Learning the truth about a bankrupt debtor's finances can sometimes become a daunting task. Even if debtors don't hide their assets or conceal their transfers, the complexity of even fairly simple economic transactions frequently require a deep study of a debtor's books and records. For this reason, the federal bankruptcy laws provide for a number of ways to discover and, if necessary, expose a debtor's financial life.
First Source of Information: Debtor’s Required Submissions
The first method is the debtor's fundamental obligation to disclose assets, liabilities, income, expenses and other financial information in the Schedules and Statement of Financial Affairs. The schedules form the initial basis into any examination of the debtor’s financial condition. The schedules need to be filed with or within fifteen days of commencing the bankruptcy case, but the bankruptcy court will regularly grant extensions provided that the schedules are filed at least a few days before the regularly scheduled meeting with the trustee (also called the First Meeting of Creditors or the 341 meeting). Typically, the Schedules and Statement of Financial Affairs offer all the information most creditors need to close their files.
Meeting of Creditors: More “Free Discovery”
Creditors will have the opportunity for more “free discovery” at the meeting with the trustee, where the debtor will have to answer questions under oath. Because the proceedings are open to the public and usually involve several cases being scheduled for examination at the same time, in chapter 7 or 13 cases the trustee may limit creditor questioning, or else move the case to the end of the docket. The debtor’s testimony is recorded on an electronic digital recorder and is available in an mp3 audio format.
Rule 2004 Exam: Fishing Expedition
When parties seek more comprehensive information, or when information is sought from non-debtors, the best technique is to ask the bankruptcy court for permission to take an intensive deposition under Bankruptcy Rule 2004 (for this reason, these examinations are generally called 2004 Exams). When requesting a 2004 Exam the party seeking information may ask the Bankruptcy Court to order production of documents, testimony under oath or both.
Courts routinely issue orders authorizing highly intrusive 2004 Exams of debtors. This makes sense, because Rule 2004 itself states that the scope of a 2004 Exam “may relate only to the acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor's estate, or to the debtor's right to a discharge.” An expansive review of the debtor’s financial condtion could include review of the following documents, at least:
bank statements for all accounts and canceled checks; check registers; tax returns; any financial reports, profit and loss reports, cash flow reports or general ledgers; payroll records; documents evidencing any loans given or received; paystubs; accountant notes or correspondence; credit card statements; documents evidencing incorporation or any amendment to a charter or similar authority to conduct business as an entity; promotional materials, including brochures, flyers, websites, emails or any other item that may appear in either printed or electronic medium that was created or disseminated to assist in the promotion of a business
In question 18 of the Statement of Financial Affairs the debtor needs to disclose information pertaining to businesses that the debtor has owned or managed within the six years prior to filing the bankruptcy case. As a result, an examining creditor may seek document production beginning six years prior to the petition date.
Debtors may complain that a creditor’s examination is nothing more than a “fishing expedition”, but in truth this kind of open ended inquiry is precisely the point of the examination. Debtors frequently lose sight of the truth that the opportunity permitted by the Bankruptcy Code to restructure or discharge debt is extraordinary. Part of the price that debtors pay for that opportunity is complete, accurate and, if necessary, exhaustive disclosure. In all of the relief chapters of the Bankruptcy Code: Chapters 7, 9, 11, 12 and 13, debtors have an inherent obligation to file their cases in good faith. In chapter 7 especially, the chapter of the Bankruptcy Code that offers debtors the greatest possible relief, debtors have a heightened obligation to provide information. Debtors, for example, cannot receive a discharge under Chapter 7 if they have “failed to explain satisfactorily, before determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor’s liabilities.” This penalty applies whether or not the debtor has acted maliciously or fraudulently. In exchange for receiving the benefits of bankruptcy debtors must be prepared for a deeply detailed examination of documents and a deposition under oath.
The real power of a Rule 2004 Exam, however, is the right of debtors or other parties in interest to examine non-debtors. Although these examinations are limited in scope and must be authorized by the bankruptcy judge, they provide an extraordinary opportunity to obtain documents and depose any person or entity that is related to the debtor. A perfect example of this power is the right of a debtor/minority shareholder to compel production of documents for the ostensible purpose of valuing the debtor’s shares. Under state law, a minority shareholder would have to file a lawsuit to compel an accounting to discover information about the corporation. In bankruptcy, on the other hand, the trustee or debtor may simply file a brief motion with the bankruptcy court to obtain as much if not more information than would be available in the state courts.
Landlords, banks, credit card companies, spouses, CPAs and others with information relative to the debtor’s financial condition are all vulnerable to being heralded before the bankruptcy court to disclose that information, even without a lawsuit pending. Under the bankruptcy rules, in addition to obtaining a court order these non-debtors must be personally served with a subpoena in order for the bankruptcy court to obtain jurisdiction to compel the production. Failure to honor the subpoena will open the door for sanctions and contempt of court.
The Rule 2004 procedure puts real teeth into bankruptcy court discovery. However, when there are actual contested matters, adversary proceedings or other lawsuits pending in the bankruptcy court the parties must resort to the normal discovery rules permitted under the Federal Rules of Bankruptcy Procedure such as interrogatories, requests for production of documents, requests for admission, depositions, etc. In these matters the normal scope of discovery relevance applies, that is the information may lead to the discovery of admissible evidence. This scope may coincide with the scope of a 2004 examination, but that Rule 2004 procedure is not available.
To Examine Or Not To Examine, That Is The Question
Filing bankruptcy is usually the end of the road for most collection efforts, but creditors can’t know that for certain unless they take steps to learn more about the debtor. Nobody wants to throw good money after bad, but if there’s enough money at stake and the creditor has the means, deposing the debtor under Rule 2004 may provide an unexpected return on investment.