THE BANKRUPTCY RACKET
Every year about 1,500 firms go bankrupt in Canada. Some of them are really “twentieth century highway robbery on a grand scale.” These are the swindles that succeed by failing behind the protection of an obsolete law
A TEAM OF BANKRUPTCY INVESTIGATORS recently spent three months combing through the accounts of a large Toronto business which had just gone bust. When they added up all their figures, there was $312,000 missing. This was not money the company had lost doing business; it was cash which the company had received but definitely had not spent. "In my opinion,” said one accountant-investigator, “the money has been stolen.”
Incredibly, the thieves are known. Both are living openly in Toronto; both drive expensive cars and live in large houses. No police have called on them and none ever will over this matter. This was a classic instance of a twentieth century refinement of highway robbery on a grand scale: deliberate bankruptcy.
Only thirty years ago. some bankrupts would commit suicide rather than face creditors. Today. bankruptcy can be an easy way to wealth, an expedient method of ducking financial obligations. Allan Perly, a member of the Greater Toronto Businessmen’s Association, said recently, "It's quite all right to go bankrupt now. The moral aspect, the shame, has been lost.” The moral stigma of bankruptcy has gone, but replacing it is a rising outcry against the ease with which some men can move in and out of bankruptcy while fleecing creditors of large sums of money. The Toronto Board of Trade has asked the Justice Department for more than a hundred changes to the Bankruptcy Act. The Small and Independent Business Federa-
tion wants changes. Half a dozen other business associations are preparing briefs for presentation to Minister of Justice Davie Fulton.
The small businessmen and the Canadian Credit Men’s Trust Association Ltd. want a special bankruptcy investigation department set up to see that crooked bankrupts were tracked down the way fraud squads now track down other criminals. The Justice Department and the RCMP are investigating the affairs of many licensed bankruptcy trustees, particularly in Montreal, men who have temporary control of the assets in bankrupt estates to ensure that creditors get a fair division of the spoils.
"Some businessmen today want a return to the good old days of King James I. of England,” says a prominent Toronto bankruptcy law'yer, "when bankrupts had their ears nailed to the pillories and, in serious instances, the creditors would lop them off.”
ONE SYSTEM: OWE VERY LITTLE TO VERY MANY
How bad is today’s bankruptcy problem? On an average, four companies go bankrupt every day in Canada. Bankruptcies cause business losses that range from $50 million to $200 million a year. Some, like the spectacular failure of Let George Do It Appliances in Toronto with liabilities of $998,000, occur after a firm has been in business only a year or so. Others may strike long-established companies, like R. Moat & Co., a respected Montreal brokerage house which went to the wall (but recovered in
four months) when somebody stole $915,000 worth of securities from it. Most bankruptcies are caused by poor judgment or changing market conditions. Another cause is overexpansion which recently toppled the Seabreeze Manufacturing Company, a $3,000,000 electronics enterprise, in Ontario.
But about ten percent of all bankruptcies— some experts say twenty percent—are planned acts, calculated to take advantage of benevolent law's, overeager creditors and human gullibility. The entire bankruptcy process—from the selection of a trustee to divide the assets among creditors, to the court discharge which frees the bankrupt from further financial obligations once settlement is made—goes back to King James' time. Punching holes in a debtor’s ears was doubtless a momentarily satisfying form of punishment but since those days lawyers, jurists and politicians have tried to rehabilitate unwitting bankrupts and save them from becoming pariahs.
In this century, they’ve succeeded handsomely, particularly since 1949, when a new Bankruptcy Act was adopted in Canada. But meanwhile, business morality has been changed by rising taxes and a flood of regulations. “Present legislation,” said a Montreal bankruptcy expert recently, “is only truly effective if the bankrupt is absolutely honest. But how many men are?”
Bankruptcy laws have swung from earpunching to something approaching coddling. For twenty-three years, there wasn't one successful prosecution of a bankrupt in Canada. The first prosecution came last year when Irving Mandel, an Ontario furniture dealer, was sent to jail for a year for cheating on his bankruptcy.
