Court Barred by First Amendment from Resolving a Dismissed Minister’s Terminated Retirement Benefits

The court concluded that the plaintiff “sought review of the procedures that resulted in ecclesiastical decisions and necessitated a review of religious law and practice, which is exactly the inquiry that the First Amendment prohibits civil courts from undertaking.”

Richard R. Hammar, Attorney, CPA

Bio

State: Federal
Categories: First Amendment, Judicial Resolution of Church Disputes, Retirement Plans

Key point. Breach of contract claims by dismissed ministers, no matter how meritorious, cannot be resolved by the civil courts if doing so would require an interpretation of religious doctrine, or involves a claim that a decision by the highest ecclesiastical tribunal of a hierarchical denomination did not comply with the church’s laws and regulations.

A federal appeals court ruled that it was barred by the First Amendment religion clauses from resolving a dismissed minister’s claim that a denominational pension board acted improperly in terminating his retirement benefits pursuant to denominational rules when he was “defrocked” and ceased to be a minister in good standing.

An ordained minister (the “plaintiff”) began collecting benefits in 2009 after fulfilling the three conditions identified in his human resource manual for eligibility: (1) he had remained as a member in good standing of the denomination, (2) completed 10 years of full-time paid service for the denomination, and (3) had reached or exceeded retirement age.

The plaintiff’s retirement benefits were terminated for not “remaining as a member of good standing of the denomination” after being defrocked and dismissed from the denomination. The plaintiff sued the denomination, claiming that the termination of his retirement benefits constituted a breach of contract and a violation of the denomination’s covenant of good faith and fair dealing. A federal district court ruled that the lawsuit turned on an “interpretation of what constitutes a ‘member in good standing’ under denominational rules of governance, custom, and faith” and any ruling by the court would violate the religious freedom guaranteed by the First Amendment.

A federal appeals court affirmed the trial court’s dismissal of the case. The court observed:

The [trial] court correctly dismissed the lawsuit. A dispute involving the application of church doctrine and procedure to discipline one of its members is not appropriate for secular adjudication. The plaintiff’s claims, which were predicated on his defrocking, his excommunication, and the termination of his retirement benefits due to a “theological disagreement” would have required encroachment into matters of church dogma and governance. Based on “the separation of church and state principles required by the … First Amendment … the [trial] court could not interfere with the purely ecclesiastical decisions of the [denomination] regarding the plaintiff’s fitness to serve in the clergy or to remain a member of the denomination.

Civil courts may apply neutral principles of law to decide church disputes that involve no consideration of doctrinal matters, but the plaintiff’s lawsuit required examination of church doctrine and polity. His claims … turned on whether he was entitled to retirement benefits. And his entitlement to retirement benefits was conditioned on, among other things, that he remain as a member in good standing of the church. As the trial court stated, it could not “define ‘member’ for a specific church or denomination … because that would require defining the very core of what the religious body as a whole believes.” Likewise, to determine if the plaintiff had remained in good standing, the trial court explained, it would have had to “scrutinize documents related to church rules and discipline and … apply its interpretation of those rules to the plaintiff’s conduct. In other words, the court would have had to determine whether [the denomination] exercised its religion in accordance with the doctrine, faith, custom, and rules of governance” of the church. Because the plaintiff’s claims required an examination of doctrinal beliefs and internal church procedures, the trial court had no power to entertain his controversy with the denomination.

The court noted that the plaintiff’s claim that the denomination breached its implied covenants of good faith and fair dealing also would require review of a decision about internal church governance. The plaintiff alleged that he had been defrocked, excommunicated, and had his retirement benefits cancelled in violation of church procedural rules and the process afforded other ministers. But, the court noted, the United States Supreme Court issued a ruling in 1976 “prohibiting civil courts from undertaking an inquiry into whether the decisions of the highest ecclesiastical tribunal of a hierarchical church complied with church laws and regulations.” Serbian E. Orthodox Diocese v. Milivojevich, 426 U.S. 696 (1976). Such an inquiry by a civil court “would undermine the general rule that religious controversies are not the proper subject of civil court inquiry, and that a civil court must accept the ecclesiastical decisions of church tribunals as it finds them.”

In conclusion, the plaintiff “sought review of the procedures that resulted in ecclesiastical decisions and necessitated a review of religious law and practice, which is exactly the inquiry that the First Amendment prohibits civil courts from undertaking.”

What this means for churches

This case illustrates the view of many courts that breach of contract claims by dismissed ministers, no matter how meritorious, cannot be resolved by the civil courts if doing so would require an interpretation of religious doctrine, or, as in this case, involves a claim that a decision by the highest ecclesiastical tribunal of a hierarchical denomination did not comply with the church’s laws and regulations. 719 Fed.Appx. 926 (2018).

Legal Developments

Liability for Retirement Fund Losses

Protect your retirement fund and its governing board from liability for losses.

Richard R. Hammar, Attorney, CPA

Bio

State: Minnesota
Categories: Denominations - Legal Liability, Retirement Plans

Church Law & Tax Report

Liability for Retirement Fund Losses

Protect your retirement fund and its governing board from liability for losses.

Richard R. Hammar, J.D., LL.M., CPA

A federal court in Minnesota ruled that a national denomination was not liable for losses suffered by beneficiaries of a denominational retirement plan because it did not exercise sufficient control over the fund to be liable for the actions of the fund’s managing board.

Four retired ministers (the “plaintiffs”) sued their denomination (the “national church”) to recover losses they incurred in a denominational pension fund. The pension fund is a defined contribution retirement plan under section 403(b) of the tax code. The plan is a “church plan” that is exempt from ERISA, absent an election to the contrary. Under the plan, defined contributions are made on behalf of participating members into their individual accounts. Plan participants have options for directing their plan accumulations. Before retirement, the accounts are considered “active,” and plan participants can direct their accumulations into funds invested in the equity or fixed income markets.

In December 2008, the plan sent a letter to the plaintiffs stating that their retirement accounts were subject to market risk and that they should expect their distributions to be decreased in 2010. In September 2009, the plan informed participants that, due to the market downturn, it was underfunded by 26 percent and that, effective January 1, 2010, monthly payments would decrease by 9 percent and would likely decrease by an additional 9 percent in both 2011 and 2012.

