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Peter Janovsky Discusses Fighting Bankruptcy Scams on BusinessWeek Online

AUGUST 23, 2006
Smart Answers
By Karen E. Klein

How to Fight Bankruptcy Scams
Yikes, a customer who owes you is conspiring to protect his assets. Here’s how to do battle—and decide whether it’s worth your trouble.

My company has a major customer who has always been slow to pay his bills. Now I’m hearing a rumor that this person is planning to transfer his assets to his wife and declare bankruptcy in order to avoid paying his debtors, including my firm. Do I have any recourse?

Unfortunately, this kind of scam occurs all too often, and small businesses sometimes end up victimized as a result, experts say. Even when an outfit declares bankruptcy legitimately, smaller companies like yours are typically listed as unsecured creditors and get low priority when it comes to payment of the debt.

Speak to your attorney about this situation immediately and stay on top of the rumor mill, advises Peter Janovsky, a partner in the New York City law firm Zeichner Ellman & Krause.

“You have to be vigilant, but laws have recently changed to be more favorable to creditors,” Janovsky says. “In some circumstances, you can even get an attachment pre-bankruptcy if you really think this person is trying to transfer assets out of state or out of the country. If you succeed in getting an attachment, the local sheriff can put a levy on those assets so the person cannot move them.” There exists a very high standard for attaching assets, however, he warns, and you might wind up liable yourself if the company can prove that you froze its assets and damaged them.

TROLLING FOR TRANSFERS. Janovsky points to a couple of common schemes that make use of the bankruptcy system for nefarious purposes. One, a “bust-out,” typically involves a business that’s doing poorly. “Before they go out of business, they transfer their remaining assets to a new business entity that they set up under a new name, in a new place. The creditors, particularly the small-business creditors, are out of luck unless they can somehow pierce through [the deception],” Janovsky says.

Another practice, “fraudulent conveyance,” is the one you described. A business owner puts his assets in a close relative’s name—or even in an offshore trust—and then declares personal bankruptcy, claiming a complete lack of resources available to repay debts. If you, as a creditor, can prove that the transfer was part of a fraudulent conveyance, you may have some recourse in bankruptcy court, Janovsky says.

“Obviously these cases involve a great deal of research, but under a 2005 amendment to the Federal Bankruptcy Code creditors can now go back 10 years to look at asset transfers. If they can show in court that those transfers were done with the intent of defrauding creditors, those transfers can sometimes be reversed, and the bankruptcy trustee can go after them,” he says.

MAKE IT PERSONAL. Of course, you’ll have to pay lawyers and accountants to pursue cases like this, so you should make sure the potential recovery justifies that expense, he says.

To avoid a perilous situation in the first place, a small business owner should exercise vigilance when agreeing to extend credit to customers, Janovsky advises: “To the extent you can, try to get some sort of collateral, such as a personal guarantee in writing. That way they are personally liable, and if they bust out, they’re still on the hook personally.”

Another good rule is never to let your receivables get old and stale, and to insist on cash on delivery whenever feasible. “To the extent that you can, stay connected within your industry and try to keep an eye out for new companies that are setting up with the same personalities that you know from another firm. And if you’re suspicious, search business filings and see what you can find,” Janovsky advises. You may be able to head off a nasty surprise before it even hits you.

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Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.