, in a wild coincidence, their bankruptcy fees of about $1,000 were their last cash, down to the penny. Nearly one-third of filers claimed they were nearly penniless after paying these fees. And SMR notes some interesting case studies: Among individual petitions, one after another stretched credibility to its limits. We illustrate with 30 case studies, all pretty clear stuff. Check James, who had $800,000 of unsecured debt but claimed the assets he acquired were gone after being struck by lightning. Russ in California had no job, no income, and no cash but somehow maintained his monthly gym membership. Brian owed money on a hot tub he claimed was stolen (by a gang of patient thieves, apparently; it takes hours to drain one and at least six large men to lift the shell.) Bob and Susan had $120,000 of annual income but couldn't pay their debts for one big reason: $826 per month they spent on a SeaRay boat. Still, they reaffirmed the boat loan. Alexis filed, owing only $2,088 in total debt, even though she had a good job and could have paid half the debt with what she spent on lawyer and filing fees. Note again that every debtor in the study received a discharge, even Brian, the unfortunate victim of hot tub theft. In a positive note, the DOJ appears to be ramping up its efforts to rein in bankruptcy fraud. (See, for instance, Operation Silver Screen.") Update: Apparently my skepticism about the plausibility of hot tub theft was unwarranted. A reader writes: As for the hot tub theft, we get them fairly often in this neck of the woods. The thieves drive up to the back of the house with a pick-up. Jack up the side of the hot tub so the water runs out. Toss the hot tub on the back of the pick-up and drive off. A hot tub like the ones at SAMS can be stolen in less than five minutes and resold for at least $300.00.