• Key point. Federal tax law requires that church charters or bylaws contain a “dissolution clause” specifying the name of an exempt organization to which the church’s property will be distributed in the event of a dissolution.
• Key point. Upon dissolution, a church cannot distribute its property to its pastor or members.
A Texas court ruled that the members of a church that voted to dissolve could sue their pastor for fraud in connection with the disposition of the church’s property. A church hired a new pastor in 1973. The church’s membership soon increased to 166, but over the years slowly declined to between ten and twenty members. In 1992 the church members decided to sell the sanctuary. A few months later another church offered to purchase the property for $90,000, and the church called a membership meeting to discuss this offer. The members voted to accept this offer. They also voted to use the proceeds to pay off the church’s debts, and then distribute any balance to various religious organizations. The pastor was directed to sell the parsonage, and distribute the proceeds to worthy causes. The pastor assured the members that he would prepare a financial statement detailing the final distribution of the church’s assets within a week. In fact, no church funds were distributed to any of the charitable organizations. The pastor sold the parsonage to his daughter and son-in-law for $10. He did not prepare the promised financial statement until nearly a year later. The statement reflects that $73,233 in net proceeds remained after the sale of the sanctuary, and that the pastor disbursed most of this amount to himself as a “gift” ($59,022) and as “past due salary” ($7,255). These disbursements were used by the pastor to purchase a new home for himself.
Former members of the church later sued the pastor for fraud in connection with his distribution of the proceeds from the sale of the church and parsonage. A trial court ruled in favor or the members, and ordered the pastor to pay $126,000 in actual damages, plus $100,000 in punitive damages, with these amounts to be distributed to various religious organizations after the payment of legal fees and other expenses. The jury based the $126,000 figure on $66,000 retained by the pastor from the sale of the sanctuary; $55,000 from the sale of the parsonage (with a market value of that amount) to his daughter for $10; and $5,000 retained by the pastor from the sale of the church van. The pastor appealed, claiming that the former members of the dissolved church had no “standing” to file this lawsuit; that the first amendment guaranty of religious freedom prevented the civil courts from resolving the lawsuit; and, that the former members had not proven fraud. An appeals court rejected all three defenses, and affirmed the trial court’s ruling in favor of the former members.
“Standing” to Sue
The court concluded that the former members of a dissolved, unincorporated church had the legal authority to bring this lawsuit. It noted that “although an association may sue in its own name, individual members may also bring suit on behalf of the association,” and that “some members may sue on behalf of the members of an unincorporated association under the doctrine of virtual representation.”
The First Amendment
The court acknowledged that the first amendment “ordinarily prohibits civil courts from concerning themselves with ecclesiastical questions and controversies.” However, it insisted that the civil courts “do have jurisdiction to review matters involving civil, contract, or property rights even though they stem from a church controversy,” so long as they can do so using neutral principles of law. Further, “when church proceedings are tainted by fraud, judicial review is appropriate.” The court observed:
[C]an a man … by chicanery, deceit, and fraud, divert the property of a church organization to a purpose entirely foreign to the purposes of the organization, for [his] own selfish benefit … ? Neither the law nor public policy will sustain such a rule. Fraud vitiates all transactions and, if [some action is taken] for a fraudulent purpose to carry out a fraudulent scheme, the [action] is a void act, and of no force of effect whatever. Equity will compel fair dealing, disregarding all forms and subterfuges, and looking only to the substance of things.
Evidence of Fraud
The court defined fraud as (1) a material representation; (2) that is false; (3) that is made with the knowledge that it is false or that is made recklessly without any knowledge of its truth; (4) with the intent that others act upon the representation; (5) a person does act in reliance upon the representation; and (6) is injured as a result. The court concluded that the pastor’s actions met this definition. He materially represented to the church that he would distribute the proceeds from the sale of the sanctuary to other charities. The pastor knew this statement to be false, the court concluded, since he had already decided to buy a new home with the proceeds from the sale. The court based this conclusion on evidence that the pastor had been actively looking for a new home, though his church income was too low to afford one. The court also concluded that the pastor intended that the church members act upon his misrepresentation, since he was able to retain the proceeds from the sale of the sanctuary on the basis of his assurance that he would distribute the proceeds to other charities after paying the church’s debts. The church’s members acted in reliance on the pastor’s misrepresentation, to their detriment. The court reached the same conclusion with respect to the pastor’s sale of the parsonage to his daughter for $10. The church allowed him to sell the parsonage, based on his representation that he would distribute the proceeds to other charities.
The court imposed a “constructive trust” upon the home the pastor purchased for himself, as well as the parsonage that he sold to his daughter. A constructive trust may be imposed by a court whenever it is established that one person holds property which in equity and good conscience should be held by another. A constructive trust may arise as a result of several factors, including fraud. The effect is that the apparent owners no longer own “their” property. Rather, the property is held by them in trust for the victims of their fraud. The court in this case named the former members as trustees, and instructed them to sell the two properties in a commercially reasonable manner and then distribute the proceeds, less expenses, to various charities.
Application. This case illustrates the basic principle that church property cannot be distributed to individual members or clergy following a vote to dissolve the church. Any church contemplating dissolution should review the dissolution clause in its corporate charter or bylaws. This clause will identify the charity that receives the church’s property in the event of a dissolution. As this case demonstrates, a failure to comply with this clause can result in significant legal problems. Libhart v. Copeland, 949 S.W.2d 783 (Tex. App. 1997). [Diversion of Church Funds, Federal Income Taxation of Churches]
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