Random Audits
It is not likely but always possible that your personal bankruptcy case will undergo an audit directed by the United States Bankruptcy Administrator which monitors and investigates bankruptcy cases to ensure compliance with applicable laws and procedures. If the Bankruptcy Administrator finds evidence of fraud, it could lead to the dismissal of your case or even criminal penalties.
There are many ways auditors can spot lack of honesty and/or sloppiness in disclosures among documents filed in a bankruptcy case. It is important to realize that all paperwork required of a bankruptcy filing is important. It is also important to recognize that, even with the counsel of an attorney, you are responsible for the accuracy of your bankruptcy filing and will bear the responsibility of any omissions or discrepancies. Audits are not the only way that fraud can be discovered. The Bankruptcy Code and Rules provide various discovery devices and consequences where a debtor is not being accurate in what is disclosed.
What Are Bankruptcy Audits?
Bankruptcy audits are part of a check and balance process in the bankruptcy system. The bankruptcy audit process involves an independent accountant or audit firm that verifies the information disclosed in the bankruptcy application is accurate.
Why Do Bankruptcy Audits Happen?
Bankruptcy audits are conducted every year to try to monitor fraud and to prevent debtors from lying about their income and schedules so that they do not receive bankruptcy relief if they’re not entitled to it.
Bankruptcy law allows the U.S. Trustee’s office to randomly audit up to one out of every 1,000 chapter 7 or 13 cases filed. While it might choose to conduct fewer chapter 13 and chapter 7 bankruptcy audits than this, it must audit at least one out of 250 cases in each federal judicial district.
In addition to the random audits, a consumer may receive notice of a bankruptcy audit after discharge if there are certain red flags, such as if the debtor’s income and expenses vary greatly from those of the average filer in the filing district.
How Does a Bankruptcy Case Get Audited?
The Bankruptcy Administrator is authorized to contract with independent firms of certified public accountants or independent licensed public accountants to perform audits of individual Chapter 7 and Chapter 13 bankruptcy cases chosen by the Bankruptcy Administrator. Audits are designed to identify and measure the magnitude of fraud, abuse, and error in the bankruptcy system and to enhance deterrence through criminal penalties.
There are two designations for bankruptcy audits:
- Random Audit. The Bankruptcy Administrator is authorized to randomly choose one out of every 250 consumer bankruptcy cases per federal judicial district.
- Exception Audit. The Bankruptcy Administrator can order an exception audit when the income or expenditures reported by a debtor deviate from the statistical norm of the district in which the case was filed.
What are the Chances of a Bankruptcy Case Audit?
Very few bankruptcy cases are audited, but many of those audited are found to contain at least one material misstatement.
In Fiscal Year 2017, the United States Trustee Program (which operates in all states except for North Carolina and Alabama) designated 1,013 cases for audit. That’s 0.13 percent of the 766,635 Chapter 7 and 13 bankruptcies filed in FY 2017. (Note that due to budgetary constraints, the designation of audits was suspended from April 13, 2016 to June 7, 2017. Typically, closer to 1 percent of cases are audited per fiscal year.)
Of the cases designated for audit in FY 2017:
- 485 were random audits and 488 were exception audits.
- 30 were dismissed before the case was assigned to an audit firm.
- 10 cases from Puerto Rico were suspended and not completed in the aftermath of Hurricanes Irma and Maria.
- 19 percent of random audits identified at least one material misstatement.
- 28 percent of exception audits identified at least one material misstatement.
- Reports of Audit were filed in 920 of the completed audits, and at least one material misstatement was reported in 23 percent of these cases.
- There were 53 Reports of No Audit filed.
What Happens When a Bankruptcy Case is Audited?
An audit consists of a comparison between selected items among a debtor’s originally filed bankruptcy papers and documents produced by the debtor at the request of the audit firm. Audit firms also conduct at least two searches using commercially and publicly available database services to look for unreported assets and to verify the market value of assets.
The audit typically requires the debtor to produce significant numbers of documents, such as bank statements, credit card statements, tax returns, etc.
After an audit has been completed, which is to occur within 21 days, the audit firm files a Report of Audit or Report of No Audit with the Bankruptcy Court and a copy is transmitted to the Bankruptcy Administrator.
A Report of Audit identifies any material misstatement identified by the audit firm. A finding of a material misstatement indicates the audit produced information that challenged the accuracy, veracity, or completeness of a debtor’s petition, schedules, or other filed bankruptcy documentation. Typically, material misstatements relate to the understatement or omission of the debtor’s assets, income, or pre-petition transfer of property.
Prior to filing a Report of Audit with the court noting a material misstatement, the audit firm contacts the debtor, through their lawyer if they are represented, to provide the debtor an opportunity to explain or supply additional information to negate the audit’s finding.
A Report of No Audit means the auditing firm could not complete the audit because the debtor did not produce documents requested in connection with the audit or because the case was dismissed while the audit was in process.
What Effect Can a Bankruptcy Audit Have?
If a material misstatement is identified in a Report of Audit, the bankruptcy court gives notice to all creditors in the case, any of whom might choose to take action(s) based on the findings.
The Bankruptcy Administrator may pursue a variety of actions depending on the circumstances of the case, including seeking denial or revocation of discharge, or reporting the material misstatement to the United States Attorney for prosecution.
When the audit firm files a Report of No Audit, the Bankruptcy Administrator may take appropriate enforcement action, including seeking revocation of discharge, if the debtor fails to satisfactorily explain the failure to make the documentation requested for the audit available.
Often, no action is taken because the Bankruptcy Administrator determines an omission was unintentional or the debtor promptly corrects the record when advised of the misstatement.
Be Confident If Your Bankruptcy is Audited
Many errors made in bankruptcy cases are the result of poor record keeping, confusion or sloppiness as opposed to intentional misrepresentations. When you file for bankruptcy, it is important to be careful with the required paperwork. It is appropriate to review documents carefully and ask questions of your bankruptcy attorney if you are uncertain as to a particular item that is being disclosed or not disclosed.
At the Sasser Law Firm, our board-certified Raleigh bankruptcy lawyers have more than 20 years of experience helping people navigate the complexities of bankruptcy filings including issues related to disclosures. Let us help you determine the best options for getting your finances back on track and, if bankruptcy is right for you, guide you through the requirements of the Bankruptcy Court. Initial consultations are free and we are happy to talk with you.
This post was originally published in May 2019 and has been updated for accuracy and comprehensiveness in September 2021.
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For more than 20 years, the Sasser Law Firm has been helping individuals and business owners sort through financial hardships to see the light at the end of the tunnel. Our North Carolina bankruptcy attorneys are all board-certified specialists, which means we have passed a complex exam, undergone a thorough peer review, and continue to earn legal education credits in this ever-evolving area of law.