He had a private furniture company but changed it to an incorporated company—-Craft Furniture Ltd.—in 1960. Soon after, he began buying heavily. By February, 1961, he owed ninety-six firms $86,536 and went bankrupt. His creditors’ meeting was a stormy one. Why was $8,000 in cash missing from his accounts? He didn’t know. Why did he suddenly incur a $60,000 loss, much of it in three months? He didn’t know. How much merchandise had he sold? He didn’t know.
Mandel had simply taken furniture bought on credit and peddled it for cash. In many instances, he had sold it at thirty percent below cost. One buyer, Max Brown, told the creditors he never made out invoices and always paid with cash, even though the bill might be as high as $3,000. Tracing such transactions can be hard on a creditor’s nerves.
The two big clues to the dishonest bankrupt are invariably a passion for cash business and a poor, or nonexistent, bookkeeping system. Mandel’s books weren’t in bad shape but 403 retail invoices in the last three months of his business were missing from a total of 600. Once an invoice is missing, all proof of the transaction is gone. It’s suspected that in another Toronto swindle—a $300,000 one—the two owners of the business must have spent hours every night destroying literally hundreds of invoices and sales slips.
But this is just one way of faking a bankruptcy. Some deliberate bankrupts carefully pick creditors in advance and measure their finances and their personalities with the idea of selecting men who will not be eager to suc in a bankruptcy action. A standard procedure is to owe as many creditors as possible, but none for a substantial amount. “A thousand dollars or less per creditor is a good rule of thumb for the unscrupulous bankrupt,” says one lawyer. One recent bankrupt in the retail business owed $213,000 to nearly 600 creditors. The creditors were convinced the operation was a phony but they could not agree CONTINUED ON PAGE 53
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The crooked bankrupt has to be pitiless: a dozen small, innocent businesses may go down with him
to spend the money to investigate it.
Frauds, even minor irregularities, are hard to prove because under the law the outraged creditor must prove that the bankrupt is an out-and-out crook who should go to jail—or nothing. If proof is lacking, all a judge can do is slap wrists.
There is growing anger and suspicion at the ease with which "related” people — friends and relatives—extricate themselves with their cash intact from bankruptcies while other people lose their shirts. The law permits such relationships and so leaves the way clear for crooked bankruptcies which are also "legal." A potential bankrupt arranges to have a bunch of friends and relatives as creditors. They charge exorbitant prices for their merchandise, or services, and make sure they have security. When the smoke and confusion of the bankruptcy has died down, the collusive bankrupt and his friends divide up the loot.
A more common, and almost foolproof, bankrupt device is for a man to sell all the assets of his company to a friend, or even to a separate company that he sets up himself. These assets are leased back to the original company at a highly inflated price. Eventually, the original company is allowed to go bankrupt. In the meantime, the second company has made a tremendous profit out of leasing—and it still owns all the assets.
The Criminal Code and the Bankruptcy Act between them provide for hefty punishment for such shenanigans. But hundreds of honest companies are also split in this way as insurance against unexpected adversity. Proving fraud is therefore difficult.
dangerous and expensive. Full-scale legal investigation may cost $100 a day and investigation of a complex business set-up can easily take six months.
The phony bankrupt knows this, particularly the one who picks his victims. He must have no conscience about the chain reaction that frequently follows his default. The Canadian Small and Independent Business Federation has found that in some large bankruptcies as many as a dozen small businesses may go down with the big one. "Actually,” says managing director Robert J. Bishop, “small businessmen may suffer more than the bankrupt himself." Typically, a recent Montreal bankrupt sold his house and belongings and moved to Florida after he got his court discharge. In an attempt to stay in business, one of his main creditors had to withdraw his son from medical school, sell his car and mortgage his house.
The crooked bankrupt may be as good a salesman as a first-rate confidence man. "The big front works as well in bankruptcy as anywhere," says one lawyer. He cites one of his own clients, who. during bankruptcy proceedings, was driving a $7,000 automobile. The lawyer remonstrated with him. said. "How do you expect fair treatment from creditors while you're driving that car?" The bankrupt grinned sheepishly. "Sorry,” he said. “It's the car that got me the credit in the first place.”
