Tuesday, October 11, 2016

Unusual Bankruptcy Fraud Case Yields Guidance on Sentencing and Proof Issues

In the rare bankruptcy fraud case to reach it, United Statesv. Free, No. 15-2939, the Court confronts an instance of a defendant who filed for voluntary reorganization under Chapter 13 despite having adequate assets to repay his creditors in full.  The proceeding was later converted into a Chapter 7 action and the creditors made whole.  Defendant Michael Free was meanwhile found guilty by a jury of making false statements in filings and testimony in the bankruptcy proceedings.  At sentencing, the government sought a 16-level enhancement under the 2014 Sentencing Guidelines for a loss amount of between $1 and $2.5 million.  The sum represented an accounting of the value of certain assets concealed by Free from the bankruptcy court.  (Note that by amendment effective November 1, 2015, Section 2B1.1 now requires a loss $1.5 to $3.5 million to trigger a 16-level bump.)

Section 2B1.1 of the Guidelines, pertaining to fraud and other economic crimes, defines “loss” as the greater of the “reasonably foreseeable pecuniary harm that resulted from the offense” or, to abbreviate slightly, “the pecuniary harm that was intended to result from the offense.”  If “there is a loss but it reasonably cannot be determined,” the sentencing court is to use “the gain that resulted from the offense as an alternative measure.”  In Free’s case, the district court made no explicit finding of any intent to cause pecuniary harm to the creditors; rather, the Circuit suggests, Free’s aim had been to protect his extensive store of valuable World War II-era firearms from liquidation.  The district court nonetheless applied the 16-level enhancement, reading the Guidelines to “reflect the commonsense proposition ‘that there would be a higher loss calculation when there is a significantly higher amount of assets that are concealed from the Bankruptcy Court[.]’”  Given “the tens of thousands of bankruptcy cases just filed here in Pittsburgh, let alone around the country,” the judicial system must “absolutely rely on people telling the truth because we can’t ferret it out any other way.”

The Circuit reverses.  Loss cannot simply be the amount of assets the debtor hides from the trustee and creditors.  Instead, the sentencing court must determine the “pecuniary harm, actual or intended, to [the defendant’s] creditors, or what he sought to gain from committing the crime.”  Despite disagreeing with the district court’s “view that the concept of ‘loss’ under the Guidelines is broad enough to cover injuries like abstract harm to the judiciary,” the Court emphasizes the relevance of this concern.  Indeed, the decision even goes so far as to contemplate an upward departure for conduct resulting in “a significant disruption of a governmental function” under Section 5K2.7 of the Sentencing Guidelines.  Separately, the Court states in a footnote that loss amount may include “administrative expenses” incurred by the bankrupt estate.

The Court otherwise rejects the defendant’s challenge to the sufficiency of the evidence.  Quoting a Sixth Circuit decision for the proposition that under the bankruptcy statute at 18 U.S.C. § 157, “filing itself is the forbidden act,” the Court concludes that the evidence Free filed fraudulent documents was “overwhelming.”  It would thus appear that in bankruptcy fraud cases there need be no proof that the defendant intended to deprive creditors of money or property.

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