Recent Developments in New York Regarding Bankruptcy

A bankruptcy court in New York ruled that a church had to turn over tithes it received from a couple during the year preceding the filing of a bankruptcy petition since the tithes represented a “fraudulent transfer” for less than “reasonably equivalent value.”

Church Law and Tax 1998-03-01


Key point. A bankruptcy trustee has the legal authority to recover donations made by church members within one year prior to the filing of a bankruptcy petition. This authority does not violate the first amendment guaranty of religious freedom.

A bankruptcy court in New York ruled that a church had to turn over tithes it received from a couple during the year preceding the filing of a bankruptcy petition since the tithes represented a “fraudulent transfer” for less than “reasonably equivalent value.” A couple contributed $5,200 to their church during the year preceding the filing of a bankruptcy petition. A bankruptcy trustee later asserted that these contributions had to be returned to the bankruptcy court on the ground that they represented fraudulent transfers. Under federal law, a bankruptcy trustee can recover transfers made by a bankrupt debtor during the year prior to filing a bankruptcy petition for less than “reasonably equivalent value.” The debtors conceded that they did not receive anything of reasonably equivalent value in exchange for their tithes, but the church refused to return the tithes on the ground that applying the fraudulent transfer rules to churches would violate the first amendment guaranty of religious freedom. A court disagreed. It relied on a 1990 Supreme Court decision finding that a “neutral law of general applicability” will not violate the first amendment, even if it burdens or restricts the exercise of religion. Employment Division v. Smith, 494 U.S. 872 (1990). The court concluded that the fraudulent transfer provision of bankruptcy law “is a law of general applicability that neither prevents nor promotes religious practices, that its definitions are neutral toward religion and that its effect on tithing is purely incidental to the goal of equal distribution to an insolvent debtor’s creditors.”

The court noted that

the church’s contention is that the debtors’ religious motivation for contributing to the church places them beyond the reach of the fraudulent transfer law. But, in making this argument, the church has also implied that the court should be partial to those Christian denominations which encourage the practice of tithing. The court may take judicial notice of the fact that all of the major religions in this country, including Judaism, Islam and the many denominations of Christianity, are supported by their congregants either monetarily or in some other fashion. Accepting the church’s arguments would actually lead the court to interpret the [law] in such a way that would, in fact, violate the first amendment. First, it would require the court to determine whether a specific gift was religiously motivated or non—religiously motivated, which would impermissibly require the court to evaluate the sincerity of a debtor’s religious belief. Second, it would appear to elevate religious groups which adhere to the tenet of tithing over other religious groups. Protecting only those religious groups which encourage their congregants to tithe from the scope of the fraudulent conveyance law would necessarily exclude from the scope of that protection those religious groups which have not sought the traditional one—tenth or, in fact, any other type of religiously motivated contribution which could not technically be characterized as a tithe. Indeed, some deeply religious people are motivated to make charitable gifts to organizations other than their own church by virtue of their religious beliefs. As a result, the [law] would not only lose its neutrality but would force courts to evaluate each debtor’s personal or spiritual beliefs and actual religious practices in the context of his or her religion.

As a result, the court rejected the church’s contention that the first amendment prohibited bankruptcy trustees from treating tithes made by bankrupt debtors as fraudulent transfers. The court noted that the fraudulent transfer provision

serves a very important policy which in effect says that prior to the time a debtor files a petition, a debtor cannot give his or her assets away, whether it is to a church or to anyone else, when it is at the expense of paying creditors. This is not a burden on religion. It is a burden on choice. If individuals choose to donate part of their income to charity, whether religious or secular, they must adjust their expenditures accordingly to live within the confines of their available income …. The first amendment … mandates the separation of church and state. Consistent with this principle, the bankruptcy court must apply [the fraudulent transfer law] to all transferees, religious institutions or not. In doing so, the court adheres to the expectation that an insolvent should be “just to his creditors before he is generous to others.”

The court further noted that even if there were no bankruptcy case, the debtors’ creditors could bring their own “fraudulent conveyance” lawsuit against the church under the fraudulent conveyance provisions of the New York Debtor and Creditor Law.

Application. This case illustrates an important principle-churches may have to turn over donations made by a member within a year prior to filing a bankruptcy petition. While a federal appeals court ruled in 1996 that such a result violated the Religious Freedom Restoration Act, the Supreme Court repealed that ruling when it struck down the Act last year. There is little if any basis for challenging a demand by a bankruptcy trustee to turn over a bankrupt member’s donations. It remains to be seen how aggressive bankruptcy trustees will be in recovering donations from churches. Church leaders should be aware of this development and be prepared to respond to similar demands by bankruptcy trustees. Rivera v. Crossroads Tabernacle, 214 B.R. 101 (S.D.N.Y. 1997).

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