Under today's revved-up business rules, a man with $5,000 cash may persuade a supplier to let him have $100,000 worth of equipment with which he can bid on a $1,000,000 job. Many bankruptcy experts believe that the real problem is not our
bankruptcy laws—it's the fierce competition in business to sell. "Caveat vendor— let the seller beware." says John Biddcll, a trustee with the Clarkson Company, a Toronto firm of chartered accountants and trustees. He says that though there must always be risk in selling on credit, there are far too many “dishonest or fraudulent overtones" about many of the hundreds of business failures every year in Canada.
His wife wasn't bankrupt
The eagerness to sell among supplying companies exactly fits the crooked bankrupt's purposes and tends to corrupt the honest man as well. “It's quite surprising,” says Murray Page, a Toronto bankruptcy lawyer, "how many sellers are caught two and three times by the same man going bankrupt." It's not uncommon for major creditors to buttonhole a bankrupt after a creditors' meeting to try to work out a deal to put the man back in business. The average businessman who loses money in a bankruptcy is rarely anxious to put a bankrupt out of commission permanently. "It's better to have him in business where you’ve some chance of getting your money back, than to have him out of business where you've no chance,” says one businessman. There are signs that this is creating a new set of ethics. Under these rules, an honest man may use bankruptcy as an escape hatch if he's pushed unfairly or too hard by his creditors.
An Ontario garage owner was forced into bankruptcy by creditors after he had rebuilt from a fire, even though he had been profitably in business for thirty years.
His lawyer advised him to work out a deal with the only secured creditor—the man who held the mortgage on the building. He did this, with the result that the unsecured creditors got four cents in the dollar. The garage man was discharged by the court and was back in business within ninety days. With new equipment and new suppliers. he's doing nicely.
Such incidents create a fine line between honesty and dishonesty and make it hard for creditors to decide whether they're the victims of genuine or phony bankruptcies. Professor Jack Sands, of the political economy department of the University of Toronto, found himself facing a similar situation recently. He, and a number of his neighbors, bought some imported shrubs from a landscape gardener but most of the shrubs died. Apparently coincidentally, the landscaper went bankrupt with liabilities of $10,000. Sands’ loss w»as small but he was interested in finding out exactly what had happened to the money because he was unhappy with the bankrupt’s explanations. So he organized a group of creditors and then discussed the matter further with the trustee handling the bankrupt estate. But the trustee declined to make a detailed examination of the bankrupt’s accounts. So Sands employed his own lawyers. They discovered that shortly before the bankruptcy, the bankrupt's wife had withdrawn $5,000 from her husband’s business bank account on which she had signing authority. Sands kept on the trail and after much more legal wrangling, managed to get a settlement of $2,000 for the group of creditors that he had organized. The rest got nothing. "If it hadn't been for
our action,” says Professor Sands, “nobody would have known anything about that $5,000.”
For the small creditor, trying to get justice may be almost impossible. A German agricultural engineer, Peter Beekman, got suspicious about the operations of a cooperative pig farm, Associated Livestock Growers of Ontario, near Toronto, in which hundreds of small investors had sunk nearly $2,000,000. Beekman could find only 1,500 pigs—enough money had been invested to buy 18.000—and failed to interest either the Agriculture Department or the Attorney General’s office in making
an investigation. For eight months he hammered away unsuccessfully. Then the pig farm went broke. Its entrepreneur, a former bankrupt called John Laun, disappeared to Germany and did not return. Liabilities arc now $1,800.000 and nobody has yet come up with a good explanation of what happened to the estimated million dollars or so that are missing.
The ease with which creditors can be kept at bay, even when the bankrupt has cash reserves, is something that worries all creditors. When bankruptcy investigators began working on the affairs of Uros Lakin, a bankrupt builder and land dcvel-
oper in Toronto, they found that though broke he was still driving an $8,400 Cadillac. On checking, they found it was owned by Mrs. Maria Gherghina who lived in Rumania. She also happened to be I-akin's mother-in-law.
