Judging the sins of the past--the power of the bankruptcy court.

• Author: Gardner, Terry L.
• Position: The 2002 Law Journal

The continuing news about the scandals in the corporate ranks is unnerving. Enron and WorldCom are just two of the mega-companies under intense scrutiny for accounting practices that have obscured financial reality to the detriment of creditors and investors. Both companies filed Chapter 11, and similar cases may soon follow suit.

While the public perception of bankruptcy varies depending upon one's experience with it, one aspect that is relatively unknown is that the bankruptcy law requires a debtor seeking protection to provide considerable financial information under penalty of perjury. It has been said that debt creates pressures that induce fraud, and fraud staves off bankruptcy. The fraud, however, is sometimes unsuccessful, and bankruptcy still ensues.

Why do parties commit fraud to stave off bankruptcy? The parties, often officers and directors, do not want to undergo the intense scrutiny inherent in the bankruptcy process or the possible liquidation of their companies. Any person or company that files for bankruptcy relief must provide a significant amount of information to the Bankruptcy Court. This information includes, but is not limited to, a record of payments to creditors within the 90 days prior to the filing and a record of transfers of any kind during the prior year.

Insider greed

One of the more sensitive areas of required information is the disclosure of any withdrawals or distributions made to an insider, including compensation in any form, loans, stock redemptions, options exercised and any other perquisite during the year preceding the bankruptcy filing. An "insider" of a corporation is defined as any officer, director, person in control of the debtor, partnership in which the debtor is a general partner, general partner of the debtor or relatives of a general partner, director, officer or person in control of the debtor. The purpose of this inquiry is to determine if insiders have improperly benefited at the expense of the corporation.

Often, when the corporate ship is sinking, insiders seek to benefit themselves to the detriment of the creditors and investors. Most states have laws providing that the officers and directors of an insolvent corporation have fiduciary obligations to the creditors of the corporation. However, the greed of management is often extreme.

Fiduciary duty to creditors

North Carolina law provides that directors of a corporation shall discharge their duties in good faith, with the care an...