Fraud

One of the things that I’ve been stuck on (besides indemnity agreements) is the concept of fraud. At our session on Thursday we were admonished that a company that continues to accept unsecured credit after making the decision to go bankrupt may be committing fraud on the vendors who continue to provide goods and services to the company. That makes some sense, right? The board of directors has a fiduciary duty to creditors when a company is in the zone of insolvency – and if you know you can’t or may not be able to pay folks back, it’s not really fair to them to let their receivables grow.

At the same time we keep getting told how much planning you have to do pre-bankruptcy. Basically on the day you show up in court to file for bankruptcy, you’ve got to have a bunch of other agreements and motions drafted. In some cases you show up in court with a complex set of pre-negotiated documents with certain “key vendors” and your lender, and you’re asking for various injunctions and permissions and all kinds of things.

So the solution, we’re told, to doing all this pre-bankruptcy planning while operating the company and continuing to take unsecured credit while you’re scheming and negotiating and figuring out who’s going to get something and who’s going home empty handed when you do file your case, is to wait to get the board resolution authorizing the filing for bankruptcy the morning that you file or the night before you file. So then it’s not fraud, because the determination hasn’t officially been made to file for bankruptcy until the date of the resolution, and everything that you did up to that point was just “contingency planning.”

Does anyone but me think that’s a ridiculous distinction? I mean, can you trick judges and creditors that easily?

Comments

[Richard Ames]

Yes. Ridiculous. The fraud analysis you outline says nothing about the CREDITOR's duty to look out for itself. Creditors can require certain assurances from the debtor before they provide the credit, something they rarely, if ever, do. All creditors know (or should know) that there is such a thing as a Bankruptcy Code which can threaten their interest if the debtor decides to make use of it. When the house of cards comes tumbling down they whine like babes about how unfairly the law and the courts are treating them, as if they had absolutely no responsibility for giving the loan in the first place ("But they promised! Waaaa"). Sounds like you're listening to a lot of academic types there. They need to get out more often.

[John P.]

I think Richard is right. As always, we lawyers need to keep clear in our heads the differences between what's dead-bang legal and what's (arguably) morally right and what's acceptably or unacceptably risky. Or, to use Lynn Lopucki's phrase, it's the debtor-creditor GAME, at least with respect to most businesspeople.

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