Plaintiffs sued the national church and the board of pensions that managed the retirement plan (the “defendants”), asserting that, under state law, the defendants were required to invest and manage retirement funds as a prudent investor, and that the defendants breached their fiduciary duties by failing to prudently invest and manage the retirement fund and failing to preserve the trust corpus which caused the fund to become significantly underfunded and reduce plaintiffs’ monthly payments.

fiduciary duties

The court concluded that the national church was not a fiduciary with respect to the retirement plan, and so the plaintiffs’ breach of fiduciary claim against the national church had to be dismissed. The court noted that the plan’s managing board, and not the national church, was the plan fiduciary in charge of administering and managing the plan. It pointed to language in the national church’s governing documents making the plan’s managing board, rather than the national church, responsible for the plan’s investment and administration.

Plaintiffs argued that the national church was a fiduciary with respect to its duty to elect members of the plan’s governing board, and that this imposed on it a limited duty to monitor the board’s activities. It observed that “a person with discretionary authority to appoint, maintain and remove plan fiduciaries is himself deemed a fiduciary with respect to the exercise of that authority. Implicit in the fiduciary duties attaching to persons empowered to appoint and remove plan fiduciaries is the duty to monitor appointees. The scope of the duty to monitor appointees is relatively narrow.” The court stressed that “the duty to monitor is limited and does not include a duty “to review all business decisions of plan administrators” because “that standard would defeat the purpose of having trustees appointed to run a benefits plan in the first place.” The court concluded that the plaintiffs’ lawsuit did not allege that the national church violated any duty to monitor, and therefore it failed to adequately allege that the national church violated a fiduciary duty owed to the plaintiffs.

“church plan” status

The court rejected the plaintiffs’ assertion that the plan’s status as a church plan somehow made the national church liable for the actions of the plan’s managing board. It acknowledged that a church plan must be “established and maintained … by a church,” and that a plan maintained by a third party, such as a pension board, is “established and maintained … by a church” if the third party “is controlled by or associated with a church or a convention or association of churches.” Church plan status is awarded not only to plans controlled by a church, but also to plans associated with a church. An organization is “associated with” a church “if it shares common religious bonds and convictions with that church.”

The court concluded that “the plan’s status as a church plan did not require that the [national church] exercise control over the board or plan, let alone control over the board’s actions at issue in this lawsuit, to the extent that [national church] is liable for the board’s actions. Here, the [plaintiffs] do not allege that [the national church] controls the board with regard to the decisions at issue in this litigation.”

alter ego liability

As an alternative means of holding the national church liable, the plaintiffs alleged that the plan and its governing board were an “alter ego” of the national church and that “injustice and fundamental unfairness would result if the national church was not held accountable” for the board’s misconduct.

The court noted that “there is a presumption of separateness between a parent and subsidiary corporation,” and that “a court may pierce the corporate veil to hold a party liable for the acts of a corporate entity if the entity is used for a fraudulent purpose or the party is the alter ego of the entity. When using the alter ego theory to pierce the corporate veil, courts look to the reality and not form, with how the corporation operated and the individual defendant’s relationship to that operation.”

Under Minnesota law, piercing the corporate veil “requires (1) analyzing the reality of how the corporation functioned and the defendant’s relationship to that operation, and (2) finding injustice or fundamental unfairness.”

The court listed the following factors that are significant in applying the first prong: “whether there is insufficient capitalization for purposes of corporate undertaking, a failure to observe corporate formalities, nonpayment of dividends, insolvency of debtor corporation at time of transaction in question, siphoning of funds by dominant shareholder, nonfunctioning of other officers and directors, absence of corporate records, and existence of the corporation as merely a facade for individual dealings.”

The plaintiffs did not allege any improper transfer of assets between the national church and the plan or its board. Nor did they allege any other type of misuse of the corporate form or plan to harm the plaintiffs. The plaintiffs alleged that the plan is undercapitalized, but “there is no allegation that the national church played any role in that situation. Beyond the conclusory allegation of undercapitalization, there are no factual allegations to support the first prong of piercing the corporate veil.”

The court acknowledged that the national church and the retirement plan “share a close relationship.” However, it concluded:

The national church’s Constitution shows the separation of the corporate structures governing the national church and the board. For example, the Constitution provides that ‘separate incorporation shall be maintained’ for the board. It enumerates the board’s responsibilities in operating and managing benefit plans, which include autonomy and independence. The documents referenced [by the plaintiff] demonstrate that the national church and the board are separate corporate entities, and the plaintiffs provide no factual allegation that these corporate formalities have been disregarded.

The court also concluded that the plaintiffs failed to establish the second prong. It noted that the plaintiffs’ lawsuit alleged that the plan’s board was “an alter ego or instrumentality of the [national church], and injustice and fundamental unfairness would result if the [the national church] is not held accountable for the liabilities resulting from shortfalls in the retirement plan due to undercapitalization or the board of pensions’ lack of resources to cover its liabilities.” But the court stressed that this “barebones allegation that injustice or fundamental unfairness will result” if the national church is not liable was insufficient. It noted that there was no allegation in the plaintiffs’ lawsuit that the national church played any role in any underfunding or that the plan was underfunded when the national church created it. As a result, the plaintiffs “failed to allege facts to support their legal conclusion of injustice or unfairness.”

The court concluded that “although corporations are related, there can be no piercing of the veil without a showing of improper conduct” by the parent corporation.

breach of contract

The plaintiffs’ final argument was that the retirement plan and its governing board were guilty of a breach of contract. The court agreed that the retirement plan constituted a contract with the plaintiffs and other beneficiaries, and it concluded that the plaintiffs’ allegations of a breach of the contract were sufficient to avoid a dismissal of this theory of liability: “The [plaintiffs] claim that the board breached the terms of the plan because, although the plan promised that plaintiffs’ annuity benefits were guaranteed for life and that all increases to those benefits would be permanent, the board implemented an across-the-board 9% decrease in the participants’ monthly annuity benefits.”

