Recent Developments in Texas Regarding Bankruptcy

A Texas state court ruled that the recently enacted Religious Freedom and Charitable Donation Protection Act of 1998 prevented a creditor from recovering contributions made by a bankrupt debtor to his church.

Church Law and Tax 1999-05-01


Key point. The Religious Freedom and Charitable Donation Protection Act of 1998 prevents creditors or bankruptcy courts from recovering contributions made by bankrupt debtors to their church, so long as the contributions were not fraudulent and did not exceed 15 percent of the debtor’s annual income (or a higher percentage, if the debtor regularly gave more).

A Texas state court ruled that the recently enacted Religious Freedom and Charitable Donation Protection Act of 1998 prevented a creditor from recovering contributions made by a bankrupt debtor to his church. A former partner (the “debtor”) was sued by other partners following the dissolution of a partnership, and a court ordered him to pay several thousand dollars in damages. The debtor d a bankruptcy trustee was appointed. The trustee later informed the debtor’s church that the debtor’s contributions to the church during the previous four years were “fraudulent transfers” because the debtor was insolvent at the time and did not receive a “reasonably equivalent value” in exchange for his contributions. The trial court agreed and ordered the church to turn over $23,428 in contributions. The church appealed this order, claiming that (1) the Religious Liberty and Charitable Donation Protection Act of 1998 prohibited the bankruptcy court from recovering any of the debtor’s charitable contributions; and (2) the Religious Freedom Restoration Act and the first amendment guaranty of religious freedom prevented the bankruptcy court from recovering the debtor’s contributions.

The appeals court began its opinion by noting that the Religious Liberty and Charitable Donation Protection Act of 1998, passed unanimously in both houses of Congress and signed by President Clinton in June of 1998, controlled the outcome of this case. This legislation was intended to cover “the exact type of charitable contributions which the trial court avoided in favor of the creditor.” The court continued:

The Act amends the bankruptcy code to eliminate claims to recover charitable contributions under federal and state law. Prior to the Act, trustees were given the right to avoid transfers made or incurred within one year before the date of the filing of bankruptcy. However, the new Act modifies this so that “[a] transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be … [voidable] if the amount of that contribution does not exceed 15% of the gross annual income of the debtor for the year in which the transfer of the contribution was made.” Congress expressly preempted federal and state law by stating: “Any [pending or subsequent] claim by any person to recover a transferred contribution described [above] under Federal or State law in a Federal or State court shall be preempted by the commencement of the case.”

The court concluded that the contributions made by the debtor were directly covered by the Act, since they comprised only 10 percent of his annual income. The court conceded that the debtor’s bankruptcy case arose prior to the time the Act became law, but it insisted that the Act still applied since the bankruptcy case was still pending at the time it became law.

A creditor insisted that a state “fraudulent transfer” law allowed the recovery of “fraudulent transfers” made by debtors during the previous four years, and that this law was not affected by the federal Act. The court disagreed, noting that “a state law is preempted and without effect if it conflicts with federal law.” It further noted that the act specifies that it applies to all cases pending on or after the date of enactment of this Act. As a result, the Act preempted conflicting state law, even though a case was filed before the Act became law-so long as the case was still pending at that time. The court concluded: “[The creditor] seeks the exact type of relief that Congress and the President contemplated and anticipated when enacting this legislation into law. Therefore, we hold that the new Act not only expressly preempts [the creditor’s] claims with respect to any of its claims under federal law, but also impliedly preempts any of its claims under [state law] to the extent that it conflicts or stands as an obstacle to the accomplishment and execution of Congress’s new legislation by allowing a creditor to [recover] a qualifying charitable transfer to a religious organization consisting of less than 15% of the debtor’s annual income.”

Application. This case is important for the following three reasons. First, it is perhaps the first case to apply the recently enacted Religious Freedom and Charitable Donation Protection Act. Second, the court clarified that the Act preempts any state law that would provide creditors with broader rights. A creditor cannot evade the plain intent of the Act by pointing to a state law as a basis for recovering a debtor’s contributions to a church. Third, the court noted that the Act applies not only to future cases, but also to any case pending at the time the Act became law (in June of 1998). Cedar Bayou Baptist Church v. Gregory-Edwards, Inc., 1999 WL 47452 (Tex. App. 1999).

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