I’ve been charged with fraud in the following situation: I have a small business, and I applied for a business loan we needed to fund some manufacturing. In order to get the loan, we had a key customer of the business guarantee the loan. The manufacturing was specifically for this client. That client is another business which I own. Long story short, due to the recession, both my businesses failed and I was unable to repay the loan. I never intended to this happen, and I did intend to repay the loan from the second business if the first one couldn’t pay it, but I’m being charged with fraud in connection with the loan guarantee. I’m also being charged with fraud in the context of some payments my businesses made to me just before going under. I thought there had to be a fraudulent or deceitful intent for there to be fraud, not just bad luck.
Answer: (1)
For “garden variety” fraud, there needs to be intent, that’s true. But the law also recognizes the concept of “constructive fraud,” which are actions that amount to fraud even without the intent. Constructive fraud typically arises in the context of related-party transactions and also transactions when there is a fiduciary or other heightened duty. The idea is that owing to the relationship or duty, a person or business entity who makes a transfer to or other transaction favoring A (who is related in some way) over B (who is not) has “as good as” committed fraud. The important thing is that the relationship, duty, or circumstances replaces the necessity for a fraudulent intent—that, in a nutshell, is the difference between actual (or common) fraud and constructive fraud.
Looking at your situation: the whole purpose of a loan guarantee is to increase the likelihood the lender will be repaid—it “guarantees” (literally!) payment. However, when both the borrower and the guarantor are controlled by the same entity, that guaranty is worth less—there’s no independent person or entity on the hook. You don’t say whether you disclosed ownership or control of the second company to the lender before you used them as a guarantor, but I suspect you didn’t—particularly if that company was described as a “customer” of the first, which usually means that it’s independent. If you didn’t make that critical disclosure, even if your intentions were pure, you still constructively defrauded the bank by inducing them to make a loan which they wouldn’t have made otherwise.
Going further, when you paid yourself instead of the bank or other creditors, that, too may have been constructive fraud—you used your inside track (controlling the companies) to advantage yourself (by taking money out) over outside, unrelated parties (since every dollar you took out was a dollar less for other creditors). Again, even if there was no bad intent, it may have been a constructive fraudulent transfer.
That’s not to say that all related party transactions are fraudulent—or even that these ones are—but there certainly is a legal basis under which they might be. I recommend you retain a good criminal defense attorney, one experienced in “white collar” crime.
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Posted by Steven Sweig on 04 Feb 2010