The board insisted that its actions were a response to the adverse economic conditions caused by the recession, and were necessary to preserve and maintain the plan. The court concluded that it “did not have the information necessary to conclude whether, in fact, a cut in payments was required to preserve the fund, the amount of any required cut, or whether the fund’s underfunding was, itself, a breach of fiduciary duty. The question of whether the board’s actions were required by—or a breach of—its fiduciary duty is one that cannot be resolved at the motion to dismiss stage.”

What This Means For Churches:

Many beneficiaries of denominational retirement plans have suffered substantial losses during the “great recession.” But, as this case illustrates, those losses are not necessarily attributable to the denomination itself if the retirement plan is a separate corporation with a separate board, and the denomination exercises little, if any, supervision or control over the management decisions of the plan. Further, retirement funds, and their governing boards, are not necessarily liable for beneficiaries’ losses if the individual accounts are self-directed, and no promises are made that are later broken. There are several ways for retirement funds to reduce their risk of liability, including allowing beneficiaries to direct their own investments, by providing educational and training resources to beneficiaries, and by repeatedly stressing that all investments involve risk. 2011 WL 2970962 (D. Minn. 2011).

This Recent Development first appeared in Church Law and Tax Report, July/August 2012.

Legal Developments

Legal Liability When a Pension Plan Fails

Denominations could be responsible for failure to provide for plan members.

Richard R. Hammar, Attorney, CPA

Bio

State: Minnesota
Categories: Denominations - Legal Liability, Retirement Plans

Church Law & Tax Report

Legal Liability When a Pension Plan Fails

Denominations could be responsible for failure to provide for plan members.

Richard R. Hammar, J.D., LL.M., CPA

Key point 10-18.3. There are several legal defenses available to a denominational agency that is sued as a result of the acts or obligations of affiliated clergy and churches. These include a lack of temporal control over clergy and churches; a lack of official notice of a minister’s prior wrongdoing in accordance with the denomination’s governing documents; lack of an agency relationship; the prohibition by the First Amendment of any attempt by the civil courts to impose liability on religious organizations in a way that would threaten or alter their polity; and elimination or modification of the principle of joint and several liability.

Key point. “Church plans” are exempt from ERISA coverage.

A federal court in Minnesota dismissed a lawsuit brought by several participants in a denominational pension plan citing ERISA violations and state law claims for breach of trust, breach of contract, breach of fiduciary duty, and consumer fraud. In 1939 a pension plan was established for the benefit of employees and retirees of a denominational publishing house (the “publisher”) that provided books and other materials to affiliated churches. The plan was terminated in 2010 at which time there were approximately 500 participants, of which 175 had already retired. A number of participants (the “plaintiffs”), on behalf of the entire plan, sued the publisher as well as the parent denomination. The plaintiffs claimed that as recently as 1999 the publisher was debt-free and had $18 million in reserves, and that it experienced financial difficulties beginning in 2002 that resulted in a severe drop in reserves and assets. The plaintiffs claimed that, despite these financial setbacks, the publisher continued to promote its retirement plan and repeatedly distributed written statements to employees promising benefits—despite knowing that the plan was severely underfunded. The plaintiffs sued the publishing house and parent denomination on several grounds under both ERISA and state law. The plaintiffs asserted that the impact on current employees and retirees has been catastrophic. Of the 500 participants, 175 have already retired, and of those, some are too old or sick to reenter the work force. All of them have lost most, and many all, of their expected retirement income.

ERISA

The court concluded that the retirement plan was a “church plan” that was exempt from ERISA, and dismissed the plaintiffs’ ERISA claims. ERISA defines “church plans” as “a plan established and maintained … for its employees (or their beneficiaries) by a church or by a convention or association of churches which is exempt from tax” under section 501(c)(3) of the tax code. The definition of “church plan” further provides that an employee of a church or a convention or association of churches includes “an employee of an organization, whether a civil law corporation or otherwise, which is exempt from tax under [section 501(c)(3) of the tax code] and which is controlled by or associated with a church or a convention or association of churches.” An organization is “associated” with a church or a convention or association of churches “if it shares common religious bonds and convictions with that church or convention or association of churches.”

The court concluded: “The court has thoroughly reviewed the applicable law and the arguments of counsel, and finds no support for plaintiffs’ position that a single employer benefit plan, established and maintained by an organization controlled by or associated with a church, is not a church plan as defined by ERISA. Rather, the court finds that the statutory language defining ‘church plan,’ as well as the applicable agency determinations and court decisions support a finding that the plan is a church plan.”

state law claims

The plaintiffs asserted that the parent denomination (the “national church”) was liable for the plaintiffs’ losses since the publisher was the “alter ego” of the national church.

Generally, one corporation cannot be liable for the acts and obligations of another corporation, even though there is some connection between the two. This is due to the fact that corporate status erects a “firewall” that prevents one corporation from being liable for the acts of the other. But under the so-called “alter ego” doctrine, one corporation can be liable for the acts of another if its control over the other is so dominant that the other has no independent existence apart from the dominant corporation and is nothing more than an alter ego, or extension, of it. The court observed:

Factors considered significant in the determination [of an alter ego relationship] include: insufficient capitalization for purposes of corporate undertaking, failure to observe corporate formalities … insolvency of debtor corporation at time of transaction in question, siphoning of funds by dominant shareholder, nonfunctioning of other officers and directors, absence of corporate records, and existence of corporation as merely facade for individual dealings.

In support of the alter ego theory, the plaintiffs cited the following evidence:

the publisher’s original board consisted of three pastors ordained by the national church;
the publisher’s articles of incorporation provide that the publisher is organized and operates exclusively for religious purposes and to assist the national church in carrying out its purposes;
delegates of the national church’s convention elect the publisher’s board;
the publisher’s articles of incorporation specify that in the event of its dissolution, any surplus property goes to the national church;
the national church’s presiding bishop participates in nominating the publisher’s CEO;
the publisher’s CEO has made statements to the effect that “we are the church, your partners in ministry.”

The court declined the national church’s motion to dismiss the plaintiffs’ alter ego claim. It observed:

The alter ego doctrine is designed to impose liability on the true defendant, rather than a corporate form. In doing so, the court is to analyze the “reality” of the corporate functions and to find injustice or fundamental unfairness. With this in mind, the court finds that plaintiffs have asserted sufficient factual allegations to support an alter ego theory. Plaintiffs’ theory is based on allegations that [the national church] is entwined in a close relationship with [the publisher] as evinced by its tight control of the publisher, the publisher’s misleading statements, which were known to the national church, and by the transfer of a revenue source worth $10 million [a denominational magazine] all while the publisher was underfunding its pension plan apparently due to financial distress. Plaintiffs have also alleged facts that raise questions as to the publisher’s solvency at the time of the termination and as to corporate siphoning ….

