When an individual files for bankruptcy, a bankruptcy trustee is given the task of seeing that the individual’s creditors are paid back as much as possible of what they are owed. In order to do this, they often look for assets or even possible donations that they can recover. This may include a person’s tithes and church donations, depending on the situation.
When a bankrupt giver’s donation is jeopardized
Section 548(a) of the bankruptcy code authorizes a bankruptcy trustee to recover (“avoid”) two kinds of “fraudulent transfers” made by bankrupt debtors within a year of filing for bankruptcy:
Intent to defraud. Section 548(a)(1) gives a bankruptcy trustee the legal authority to recover “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 voluntarily or involuntarily made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted.”
Transfers of cash or property for less than reasonably equivalent value. Section 548(a)(2) gives a bankruptcy trustee the legal authority to recover “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 voluntarily or involuntarily … 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 or such obligation was incurred, or became insolvent as a result of such transfer or obligation … or intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured.”
In the past many bankruptcy trustees contacted churches, demanding that they return donations made by bankrupt debtors within a year of filing for bankruptcy. They argued that charitable contributions made by bankrupt debtors to a church are for less than “reasonably equivalent value”; therefore they can be recovered by bankruptcy trustees under the second type of “fraudulent transfer” mentioned above.
Donors and churches protested such efforts. They insisted that donors do receive valuable benefits in exchange for their contributions, such as preaching, teaching, sacraments, and counseling. Not so, countered bankruptcy trustees. These benefits would be available regardless of whether a donor gives anything, so it cannot be said that a donor is receiving “reasonably equivalent value” in exchange for a contribution. Many courts agreed with this logic and ordered churches to turn over contributions made by bankrupt debtors. This created a hardship for many churches. After all, most churches had already spent the debtor’s contributions before being contacted by the bankruptcy trustee, so returning them (especially if they were substantial) was often difficult.
The Religious Freedom and Charitable Donation Protection Act
Congress enacted the Religious Freedom and Charitable Donation Protection Act in order to protect churches and other charities from having to turn over charitable contributions to a bankruptcy trustee. The key to the Act is the following provision, which is an amendment to section 548(a)(2) of the bankruptcy code:
A transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be a transfer [subject to recovery by a bankruptcy trustee] 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.
Note that this provision only amends the second type of “fraudulent transfer” described above—transfers of cash or property made for less than reasonably equivalent value within a year of filing a bankruptcy petition. The Act does not amend the first kind of fraudulent transfer—those made with an actual intent to defraud.
What if a bankrupt debtor makes a contribution to a church in excess of 15 percent of annual income? Is the entire contribution avoidable by the bankruptcy, or only the amount in excess of 15 percent of annual income?
A federal appeals court addressed this question in a recent ruling. A married couple donated more than 15 percent of their annual income to their church during the year prior to filing for bankruptcy protection. The bankruptcy trustee attempted to recover all of the contributions from the church, while the church claimed that it was only required to return contributions the couple made during the preceding year that exceeded 15 percent of their annual income. The court concluded that contributions in excess of 15 percent of annual income are entirely recoverable by the bankruptcy trustee, including the first 15 percent.
The court’s ruling is relevant to every church. If members make donations in excess of 15 percent of their annual income, all of the contributions may be recoverable by a bankruptcy trustee, and not just the amount of the contributions that exceed 15 percent of annual income. In re McGough, 737 F.3d 1268 (10th Cir. 2014).