Bankruptcy

• Key point 9-09. Bankruptcy trustees are prohibited by the federal Religious Liberty and Charitable Donation Protection Act from recovering contributions made by bankrupt debtors to a church or other charity prior to declaring bankruptcy, unless the contributions were made with an intent to defraud creditors. This protection extends to any contribution amounting to less than 15 percent of a debtor's gross annual income, or more if the debtor can establish a regular pattern of giving more. In addition, the Act bars bankruptcy courts from rejecting a bankruptcy plan because it allows the debtor to continue making contributions to a church or charity.

* A bankruptcy court in Arkansas ruled that a bankruptcy trustee could not object to a couple's bankruptcy plan on the ground that they proposed to continue making contributions to their church. A married couple filed a bankruptcy petition under Chapter 13 of the Bankruptcy Code. The couple's bankruptcy plan called for the payment of $879 per month for 36 months to secured and unsecured creditors, which would satisfy less than 1% of unsecured creditors' claims. Their plan also called for the payment of monthly contributions to their church of $416, representing 9.8% of their monthly gross income. The bankruptcy trustee opposed the plan on the basis of the charitable contributions. The trustee insisted that the contributions should be redirected to the creditors.

Section 1325 of the Bankruptcy Code specifies that if a bankruptcy trustee objects to the confirmation of the plan, then the court may not approve the plan 'unless, as of the effective date of the plan … the plan provides that all of the debtor's projected disposable income to be received in the three year period beginning on the date that the first payment is due under the plan will be applied to made payments under the plan.' Disposable income is defined as income which is received by the debtor and which is not reasonably necessary for the maintenance or support of the debtor or a dependent of the debtor.

The Religious Liberty and Charitable Donation Protection Act of 1998 amended the Bankruptcy Code to define disposable income to exclude charitable contributions 'in an amount not to exceed 15 percent of the gross income of the debtor for the year in which the contributions are made.' While the couple's charitable contributions amounted to less than 15 percent of their gross income, the trustee insisted that this did not automatically require their plan to be accepted. Rather, the trustee insisted that the plan as a whole must still be 'reasonable,' and he concluded that it was not.

The bankruptcy court noted that the Code recognizes that 'charitable contributions that do not exceed 15 percent of a debtor's gross income may be excluded from the debtor's disposable income,' and that 'the Code makes clear that a court is not supposed to engage in a separate analysis to determine whether charitable contributions up to 15 percent are reasonably necessary for the debtor's maintenance and support.'

The court acknowledged that 'despite the plain meaning of the statute, some courts have interpreted the Code to subject charitable contributions to two limitations. First, that the amount of the contribution cannot exceed 15 percent of the debtor's gross income, and, second, that the amount of the contribution itself is reasonable.' The court concluded that such an interpretation of the Bankruptcy Code

obviates the goal of the Code, namely to protect certain charitable contributions from the consideration-based, cost/benefit oriented disposable income test. Allowing a court to apply a 'reasonably necessary" qualification to the charitable contributions provision would thwart that stated purpose of [the Code]. Courts would be compelled by precedent and common sense to conclude that a religious gift could never be reasonably necessary for support in the same economic sense as food expenditures or the cost of transport to a place of employment. The only lasting effect of [the Code] would be to deprive courts of the power to find all such contributions unnecessary as a matter of law and thus provide a debtor with a futile evidentiary hearing at which to defend his contributions as reasonably necessary. Surely Congress did not intend [the Code] to serve such a limited purpose ….The debtors' proposed charitable contributions fall within the amount allowed by [the Code] and will not be included in the debtors' disposable income for the purpose of plan confirmation.

The bankruptcy trustee also argued that the plan must be rejected on the ground that it was not made in 'good faith.' The Bankruptcy Code specifies that for a court to confirm a plan, it must find that the plan 'has been proposed in good faith and not by any means forbidden by law." In rejecting this argument, the court noted that the couple had regularly tithed to their church.

Application . The Religious Liberty and Charitable Donation Protection Act of 1998 provides important protections to churches and church members. This historic legislation is addressed fully in a feature article in the May-June 1999 issue of this newsletter. One of the key protections of the Act prevents bankruptcy trustees from objecting to bankruptcy plans on the ground that the debtor proposes to continue making charitable contributions so long as the amount of the contributions does not exceed (1) 15 percent of the debtor's income or (2) more than 15 percent of the debtor's income if the contributions were 'consistent with the practices of the debtor in making charitable contributions.' In re Petty, 338 B.R. 805 (E.D. Ark. 2006).

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