There are also allegations as to misconduct. Plaintiffs allege they were misled in two ways about the plan. First, they were misled into believing they would receive pensions. Plaintiffs were repeatedly given written statements that they would receive pension benefits when they retired. Second, the publisher’s CEO frequently described the publisher and the national church as partners, which implied that they would stand together, look after each other and their employees.

What This Means For Churches:

This case represents one of the few cases to recognize the viability of an alter ego claim against a national church organization on the basis of the acts and obligations of an affiliate. Most courts have concluded that the alter ego theory’s strict requirements generally are not met in cases involving national churches and their affiliated churches and agencies. One authority lists the following factors to consider in applying the alter ego doctrine:

The factors include whether: (1) the parent and subsidiary have common stock ownership; (2) the parent and subsidiary have common directors and officers; (3) the parent and subsidiary have common business departments; (4) the parent and subsidiary file consolidated financial statements and tax returns; (5) the parent finances the subsidiary; (6) the parent caused the incorporation of the subsidiary; (7) the subsidiary operates with grossly inadequate capital; (8) the parent pays the salaries and other expenses of the subsidiary; (9) the subsidiary receives no business except that given to it by the parent; (10) the parent uses the subsidiary’s property as its own; (11) the daily operations of the two corporations are not kept separate; and (12) the subsidiary does not observe the basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings. Fletcher Cyc. Corp. § 43.

Obviously, few if any churches or agencies would be deemed an “alter ego” of a national church under this analysis.

It must be stressed that the court did not find the national church liable on the basis of the alter ego theory for the publisher’s obligations. Rather, it rejected the national church’s request that the alter ego claim be dismissed. The court’s decision will allow the plaintiffs to pursue their alter ego claim in the trial court. Thorkelson v. Publishing House, 764 F.Supp.2d 1119 (D. Minn. 2011).

This Recent Development first appeared in Church Law and Tax Report, March/April 2012.

Legal Developments

Retirement Plans

An Indiana court ruled that a provision in a church’s bylaws requiring the church to make retirement payments to two former pastors took precedence over conflicting provisions.

Richard R. Hammar, Attorney, CPA

Bio

State: Indiana
Categories: Retirement Plans

Key point 6-02.2. Churches are subject to the provisions of their governing documents, which generally include a charter and a constitution or bylaws (in some cases both). A charter is the state-approved articles of incorporation of an incorporated church. Most rules of internal church administration are contained in a constitution or bylaws. Specific and temporary matters often are addressed in resolutions. If a conflict develops among these documents, the order of priority generally is as follows-charter, constitution, bylaws, and resolutions.
Corporations

An Indiana court ruled that a provision in a church's bylaws requiring the church to make retirement payments to two former pastors took precedence over conflicting provisions in individual contracts the church and pastors had executed.

Pastor Paul founded a church in 1956. In 1970, his son (Pastor Nick) joined the pastoral staff as co-pastor. In 1988 Pastor Paul retired as pastor and became "bishop" of the church, and Pastor Nick was appointed senior pastor. In 2000, the church began to experience considerable turmoil over rumors that Pastor Nick was having an inappropriate relationship with a female employee of the church. Allegedly, Pastor Nick and the female employee had met alone, which was contrary to a church policy prohibiting a pastor from meeting alone with a member of the opposite sex. In addition, at one meeting that took place at a local restaurant both Pastor Nick and the female employee consumed alcohol, which also violated church policy.

Pastor Nick denied that the relationship was sexual, but he did admit that his "emotional involvement" in the relationship was "unhealthy." In the summer of 2000 Pastor Nick made a public statement to the congregation that he had "compromised some principles," that he was sorry, and that he was working with a prayer group of men in the church to increase his accountability. This statement did little to soothe the turmoil in the church. Pastor Nick and his wife were divorced in 2001, and he resigned as pastor later that year. His father, Pastor Paul, also separated from the church in 2001. A dispute soon arose over the amount of pension payments that the church owed to both pastors.

The church executed "pension contracts" with its pastors. In a 1976 contract, the church agreed to pay Pastor Paul, following his retirement, the salary he was receiving at the time of his retirement until his death. However, the contract stipulated that no retirement benefits would be paid if Pastor Paul "accepted a similar position with any other church within a thirty-mile radius." Another pension contract executed in 1991 pertained to Pastor Nick. It provided: "Should Pastor Nick complete 25 years of service with the church, and thereafter leave the employment of the church for any reason after the date of the execution of this agreement, at the later of age sixty-five or his retirement from the church and for and during his natural life thereafter, he shall receive yearly, as deferred compensation, 75% of the average of his last three years annual salary." Pastor Paul received retirement benefits pursuant to the 1976 agreement beginning with his retirement in 1988.

In 1992, the church bylaws were amended in the following two ways: (1) Pastor Paul would receive retirement benefits equal to his full salary at the time of retirement, for the remainder of his life, without regard to whether he started another church. (2) Pastor Nick's retirement benefits began upon his retirement, after 20 years of service. He was not required to be at least sixty-five years of age, as his 1991 pension contract specified.

When the pastors announced their separation from the church in 2001, they also announced that they were starting a new church nearby. The entire church office staff, half the congregation, and half the board, followed the pastors to the new church. This left the church in a financial crisis, which prompted it to discontinue Pastor Paul's retirement payments, and to make no retirement payments to Pastor Nick. Both pastors sued the church for breach of contract.

The church argued that its obligation to pay retirement benefits was based entirely on the individual pension contracts that it executed with the pastors, and not on the church bylaws. It claimed that it was not required to pay Pastor Paul any retirement benefits since the 1976 pension contract provided that no benefits were owed if he started a new church within a thirty-mile radius (which he had done). It claimed that it was not obligated to pay Pastor Nick any retirement benefits since his 1991 pension contract clearly stated that no benefits would be paid until he was sixty-five years of age. The pastors insisted that the church's legal duty to make retirement payments was based on the church bylaws, as modified in 1992, rather than on the individual pension contracts. And, since the bylaws did not contain any references to starting a new church, or age sixty-five, the church was obligated to make retirement payments to them.