They also discovered that Lakin had paid over $4.500 of the car’s cost in cash—including a number of thousand-dollar bills —and that he had been doing quite a lot of other business in cash, too. Where this money had come from nobody could be sure. Lakin said that his mother-in-law had sent $19,000 to his wife, in high-denomination American and Canadian bills, all stuffed into the head of a doll.
But a great deal of cash was missing from I.akin’s business itself and Lakin explained this by saying that when a mortgage cheque for $43,445 had come through from the Canada Trust Co. in late 1960, he had cashed it at his bank. He had then carried the cash around in his pocket for a few days before losing it, he said, perhaps while downtown one day.
Such a story must be accepted till proved false and this is why many bankrupts are tempted to turn as much of their dealings into cash as possible. They can then claim they lost the money, or, as one bankrupt builder said recently when asked about a missing $168,000, "Perhaps my foreman, or maybe one of the carpenters, stole it."
Lakin subsequently faced charges under both the Bankruptcy Act and the Criminal Code. (The case has been postponed due to the death of the prosecuting attorney.) But the really big interest in his case is not the casual loss of a fortune on a downtown street but the fact that he got into business in the first place. He emigrated from Rumania with his wife in 1929 and, according to her, did not work till 1959 in this country. He was jailed for four months in 1939 for possessing counterfeiting instruments. Yet somehow, in I960, he got going in the building business and was building seven duplexes, when he went bust in 1961.
Wiping out deliberate bankruptcy may never be possible. But it won't be through lack of trying by the business community. The Justice Department in Ottawa has received, in the last six months, a blizzard of recommendations to change the Bankruptcy Act. Actually nobody — lawyer, trustee, businessman, credit man—has any real argument against the basic soundness of the act. The trouble is, say the lawyers, there’s nobody to police it—-no special bankruptcy prosecutors or judges, no en-
forcing agency. When Mr. Justice Smily of Ontario, who has done much bankruptcy work, fell ill recently, cases began piling up in the courts because other judges were reluctant to handle their specialized complexities.
Superintendent of Bankruptcy J. S. Larose has four accountant-investigators who can handle routine work from Ottawa. But the Act doesn't empower them to be federal watchdogs over dubious bankruptcies. When it was found that some Montreal trustees were playing fast and loose with bankrupt property entrusted to them, the justice department had to appropriate $100,000 to hire special investigators to get the facts. This was one more indication that the Bankruptcy Act depends on people’s honesty in order to work efficiently.
E. T. C. Burke, manager of the Canadian Credit Men’s Trust Association Ltd., recently took a group of leading bankruptcy lawyers from all across the country to discuss, with Justice Minister Davie Fulton, ways of cutting down bankruptcy frauds and improving the Act generally. The lawyers were unanimous that a special federal investigation department would help eliminate the reluctance of creditors, lawyers and trustees to initiate proceedings against those practising fraud. It would bring federal policing of bankruptcies in line with the work of other agencies nowworking in narcotics and combines investigation cases.
Whatever the answer, one thing remains constant to all bankruptcies. There will always be rooms full of angry, frustrated and disappointed creditors who, by an irony they don't understand, are responsible for all bankruptcies because they provide the credit. At a creditors’ meeting in February, 1962, over the affairs of builder and real estate wonder boy Marvin Turk, the thirty-four-year-old who piled up an empire on a personal capital investment of $4, there was something approaching hysteria. Turk owed around $600,000, had four companies and no assets in any of them. Some of his creditors faced insolvency themselves through his business failure.
In the angry, smoke-filled meeting, one creditor suddenly said, “For God’s sake, open a window.”
There was a pause, then another creditor provided what is probably the best short commentary on why bankruptcy of any sort is always a tragedy for someone. “Why?” he asked grimly. “Does somebody want to jump out?” ★