A federal court in New Jersey ordered a church to return a $20,000 contribution to a bankruptcy court that had been made by a church member within a year before he filed for bankruptcy.

Church Law and Tax 2001-03-01


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. Again, this protection applies to debtors whose bankruptcy plan calls for making charitable contributions of less than 15 percent of their gross annual income, or more if they can prove a pattern of giving more.

A federal court in New Jersey ordered a church to return a $20,000 contribution to a bankruptcy court that had been made by a church member within a year before he filed for bankruptcy. Dale was a member and trustee of his church. Throughout his association with the church, Dale made numerous donations to the church and other charities. In 1995, 1996, and 1997 Dale gave 17%, 28%, and 7% of his income to charity, much of it going to his church. In 1998 Dale filed for bankruptcy. Within one year prior to filing his petition, Dale had made total charitable donations of $22,650 to his church, representing nearly 95% of his total income. One of these donations was a transfer of $20,000 by personal check less than five months prior to the bankruptcy filing. This single donation was approximately 74% of Dale’s 1998 income. The source of the $20,000 donation was an inheritance of $21,646 received by Dale from a fellow church member. A bankruptcy trustee demanded that the church return the $20,000 gift, and the church refused. The trustee brought a proceeding to recover the $20,000 donation from the church as a fraudulent transfer under the bankruptcy law. Section 548(a)(1)(B) of the Bankruptcy Code specifies that a bankruptcy trustee “may avoid any transfer of an interest of the debtor in property … that was made or incurred on or within one year before the date of the filing of the petition, if the debtor … received less than a reasonably equivalent value in exchange for such transfer or obligation and was insolvent on the date that such transfer was made ….”

The church did not dispute that Dale was insolvent at the time of the $20,000 donation, nor did it dispute that Dale did not receive “reasonably equivalent value” in return for the contribution. However, the church insisted that section 548(a)(2) of the Bankruptcy Code shielded it from having to return the $20,000. Section 548(a)(2), which was enacted as part of the Religious Liberty and Charitable Donation Protection Act of 1998, provides:

A transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be a transfer covered under [section 548(1)(B)] in any case in which-(A) the amount of that contribution does not exceed 15 percent of the gross annual income of the debtor for the year in which the transfer of the contribution is made; or (B) the contribution made by a debtor exceeded the percentage amount of gross annual income specified in subparagraph (A), if the transfer was consistent with the practices of the debtor in making charitable contributions.

The trustee noted that Dale’s contributions for 1998 exceeded 15% of his income, and were not “consistent with the practices of the debtor in making charitable contributions.” As proof, the trustee compared the $20,000 transfer to the numerous other donations Dale made over the previous three years. As no single donation approached the amount of this one, the trustee argued that this donation was not “consistent” with Dale’s prior practices. Further, the total donations in each of the three previous years were all considerably less than the $20,000 gift the trustee was seeking to recover.

The church countered by arguing that the reason for the large $20,000 donation was the inheritance received by Dale less than one month before the donation to the church. This was not ordinary income, but was rather in the nature of a “windfall.” The church claimed that Dale felt compelled to donate the money, as he would not have received it had he not been involved in church activities. The church further asserted that a review of donations made by Dale up to eight years prior to the $20,000 donation showed that he had made larger annual donations in the past.

The court noted that the Bankruptcy Code provides no guidance as to interpretation of the phrase “consistent with the practices of the debtor in making charitable contributions” for purposes of Code section 548(a)(2)(B), and there are no reported cases on the issue. However,

interpretation of the phrase clearly requires … a comparison of the amount of the transfer in question with the amounts of the debtor’s past transfers. Where a debtor’s income has changed it is also appropriate to compare the transfer as a percentage of the debtor’s income with past transfers as such percentages. The degree of variation which is permitted within the meaning of the term “consistent” will undoubtedly be difficult in certain cases. The term “consistent” is defined by Webster’s New Collegiate Dictionary as “marked by harmonious regularity or steady continuity: free from irregularity, variation or contradiction.” Since Code section 548(a)(2) is a statutory affirmative defense to an otherwise-avoidable transfer, the defendant will have the burden of proving the applicability of the safe harbor.

In this case, however, it is beyond reasonable dispute that the debtor’s $20,000 donation to the church was not consistent with his prior practices in making charitable contributions. The next largest donation made by the debtor during the prior two years was $2,000. The $20,000 donation also exceeds his total annual donations for each of the years 1995 through 1997. It would be a gross distortion of the concept of consistency to hold that this donation was consistent with the debtor’s prior practices in making charitable contributions.

The court rejected the church’s claim that Dale’s practices for years prior to 1995 should be considered. The church relied on an affidavit from Dale stating his total charitable contributions for the years 1990, 1992, 1993, and 1994 as $62,757, $16,700, $27,835, and $26,992 respectively. But Dale’s affidavit failed to state what his income was for those years. Therefore, “the court cannot compare those contributions with the debtor’s income from those years and the significance of the contribution amounts for those years is limited without reference to the income. If the figures for 1990 through 1994 prove anything, it is that the debtor’s practices in making charitable contributions have no consistency at all from year to year.”

The court concluded that Dale’s donation of $20,000 to the church in 1998 from a windfall inheritance of $21,646 “was not consistent with his prior practices in making charitable contributions” and therefore the church could be ordered to return it to the bankruptcy trustee.

The court rejected the trustee’s demand that the church pay interest on the $20,000 from the date of the trustee’s original demand. It concluded that “unless a qualified religious or charitable organization has been found to have demonstrated bad faith in opposing turnover of a charitable contribution, or other compelling reasons exist for prejudgment interest, this court does not consider it equitable to award prejudgment interest against such an organization when it has merely opposed the return of a charitable contribution.”

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 recovering a bankrupt debtor’s charitable contributions from a church if the amount of the contributions does not exceed (1) 15% of the debtor’s income or (2) more than 15% of the debtor’s income if the contributions were “consistent with the practices of the debtor in making charitable contributions.” When a bankruptcy trustee seeks to recover donations to a church that exceed 15% of the debtor’s annual income, the question becomes whether the higher donation is consistent with the practices of the debtor in making contributions. This is the first court to interpret this important language. The court concluded that a comparison of the amount of a debtor’s current year contributions with amounts contributed in prior years was the best evidence of a consistent practice. Also relevant would be a comparison of the percentage of total income given to charity in the current and previous years. But the church squarely rejected the church’s argument that an uncharacteristically large donation can be disregarded in an evaluation of “consistency” on the ground that it came from an unexpected “windfall.” Jackson v. The Church of Manalapan, 249 B.R. 373 (D.N.J. 2000).

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