A trial court ruled in favor of the pastors on the basis of the amendments to the church bylaws in 1992, and the church appealed. The appeals court focused on two issues-the legal effect of the church bylaws, and the religious nature of the dispute.

Legal effect of church bylaws

The church insisted that the pastors' legal right to retirement benefits was based solely on their individual pension contracts rather than on conflicting provisions in the church bylaws. The pastors claimed that the church bylaws defined their right to retirement benefits. The appeals court agreed that if the bylaws prevailed, then the church was legally obligated to pay retirement benefits to each pastor; but, "if the pension agreements prevail, then Pastor Paul is owed nothing because he violated his agreement by establishing a church within thirty miles and Pastor Nick is owed nothing yet because he has not yet reached the age of sixty-five."

The appeals court noted that "the articles of incorporation and bylaws of a nonprofit corporation constitute a contract between the state and the corporation, the corporation and its members, and the members among themselves." It concluded that this "contract" superceded the individual pension agreements as a result of the legal principle of "substituted contract." Generally, a substituted contract arises if: (1) a valid contract exists; (2) agreement of all parties to a new contract; (3) a new contract; and (4) an extinguishment of the old contract in favor of the new one. The court concluded that the church bylaws satisfied all four factors required to establish a substituted contract.

Religious nature of the controversy

The church asserted that Pastor Paul and Pastor Nick were not entitled to pension benefits because: (1) the division that resulted from Pastor Nick's alleged inappropriate relationship; (2) Pastor Nick's own admission that he had compromised his personal and the church's principles; (3) the fact that Pastor Paul and Pastor Nick started another church nearby; and (4) the fact that the church relies on the generosity of its members for financial support, and is required to pay a significant amount of money (over $17,000 per month) to two former pastors who, in the church's opinion, did not follow the principles of the organization during their tenure.

The court pointed out, however, that the amended bylaws contained no requirements for "a pastor's fidelity to church teachings or to other provisions of the church's bylaws in order for that pastor to be entitled to pension benefits." It continued:

In fact, the pension provision requires only that the pastor retire after a certain number of years of service to the church. In other words, the unambiguous, purely secular pension provisions of bylaws do not require the court to apply or interpret, any sections of the bylaws that set forth the religious or doctrinal teachings of the church. Based on this conclusion and on the fact that the church bylaws are the controlling document regarding the pension payments, we find no error in the trial court's granting of summary judgment to Pastor Paul and Pastor Nick.

The court rejected the church's argument that this was an inherently ecclesiastical dispute involving the employment of two pastors:

We cannot agree with the church that this case involves an ecclesiastical dispute. Instead, the issue revolves around how many years the pastors worked for the church. This fact does not require the invocation of any church doctrine-either the pastor did work the required number of years or he did not. The plain text of the pension provisions of the church bylaws does not require us to delve into Pastor Paul's or Pastor Nick's behavior, devotion to church beliefs, or effectiveness as pastors or bishops during the years they were employed. Their pensions were not contingent on such criteria. To discern their entitlement to their pensions, we must only determine that they were employed for the time period required, a fact that even the church does not dispute. Because deciding this case required no intrusion upon the faith, doctrine, and internal governance of the church, the trial court did not err in its decision to decide it.

What this means for churches

The cost to the church as a result of the court's ruling is significant. The church was required to pay $426,000 in back retirement benefits to Pastor Paul, plus monthly benefits of $10,000 for life; and $306,000 to Pastor Nick plus monthly payments of $7,000 for life. As security for these judgments, Pastor Paul was granted a second mortgage on the church's property, and Pastor Nick was granted a third mortgage.
Church leaders should recognize that the church's governing documents (charter, constitution, bylaws, etc.) may constitute a "contract" between the church and its members that takes precedence over conflicting provisions in individual employment contracts. As the church in this case found out, this can result in unforeseeable liability to the church. It is imperative for church leaders to be familiar with their church's governing documents, and to be sure that employment contracts are consistent with those documents.
Some churches have enacted a binding arbitration policy in their governing documents that compels employees to resolve their disputes with the church by means of mediation or arbitration. This is a matter that church leaders should consider seriously. This newsletter has contained a number of articles addressing church arbitration clauses. We recommend that an attorney be consulted to discuss the advisability of such a policy. Calvary Temple Church v. Paino, 827 N.E.2d 125 (Ind. App. 2005).

Legal Developments

Dismissed Ministers’ Rights to Pension Benefits

Court rules that it is permitted to resolve claim.

Richard R. Hammar, Attorney, CPA

Bio

State: South Carolina
Categories: Retirement Plans

Church Law and Tax 1997-11-01

Retirement Plans

Richard R. Hammar, J.D., LL.M., CPA

• Key point. The civil courts are prohibited by the first amendment guaranty of religious freedom from resolving lawsuits brought by dismissed clergy challenging a loss of their retirement benefits based on their dismissed status, especially if the resolution of such a dispute would require consideration of ecclesiastical matters.

The South Carolina Supreme Court ruled that the civil courts could resolve a dispute over a dismissed minister’s right to pension benefits. A minister served from 1952 until he retired in 1986 in churches of the Church of God (the Church). During his 33—year active ministry, he made the required monthly contribution to the Aged Ministers Pension Plan Fund of 4 percent of his gross income from the ministry. Following his retirement, he began receiving payments from the Fund. Payments from the Fund are governed by the Minutes of the Church of God, which provide that “any aged minister receiving benefit from the Aged Ministers’ Fund whose ministry has been revoked shall cease to draw compensation from the fund.” The Minutes further provide that “the license of a minister must be revoked when found guilty of adultery or fornication.” In 1989 the Church revoked the minister’s license after he confessed to adultery, and he stopped receiving pension payments. The minister sued the Church claiming that although the Church revoked his pastoral “license,” the Church did not thereby effectively revoke his “ministry.” He also argued that the Church could not have revoked his ministry by revoking his license because once he retired he had no “ministry” to revoke. A trial court agreed with the minister that his pension benefits had been wrongfully terminated by the Church, and awarded him $71,000 in damages. The state supreme court disagreed. It began its opinion by identifying the following three principles that emerge from a reading of decisions by the United States Supreme Court:

(1) courts may not engage in resolving disputes as to religious law, principle, doctrine, discipline, custom, or administration; (2) courts cannot avoid resolving rights growing out of civil law; and (3) in resolving such civil law disputes, courts must accept as final and binding the decisions of the highest religious judicatories as to religious law, principle, doctrine, discipline, custom, and administration.

