He Milked it For All it Was Worth: A Dairy Farm Bankruptcy Fraud

Bankruptcy fraud, which is a form of financial statement fraud, is perpetrated by concealing assets through misappropriation and/or a misclassification of accounts. In the following case, we will show how delayed bankruptcy schedule filings, inaccurate bankruptcy schedules and incorrect monthly operation reports can create an opportunity for a dishonest debtor to misappropriate assets of a bankruptcy estate.

The consequences of this particular bankruptcy fraud case resulted in $1.5 million in misappropriated assets, negligence action against the attorney and the convicted debtor receiving a 10-year prison sentence.

THE DAIRY FARMER CASE

The wayward debtor in this case, a dairy farmer (we will call him Stan), was suspected of gambling away the majority of the misappropriated $1,528,502 from the estate at casinos.

Eight months prior to filing bankruptcy, Stan submitted a signed personal financial statement showing $5,582,103 of assets and $4,842,505 of liabilities, which set his net worth at $739,598.Three months prior to filing bankruptcy, Stan submitted a signed personal financial statement showing $11,607,450 of assets and $4,981,100 of liabilities, which then made his net worth $6,626,350.

When he finally filed, the assets of the farmer's bankruptcy estate consisted of farmland, farm equipment, buildings, dairy cows, growing crops and crops in storage. The bankruptcy schedules showed real property of $1,116,000 and personal property of $574,370, for total assets of $1,690,370. The farmer's liabilities consisted of secured creditors and priority creditors holding claims of $4,661,866, and unsecured creditors holding claims of $293,202. This brought the total claims to $4,955,068.

COURSE OF THE BANKRUPTCY

This bankruptcy was extremely adversarial from the beginning. The bankruptcy estate attorney imposed several delays that undermined what little trust existed. The attorney initially filed for a Chapter 12 bankruptcy proceeding, which is a type of bankruptcy for farmers who have less than $1.5 million of debt. However, his client's estate had more than $1.5 million of debt, and the attorney admitted during his deposition that he knew his debtor did not qualify for Chapter 12 at the time he submitted the filing. A plausible explanation for the attorney's action was that a Chapter 12 filing would result in future filings to correct the initial filing. Those filings would delay reporting requirements for the debtor.

The attorney continuously requested extensions to file bankruptcy schedules, saying that he wanted to ensure their accuracy. However, the amended bankruptcy schedules were also inaccurate. Moreover, Stan's monthly reports of operations, when they were filed with the U.S. Trustee office, were filled with inaccuracies and misapplications of accounts. The most cursory review could detect these inaccuracies, so it was clear that the attorney had not reviewed these reports prior to their submittal. Lastly, Stan's plan for reorganization was submitted late and was unrealistic in scope. The creditors' attorneys objected to virtually every filing.

Because of these delays, the creditors did not have accurate information about the estate's assets and monthly cash flow, and Stan was able to maintain control over the estate's assets for 2½ years, instead of being removed and replaced with a court-appointed Chapter 7 trustee who would administer the estate. Almost two years after the initial filing, the bankruptcy court established the value of the farmland at $2,926,000, which differed from the initial $1,116,000 valuation on the schedules. The farmland eventually sold for more than $3 million.

The risk to the creditors was not the farmland's decreased value on the schedules, because the farmland itself was not a liquid asset. The real risk was Stan's misappropriation of assets (i.e., dairy cows, farm equipment, etc.) when he sold those assets outside the normal course of business without first obtaining the court's permission. He used the funds from those sales for his personal gain.

The creditors attempted to deter the debtor's liquidation of assets by taking inventories and by taking court action. However, the court action was slow and the inventory results were disputed. Without cooperation from the estate attorney, the creditors did not accomplish much in trying to thwart the debtor from liquidating his assets.

The debtor misappropriated the following assets for these amounts: