Penalties for filing Fraudulent Proofs
of Claim and Issues Under
Section 502(d)
Folarin S. Dosunmu
Locke Lord Bissell & Liddell LLP
111 South Wacker Drive
Chicago, IL 60606
312.443.0219
[email protected]
A proof of claim is a written statement, usually filed by a creditor, describing the reason
for and amount of the debt allegedly owed by the debtor to the creditor. Official Form B10,
which is used in completing a proof of claim, is available at the websites of most bankruptcy
courts. 11 U.S.C. §§ 501 and 502 and Rules 3001, 3002, 3003, 3005, 3006, 3007 and 3008 of
the Federal Rules of Bankruptcy Procedure (“FRBP” or “Bankruptcy Rules”) govern the manner
in which creditors and equity security holders submit their claims and interests to the bankruptcy
court.
Creditors must file a proof of claim not merely to provide information to the bankruptcy
court, but also to submit their claims to the bankruptcy court's jurisdiction in order to establish
that creditor's right to participate in the distribution of the bankruptcy estate. By filing a claim
against the estate, a creditor triggers the process of allowance and disallowance of claims. In re
Cruisephone Inc., 278 B.R. 325, 330 (Bankr. E.D.N.Y. 2002).
There are varying rules for filing, allowance and disallowance depending on the
respective chapter in which the debtor seeks protection: Chapter 7 (liquidation); Chapter 9
(municipality debt adjustment); Chapter 11 (reorganization); Chapter 12 (family farmer/family
fisherman debt adjustment); and Chapter 13 (individual debt adjustment). One requirement that
is present in every chapter of bankruptcy is the penalty of presenting a fraudulent or false claim
to the bankruptcy court.
A person who knowingly and fraudulently presents any false claim for proof against the
estate of a debtor, or uses any such claim in any case under title 11, in a personal
capacity, or as or through an agent, proxy or attorney… shall be fined under this title,
imprisoned not more than 5 years, or both.
18. U.S.C. § 152. Defendants that are found guilty under 18 U.S.C. § 152 are subject to a
maximum fine of $250,000 for individuals and $500,000 for corporations. 18 U.S.C. § 3571.
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Additionally, a bankruptcy court may set aside a fraudulent claim or, in appropriate cases,
subordinate the claim of one creditor to those of others to prevent inequitable conduct. In re
Pyramid Energy, Ltd., 160 B.R. 586 (Bankr. S.D. Ill. 1993).
Every pleading in bankruptcy, except for specified statements and schedules, must be
signed by counsel or an unrepresented party. Fed. R. Bankr. P. 9011(a). The execution
represents that the signer has determined through inquiry that the allegations have a factual basis.
Fed. R. Bankr. P. 9011(b); Knox v. Sunstar Acceptance Corp., 237 B.R. 687, 699 (Bankr. N.D.
Ill. 1999).
It is so important not to file fraudulent, false or misleading claims with the bankruptcy
court that a “friendly reminder” of the penalty for presenting fraudulent or false claims is
conveniently located on Official Form 10 below the signature block of the person authorized to
file such claim, as depicted below:
Date:
Signature: The person filing this claim must sign it. Sign and print name and title, if any,
FOR COURT USE ONLY
of the creditor or other person authorized to file this claim and state address and
telephone number if different from the notice address above. Attach copy of
power of attorney, if any.
Penalty for presenting fraudulent claim: Fine of up to $500,000 or imprisonment for up to 5 years, or both. 18 U.S.C §§ 152 and 3571
Additionally, the instructions for the proof of claim form also inform the claimant that Rule 9011
of the Bankruptcy Rules apply and that criminal penalties apply for making a false statement on
a proof of claim.
No Private Right of Action
If a debtor suspects that a creditor has filed a fraudulent claim, the debtor cannot simply
file a complaint alleging fraud against the creditor in state court. The issue of whether 18 U.S.C.
§ 152(4) gives rise to a private action, outside of the bankruptcy claims objection process, has
been analyzed by various courts. There is no private cause of action under 18 U.S.C. §152(4) for
filing a false proof of claim in a bankruptcy proceeding. Martin v. CitiFinancial, Inc., 2007 WL
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5171046 (Bankr. S.D. Ga. 2007); Heavrin v. Boeing Capital Corp., 246 F. Supp. 2d 728, 731
(W.D. Ky. 2003).
The bankruptcy court in Heavrin utilized the four-part test articulated in Cort v. Ash, 422
U.S. 66 (1975). to determine whether Congress intended to create a private right of action:
(1)
whether the plaintiff is a member of a class for whose special benefit the statute
was enacted;
(2)
whether there is any explicit or implicit indication of congressional intent to
create or deny a private remedy;
(3)
whether a private remedy would be inconsistent with the underlying purposes of
the legislative scheme; and
(4)
whether the cause of action is one traditionally relegated to state law.
Heavrin v. Boeing Capital Corp., 246 F. Supp. 2d at 731; Knox v. Sunstar Acceptance
Corp., 237 B.R. at 700. The four factors are not equally weighted when applying the four-factor
test. Id. The Heavrin court found that the legislative history of 18 U.S.C. § 152 indicates that
the provision was enacted to do away with the previous requirement that proofs of claim be filed
under oath, as the oath was found to be burdensome and expensive to creditors. Congress did
not intend to create a private right of action by the enactment of 18 U.S.C. § 152. Heavrin v.
Boeing Capital Corp., 246 F. Supp. 2d at 731.
Even the all-encompassing Section 105 of the Bankruptcy Code does not allow a private
cause of action for filing a false or fraudulent claim under 18 U.S.C. § 152(4). Section 105(a) of
the Bankruptcy Code provides that the bankruptcy court may issue any order, process, or
judgment that is necessary or appropriate to carry out the provisions of the bankruptcy code.
However, Section 105 of the Bankruptcy Code must be used in tandem with another Bankruptcy
Code section. The Knox court found that that allowing a private cause of action to remedy the
filing of a fraudulent claims would be inconsistent with the underlying legislative scheme where
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Congress has already provided an express remedy for such asserted abuses. Knox v. Sunstar
Acceptance Corp., 237 B.R. at 701.
Debtors’ Adversary Proceeding to Recover from Creditor’s Consistent Inflated Claims
In In re Abramson, 313 B.R. 195, 196-97 (Bankr. W.D. Penn. 2004) three respective
debtors commenced a class action against Federman & Phelan (“Federman”) a claimant in each
of the debtors’ respective bankruptcies, alleging that Federman violated the Pennsylvania Fair
Debt Extension Uniformity Act and the Pennsylvania Unfair Trade Practices and Consumer
Protection Law. Federman, acting as the debt collector representing the mortgagees in each case,
filed proofs of claim that overstated the mortgage arrears as part of a course of conduct. In each
respective case, Federman filed a proof of claim, the debtor objected, and then Federman filed an
amended proof of claim in a reduced amount. Upon Federman’s filing of the amended proof of
claim, the respective debtors withdrew their proofs of claim objections. Id.
Federman moved to dismiss the complaint asserting that no cause of action can arise
under the FDCPA or the Consumer Protection Law out of the filing of a proof of claim in
bankruptcy court. The Abramson court held that once a debtor is in bankruptcy court, the
debtor’s remedies to attack an allegedly-inflated proof of claim are limited to those provided for
in the Bankruptcy Code. In granting Federman’s motion to dismiss, the court held that the
remedy for allegedly-inflated claims is through the claims objection process and, if necessary
through Rule 9011 or the equitable powers set forth in Section 105 of the Bankruptcy Code. Id
at 198.
Successful Enforcement of 11 U.S.C. § 152(4)
The proper procedure for a debtor to contest the filing of a fraudulent claim is to object to
the allowance of the proof of claim. A debtor cannot attack an inflated proof of claim in an
adversary proceeding in bankruptcy court, nor in a separate suit in district court. A debtor can
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only attack the proof of claim in the claim objection process in bankruptcy court and only by
using the remedies provided in the Bankruptcy Code. Gray-Mapp v. Sherman, 100 F. Supp. 810
(N.D. Ill. 1999) (granting the creditor’s motion to dismiss the debtor’s complaint alleging that
the creditor filed an inflated claim and violation of the Fair Debt Collection Practices Act).
In In re Campell, the debtor objected to the proof of claim filed by an attorney on behalf
of Banc Plus Mortgage Corporation. The court found that the amount of the proof of claim was
grossly fraudulent. The attorney on behalf of Banc Plus stood to receive more than $5,000 based
on the fraudulent proof of claim. The court ordered the attorney filing the claims to pay the
debtor’s $5,000 of attorney fees incurred in objecting to the fraudulent proof of claim. The court
also ordered the attorney to pay the debtor $15,000 on account of his outrageous greed. In re
Campbell, 140 B.R. 35, 42 (Bankr. E.D.N.Y. 1992). Thus, the signer of the fraudulent proof of
claim was fined four times the amount of his potential windfall on account of his fraud.
There are not a great amount of reported cases in which a claimant has been fined and/or
imprisoned on account of filing a fraudulent proof of claim. This may be on account of the clear
reminder on every proof of claim form. This may also be attributed to the fact that once a debtor
objects to a proof of claim, a creditor may withdraw or amend the proof of claim, as amended
should be freely given. See In re Unroe 937 F.2d 346 (7th Cir. 1991). However, once a claim
has been objected to by a party-in-interest, the claimant cannot withdraw the claim without leave
from the court. Fed. R. Bankr. P. 3006.
A claimant should not play roulette by filing an inflated claim with the hope that debtor
does not object and if the debtor does object, simply amending the proof of claim. Once the
proof of claim is filed with the court, it becomes subject to the requirements and penalties of the
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Bankruptcy Code and the Bankruptcy Rules. Therefore, if a claimant files an inflated,
misleading, false or outright fraudulent proof of claim, it does so at its own peril.
Section 502(d) - An Affirmative Defense for Debtors or Creditors?
Section 502(d) of the Bankruptcy Code (§ 502(d)) is unique as it may be used both as an
affirmative defense by both a debtor and a creditor. Section 502(d) can be used as an affirmative
defense by a debtor to defend a creditor’s claim asserted against the estate. Section 502(d) may
also be used as an affirmative defense by a creditor to defend against a debtor’s prosecution of an
avoidance action against a creditor.
Purpose
Section 502 of the Bankruptcy Code governs the allowance of claims in a bankruptcy
case. A filed proof of claim is deemed allowed unless a party-in-interest objects to the claim. 11
U.S.C. § 502(a). Section 502(d), however, deviates from the deemed allowance operation of
subsection (a). Section 502(d) of the Bankruptcy Code states:
Notwithstanding subsections (a) and (b) of this section, the court shall disallow any claim
of any entity from which property is recoverable under section 542, 543, 550, or 553 of
this title [11 U.S.C. §§ 542, 543, 550, or 553 or that is a transferee of a transfer avoidable
under section 522(f), 522(h), 544, 545, 547, 548, 549, or 724(a) of this title [11 U.S.C. §§
522(f), 522(h), 544, 545, 547, 548, 549, or 724(a)], unless such entity or transferee has
paid the amount, or turned over such property, for which such entity or transferee is liable
under section 522(i), 543, 543, 550, or 553 of this title [11 U.S.C. §§ 522(i), 543, 543,
550, or 553].
11 U.S.C. § 502(d). There is a split of authority, even within the Delaware bankruptcy courts, as
to the application of § 502(d). Some cases have found that § 502 stands for the proposition that
if a claim is allowed, there is no longer a voidable transfer due from the claimant. Thus, a
voidable transfer, such as a preference, must be determined as part of the claims process and not
a later date, especially after distribution under the plan has been made. In re LaRoche Industries,
Inc., 284 B.R. 406 (Bankr. D. Del. 2002). Other cases hold that § 502(d) does not prevent a
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debtor or trustee’s attempt to recover a voidable transfer after a claim has been allowed or
settled. In re TWA Inc. Post Confirmation Estate, 305 B.R. 221 (Bankr. D. Del. 2004)
Section 502(d) Precludes an Avoidance Action after Claim is Adjudicated
In reaching its decision, the LaRoche court found that the current § 502(d) had its origins
in § 57 of the Bankruptcy Act, which provided that:
The claims of creditors who have received or acquired preferences, liens, conveyances,
transfers, assignments or encumbrances, void or voidable under this title, shall not be
allowed unless such creditors shall surrender such preferences, liens, conveyances,
transfers, assignments, or encumbrances.
11 U.S.C. §93(g). The LaRoche court found that. Katchen v. Landis, 382 U.S. 323 (1966),
instructs that the debtors should have brought the preference action before, or at the same time,
as they filed their objections to the creditor’s claim. Having failed to do, they cannot now bring
the preference action.” LaRoche Industries, Inc., 284 B.R at 409.
Likewise, In re Cambridge Industries Holdings, Inc. indicates that § 502(d) of the
Bankruptcy Code requires the application of principles of claim preclusion, so that the avoidable
transfer issues must be raised as part of the claim objection/allowance process. In re Cambridge
Industries Holdings, Inc., 2003 WL 21697190 (Bankr. D. Del. 2003). The court also found that
that consolidation of the claim objection and adversary proceeding prosecuting an avoidance
action presents no procedural problems.
A contested matter is any dispute in bankruptcy that is not required to be addressed by
way of an adversary proceeding. A contested matter is initiated by the filing of a motion or
application. Contested matters are less formal and usually proceed more quickly than adversary
proceedings. An adversary proceeding is a separate lawsuit filed in a bankruptcy case, initiated
by the filing of a summons and complaint. Adversary proceedings are governed by the rules of
Part VII of the Federal Rules of Bankruptcy Procedure.
A claim objection is a contested matter pursuant to Fed.R. Bankr. P. 9014. An action to
avoid a preference is an adversary proceeding, pursuant to Fed. R. Bankr. P. 7001(1). The
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bankruptcy court may direct at any stage of a contested matter that other rules applicable to
adversary proceedings apply to the contested matter. Fed. R. Bankr. P. 9014(c). Contested
matters, such as objections to claims, are easily consolidated with adversary proceedings. In re
Cambridge Industries Holdings, Inc., 2003 WL 21697190 at 4. “The command of § 502(d) is
clear: The preference dispute must be resolved in tandem with the claim objection.” Id. at 5.
Section 502(d) does not Preclude an Avoidance Action after a Claim is Adjudicated.
A line of cases stand for the proposition that § 502(d) does not prohibit preference actions
to be commenced after a claim is allowed by settlement or a hearing. See, e.g., In re TWA Inc.
Post Confirmation Estate, 305 B.R. 221 (Bankr. D. Del. 2004); In re Rhythms NetConnections,
300 B.R. 404 (Bankr. S.D.N.Y. 2003) (rejecting the finding in LaRoche and holding that the
settlement of claims were made at time when the debtors were not focusing on preference issues,
thus the debtors should not be barred from bringing a preference action). In re Bridge Info. Sys.,
Inc., 293 B.R. 479 (Bankr. E.D. Mo. 2003) (finding that the issue of whether a debtor who failed
to object to a creditor’s claim based on § 502(d) was precluded from later asserting a preference
action against the creditor was not at issue in Katchen).
In In re TWA Inc. Post Confirmation Estate, the court rejected LaRoche and Cambridge,
holding that a debtor is not compelled to bring an avoidance action to object to a proof of claim.
The court also discussed the practical effect of requiring the claims process and preference
litigation to take place simultaneously. The court found that generally in larger chapter 11 cases,
the resolution of a large number of claims affected the plan confirmation process. The debtor is
focused on reorganizing and usually does not turn its attention to the preference analysis until
sometime later in the bankruptcy case or when its readily apparent that the debtor would be
forced into liquidation. In re TWA Inc. Post Confirmation Estate, 305 B.R. at 410.
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In In re Dornier Aviation (North America), Inc., the court also rejected LaRoche and
Cambridge and found that the plain language of § 502(d) does not suggest a right of creditors to
dispute avoidance actions on the basis of previously allowed claims. In re Dornier Aviation
(North America), Inc., 320 B.R. 831 (E.D. Va. 2005). Construing § 502 as requiring the debtors
to bring avoidance actions simultaneously with the adjudication of creditor’s claims would
eviscerate Congress’ determination that debtors and trustees should have two years in which to
file such actions. Id. at 837.
Another instance in which § 502(d) was used to protect a debtor from a creditor’s claim
was in In re Weinstein. In that case, the trustee failed to bring a preference action within the
two-year statute of limitation. However, the trustee objected to the creditor’s claim pursuant to §
502(d) because the creditor had in fact received a preference and had not returned the funds to
the debtor’s estate. In sustaining the trustee’s objection, the court found that allowing the
creditor to retain the judgment it received during the preference period and receiving a
distribution as a secured creditor would defeat the intent of the Bankruptcy Code. In re
Weinstein, 256 B.R. 536, 538 (Bankr. S.D. Fla. 1999). Furthermore, the court held that had the
creditor received a preference beyond the amount it sought from the debtor as a secured claim,
the trustee would be unable to recover the additional preference without commencing a timely
adversary proceeding. Id.
Although TWA was decided after LaRoche, Cambridge, the application of § 502(d) is
still up for debate as neither LaRoche nor Cambridge have been overruled. The particular
circumstances of a case, such as the size and complexity of a case, may be determinative to the
court of whether to preclude avoidance actions being brought after the adjudication or settlement
of a claim.
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Application of Section 502 after a Sale of a Claim
A recent case in the Enron bankruptcy shed some light on the application of § 502(d)
after a claim is sold. The court held that a claim sold post-petition cannot be disallowed based
on the original claimholder’s receipt of, and failure to repay, an avoidable transfer. “Applying §
502(d) to purchasers of claims would be punitive because they have no option to surrender
something they do not have, which means they have not personally obtained any advantage that
they could surrender.” In re Enron Corp., 379 B.R. 425, 443-44 (S.D.N.Y. 2007). The court
found that the plain language of the § 502(d) focused on the claimant as opposed to the claims,
and leads to the conclusion that disallowance is a personal disability of a claimant, not an
attribute of a claim. Id. at 443. This analysis only applies to the sale of a claim. With
assignments of claims, the parties can contract around the risk of disallowance by entering into
indemnity agreements to protect the assignee. Id. at 442.
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