The court concluded that the first amendment did not prevent it from resolving this case, since it was not being asked to adjudicate a matter of religious law, principle, doctrine, discipline, custom, or administration.” Rather, it was being asked to resolve a contractual dispute: “The issue here is the effect of the revocation of [the pastor’s] ministry on the pension agreement he had with the Church. This case simply requires the application of neutral principles of contract law and very little inquiry into religious law.” The court noted that the Church’s Minutes were “very clear” that if the pastor’s ministry was revoked he was not entitled to draw compensation from the Aged Ministers’ Fund. The court refused to address the former pastor’s claims that as a retired minister he had no ministry to “revoke,” and that revocation of a license to preach is not the same as revocation of ministry. These claims were “foreclosed by the fact that a court must accept the doctrinal and administrative determinations of the highest ecclesiastical body of the Church.” The court concluded that “because the [Minutes] unambiguously allowed the Church to discontinue [the former pastor’s] pension payments as a result of the revocation of his ministry, the trial court should have directed a verdict in favor of the Church.” Pearson v. Church of God, 478 S.E.2d 849 (S.C. App. 1995). [Termination, Judicial Resolution of Church Disputes]

© Copyright 1997, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m63 c0697

Legal Developments

Termination of Retirement Benefits

Court rules that retired pastor can sue his former church for breaching its promise to pay him in retirement.

Richard R. Hammar, Attorney, CPA

Bio

State: Ohio
Categories: Breach of Contract, Retirement Plans

Church Law and Tax 1994-05-01 Recent Developments

Retirement Plans

Richard R. Hammar, J.D., LL.M., CPA

• Key point: A church’s promise to pay a retiring pastor a portion of his former salary for the rest of his life may be legally enforceable.

• An Ohio appeals court ruled that a retired pastor could sue his former church for breaching its promise to pay him one-third of his former salary for the remainder of his life. The retired pastor had become the pastor of a local Baptist church in 1958. In 1971 he suffered a heart attack and was hospitalized. While he was recuperating, a church deacon told him that the church had voted to pay his full salary for the remainder of his lifetime. That promise was never fulfilled because the pastor later recovered and resumed his pastoral duties. In 1980, the pastor again experienced heart problems. Under the advice of his doctor, he approached the deacons of the church about his retirement. He proposed that his salary be reduced after retirement through a series of gradual “step-downs,” to an amount approximately one-third of the salary he was then receiving. This proposal was accepted by the deacons, and an agreement was approved that contained that placed the pastor on “disability retirement” status, conferred upon him the title “pastor emeritus,” allowed him to set up an office in the church, and agreed to pay him retirement benefits according to the step-down schedule agreed to by the deacons. The pastor also was obligated to aid, assist and advise whomever the church called as its next pastor, to the extent that his health would permit. The pastor and deacons recommended to the church congregation that it approve the agreement, which it did by unanimous vote at a business meeting in 1980. In 1985 the congregation was advised by a church officer that the retirement benefits being paid to the former pastor under the 1980 agreement should continue for his lifetime, The church congregation again unanimously reaffirmed the agreement. From 1980 through 1990, the retired pastor occasionally preached at the church, taught Sunday School classes there, served on the budget committee, and helped with various administrative matters. Retirement benefits were paid throughout this period according to the agreement. In 1990, however, church officials notified the former pastor that he had been dismissed from membership in the church and that no more payments would be made to him. All other benefits, such as the free office space, were also discontinued. The former pastor sued the church, claiming that it had breached its contract to pay him retirement benefits for life. The church insisted that there was no legally binding contract obligating the church to pay the former pastor retirement benefits for life, and that the payments made by the church from 1980 until 1990 were gifts. A jury ruled in favor of the retired pastor, awarding him $151,000 (representing the present value of all amounts due under the agreement for the balance of the pastor’s life expectancy). The church appealed. The church argued on appeal that the agreement to pay the pastor retirement benefits was not a legally enforceable contract for two reasons. First, there had been no “meeting of the minds,” and second, the pastor had given no “consideration” in exchange for the church’s promise to pay him retirement benefits. The appeals court rejected both of these arguments. It acknowledged that “one of the elements essential to a valid contract is a meeting of the minds of the parties as to the terms of the contract.” However, it rejected the church’s claim that no such “meeting of the minds” had occurred. With regard to the church’s claim that there was no “consideration” for the church’s promise to pay retirement benefits, the court observed: “Consideration is, of course, an element necessary for a binding contract, and a complete lack of any consideration is a valid defense to a breach of contract action.” The court noted that consideration refers to something of value given by a promisee (the pastor) in exchange for the promisor’s (the church) promise. The court concluded that the pastor in fact had given something of value to the church in exchange for its promise to pay him retirement benefits: “[He] was obligated to aid, assist and advise whomever the church called as a new pastor, to the extent that [his] health would allow.” This commitment on the part of the pastor was sufficient consideration to make the agreement with the church a legally enforceable contract. The court further observed that “consideration is not deemed legally insufficient merely because it is inadequate.” However, the court rejected the jury’s verdict in the amount of $151,000, and instead ordered the church to pay the pastor the agreed upon retirement benefits for the remainder of his life.

The court rejected the church’s argument that the church constitution gave it the right to terminate the promise to pay retirement benefits to the former pastor. The church constitution specified that

[a] statement of consideration shall be drawn up in writing by the committee and the pastor at the time of his call and shall be presented to the church for approval. Said statement shall include such consideration as salary, vacation, retirement, convention expenses, and any others deemed advisable by the church or the pulpit committee. Said statement may be changed or altered by mutual agreement between the church and the pastor at any time. When mutual agreement cannot be reached, said statement may be changed by a two-thirds majority of the members present and voting.

The church argued that this provision controlled the contract between the former pastor and the church and that it gave the church the legal right to terminate the payments made to the former pastor. The court rejected this position, noting that the evidence presented by both the pastor and the church “was consistent in establishing that the church constitution, while applying to active pastors, did not apply to retired pastors or retirement benefits paid to former pastors.”

Finally, the church suggested that its decision to terminate retirement benefits to the former pastor was justified because it was based on the church’s dismissal of the former pastor from church membership (an act protected by the first amendment). The court again disagreed:

The church argues that its decision to dismiss a pastor or member from its membership is protected by the first amendment to the United States Constitution and that such decisions are not reviewable by courts of law. A review of the record in this case clearly reveals that not only did all parties and the court agree with this general proposition but, more important, that the right of the church to dismiss [the former pastor] from membership in the church was never an issue in this case and that the trial court explicitly instructed the jury not to inquire into or consider that issue, in accordance with the church’s [request]. Brads v. First Baptist Church, 624 N.E.2d 737 (Ohio App. 2 Dist. 1993).

Fiduciary Duties of Pension Plans

Do pension plans have a duty to warn of the tax consequences of withdrawing funds?

Richard R. Hammar, Attorney, CPA

Bio

State: Michigan
Categories: Fiduciary Duty, Retirement Plans

Church Law and Tax 1994-05-01 Recent Developments

Retirement Plans

Richard R. Hammar, J.D., LL.M., CPA

• Key point: Pension plans should carefully review the representations and assurances set forth in their plan documents and informational brochures, since they may be legally accountable to employees if such representations are not honored.

• Do pension plans have a fiduciary duty to warn participants of the tax consequences of a decision to withdraw their funds? That was the question addressed by a federal court in Michigan. An employee received a lump sum distribution from his pension plan in the amount of nearly $120,000 and promptly rolled it over into an individual retirement account (IRA). By investing in an IRA within 60 days of the distribution, the employee avoided income taxes on the funds. However, the employee later removed the funds from his IRA and used them to buy real estate, assuming that he would still not need to pay income taxes on the funds since they had been properly rolled over into his IRA. The employee was wrong in assuming that the funds did not become taxable when he withdrew them from his IRA to buy real estate. The IRS determined that he owed taxes of $33,000 on the transaction. The employee sued his pension fund, claiming that it had breached a “fiduciary duty” to him by not warning him of the tax consequences of withdrawing his funds from the IRA. A federal court rejected the employee’s position and dismissed the lawsuit. The court acknowledged that federal law requires some types of pension plans to inform employees of the tax treatment of distributions they request from their retirement account. However, the court pointed out that the pension plan in this case had provided the employee with a brochure at the time he received the lump sum distribution of his account. The brochure explained that lump sum distributions are taxable unless they are rolled over into an IRA (or other eligible plan) within 60 days. The employee admitted that he received this brochure, but complained that the pension fund did not inform him that once the lump sum distribution was invested in an IRA it could not be removed to buy real estate without becoming taxable. The court disagreed, noting that federal law “does not require that a plan administrator inform a distribution recipient of every possible investment option and tax consequence.” It added that the employee’s tax liability “arose not from the fact that he did not know that he must invest in an IRA within two months of receiving the distribution, but rather because he did not know the consequences of thereafter removing that money from the IRA and investing it in real estate.” The court cautioned that a pension plan may be liable for failing to provide information promised in its promotional or informational literature. However, there were no promises in the pension plan or in any of its promotional materials to provide participants with “information regarding the tax consequences of the various types of distributions.” The lesson of this case is clear—church and denominational pension plans should carefully review the assurances they make in their plan documents and informational brochures, and be certain that they are honoring such assurances. One final point—the court in this case rejected the employee’s argument that he was not bound by the pension plan’s informational brochure because he had not read it. The court observed that the pension plan did “not have a duty to ensure that beneficiaries actually read the material and act upon it. It appears [that the employee] simply did not take the time to read over the material because he was eager to receive the money …. {his] assertion that he did not have ample time to read the material is irrelevant.” Bouteiller v. Vulcan Iron Works, Inc., 94-1 USTC 50,157 (S.D. Mich. 1994).

Legal Developments

Life Insurance and 403(b) Tax-Sheltered Annuities

The IRS recently made a ruling on this issue.

Richard R. Hammar, Attorney, CPA

Bio

Church Law and Tax 1992-09-01 Recent Developments

Retirement Plans

Richard R. Hammar, J.D., LL.M., CPA

• The IRS ruled that a provision in a “403(b)” tax-sheltered annuity giving church employees the option of purchasing a life insurance contract with a portion of their annual contributions does not adversely affect the continued qualification of the 403(b) annuity plan. A church adopted a 403(b) retirement program for its employees. The arrangement permits employees to elect to use part of their annual contributions under the arrangement to pay premiums on life insurance. This option is provided as part of the employees’ “salary reduction agreement” with the church. The salary reduction agreement provides that an employee may direct the investment of a portion of the deferred amounts to the purchase of a whole life insurance contract on the life of the employee, provided at all times less than 50 percent of the total contributions made on the employee’s behalf are allocated to the life insurance contract. The insurance contract specifies that (1) an employee may not at any time withdraw cash or surrender the contract except upon attainment of age 59 1/2, separation from service, or death; and (2) insurance premiums may not exceed the limits that apply to annual contributions to a 403(b) tax-sheltered annuity. The IRS ruled that such an arrangement would not adversely affect the status of the church’s 403(b) retirement plan. It noted that the income tax regulations specifically permit 403(b) plans to purchase life insurance so long as the insurance is “incidental” in amount. The IRS concluded:

Section 403(b) of the Code provides for a limited exclusion from gross income with respect to amounts contributed for the purchase of an annuity contract, where the contract is purchased for an employee by an employer described in section 501(c)(3) … if all the conditions of section 403(b) are met. Section 1.403(b)-1(b)(4) of the regulations provides that if, during a taxable year of an employee, amounts are contributed by his or her employer for two or more annuity contracts for such employee, such two or more annuity contracts shall, for such taxable year, be considered a single contract …. Section 1.403(b)-1(c)(3) of the regulations provides that an individual contract, or a group contract, which provides incidental life insurance protection may be purchased as a Code section 403(b) annuity contract …. In this case, it has been represented that the annuity arrangement meets the requirements of section 403(b) of the Code, and therefore it meets the form requirements of a section 403(b) arrangement. The limitations imposed by [the insurance contract], if met in operation, comply with the requirement that any insurance protection offered as part of a section 403(b) annuity arrangement be incidental to the annuity. Accordingly, we conclude … that the provision in the Code section 403(b) annuity arrangement in which you participate that allows you to direct a portion of your contribution to the purchase of life insurance does not violate … the regulations, and that [the insurance contract] will be considered incidental within the meaning of [the regulations] so long as the aggregate premiums for such life insurance are less than 50 percent of the aggregate of the contributions allocated to you under [the church’s] Code section 403(b) annuity arrangement. Private Letter Ruling 9214026.

© Copyright 1992, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m63 c0592

Legal Developments

Pension Funds and Bankruptcy

Can a bankrupt minister protect his pension funds?

Richard R. Hammar, Attorney, CPA

Bio

State: Federal
Categories: Compensation and Benefits, Retirement Plans

Can a minister who files for bankruptcy protect his pension funds from bankruptcy creditors?

That was the issue before a federal bankruptcy court in an important ruling. A 56-year-old minister declared bankruptcy, and both he and his denominational pension board sought to protect his pension funds from the reach of creditors in the bankruptcy proceeding.

The pension plan is funded by a combination of member and congregation contributions. The plan provides that the minister shall contribute 3% of his salary and the congregation which employs him shall contribute 8% of the member's salary.

Both the member and the congregation may make additional optional contributions, which are to be allocated as member or congregation contributions, respectively. When a member attains the age of 60 years or completes 40 years of service, the combined accumulation of the member and congregation contributions is applied to purchase a retirement annuity for the member.

The plan provides that if a member becomes ineligible under the plan before the age of retirement or 40 years of service, he may elect to withdraw part or all of the accumulated member contributions. The amount remaining in the member's account will be fully vested in the member and will continue to draw interest until it can be applied toward an annuity or death benefit as provided in the plan.

The member accumulation that may be withdrawn consists solely of member contributions and does not include interest on those amounts. The pension board conceded that the debtor could become eligible to withdraw the accumulated member contributions under the plan by the act of resigning his ordination as a minister.

The current balance in the pension fund is $51,273.35, and the total member contribution, which is the amount the debtor actually contributed to the plan, is $6,848.10. The pension board argued that the entire pension was beyond the reach of the bankruptcy court, or, if this argument lost, that only those funds contributed by the minister himself (and not the congregations) could be reached by the court.

The pension board noted that, under a clause prohibiting alienation or assignment of an interest in the plan, the plan assets could neither be levied upon by creditors nor transferred by the debtor. The board did not dispute the court's characterization of the minister's personal contributions as "voluntary," but asserted that since the minister has no present right to withdraw the member accumulation portion of the plan, neither should the court be able to reach the minister's interest for the benefit of creditors.

The court concluded that the minister's own contributions to the plan were reachable by the bankruptcy creditors, but not the contributions made by congregations to the plan. It emphasized that "the scope of the bankruptcy estate under the Bankruptcy Code is quite broad and consists of 'all legal or equitable interests of the debtor in property as of the commencement of the case.'

In general, property becomes part of the debtor's estate regardless of any restrictions which may have been placed on its transfer." However, there is an important exception to this rule—a minister's pension account is not reachable by bankruptcy creditors if the plan prohibits transfers to creditors (or anyone else) in a way that satisfies the definition of a "spendthrift trust" under state law. A spendthrift trust is a trust that is created for the benefit of a particular beneficiary by a person who does not want the beneficiary to have any control or access to the trust funds. It ordinarily is designed to protect a beneficiary "from his own improvidence or incapacity."

The court noted that "traditionally, there are three requirements for a spendthrift trust: (1) the settlor [i.e., the person who creates the trust] may not be a beneficiary of the trust plan, (2) the trust must contain a clause barring any beneficiary from voluntarily or involuntarily transferring his interest in the trust, and (3) the debtor-beneficiary must have no present dominion or control over the trust corpus." The court emphasized that "the beneficiary's inability to gain access to or demand distribution from the trust corpus is the primary element of a spendthrift trust."

The court concluded that the minister, at the time of filing bankruptcy,

"had the ability to withdraw the member accumulation portion of his pension assets by the act of resigning his ordination as a minister …. In a true spendthrift trust, a beneficiary can take no action to initiate an early termination of the trust or invasion of the trust corpus. A right to control distribution from trust funds is inimical to the purpose of a spendthrift trust, which is to provide for the maintenance of another while protecting the beneficiary from his own improvidence or incapacity. Because the [minister] could access the entire amount of his member contributions by the voluntary act of resigning his ordination as a minister, he has effective dominion and control over these assets sufficient to disqualify this portion of the plan as a spendthrift trust."

The court concluded that "the plan fails as a spendthrift trust to the extent that the [minister] can compel a premature distribution of plan assets, as this is contrary to the purpose and requirements of a spendthrift trust."

However, the court concluded that the congregational contributions to the minister's pension fund were not accessible to the bankruptcy creditors, since this aspect of the plan satisfied the requirements of a spendthrift trust.

The court observed:

"Under the terms of the plan, the [minister] could withdraw only the member contribution portion resigning his ordination at this time. The amount remaining the pension plan is shielded from his dominion and control thus retains its character as a spendthrift trust. Disqualification of a portion of a plan as a spendthrift does not bring the [minister's] entire interest, including funds to which he has no rights of withdrawal, into property the estate. The funds to which the [minister] has no right of withdrawal satisfy traditional spendthrift requirements [and are excluded from the reach of bankruptcy creditors]."

The court stressed that as to the congregational contributions to the pension fund, the plan "contains an absolute restriction on alienation or assignment of plan benefits, and there is no question … regarding the sufficiency of the plan's anti-alienation clause." This case provides important insight into the ability of creditors to access clergy pension funds. It should be reviewed carefully by both ministers and denominational pension boards. Tomer v. Board of Pensions of the Church of God, 117 B.R. 391 (S.D. Ill. 1990).