A federal law protects the charitable giving of donors who declare bankruptcy
Article summary. Last year Congress enacted the Religious Liberty and Charitable Donation Protection Act. The Act accomplishes two important results. First, it protects churches and other charities from demands by bankruptcy courts that they return contributions made by a bankrupt donor. Second, the Act allows most persons who file for bankruptcy to continue making contributions to their church or charity. In the past, many courts rejected both of these protections. This article provides church leaders with a practical understanding of how the new law will affect them.
In the past, churches were hurt by federal bankruptcy law in two ways. First, many courts ruled that bankruptcy trustees could recover contributions made to a church by a bankrupt donor within a year of filing a bankruptcy petition. Second, church members who declared bankruptcy were not allowed by some bankruptcy courts to continue making contributions to their church. These harmful restrictions were eliminated last year when Congress enacted the Religious Liberty and Charitable Donation Protection Act. The Act, which is actually an amendment to the bankruptcy code, provides significant protection to churches as well as to church members who file for bankruptcy. This feature article will review the background of the Act, explain its key provisions, and demonstrate its application with practical examples.
Authority of bankruptcy trustees to recover charitable contributions
Section 548(a) of the bankruptcy code authorizes a bankruptcy trustee to “avoid” or recover two kinds of “fraudulent transfers” made by bankrupt debtors within a year of filing for bankruptcy:
(1) 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.”
(2) 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,” and therefore 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 whether or not a donor gives anything, and 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, and so “returning” them (especially if they were substantial) was often difficult.
Beginning in 1993, several events occurred that culminated in the enactment of the Religious Freedom and Charitable Donation Protection Act of 1998. Here is a brief summary of what happened.
Round 1-the First Young Case
In 1993, a federal district court in Minnesota ruled that a church had to turn over contributions made by a couple to their church within a year of filing a bankruptcy petition. In re Young, 152 B.R. 939 (D. Minn. 1993). The debtors (husband and wife) contributed a total of $13,450 to their church before filing a chapter 7 bankruptcy petition. The bankruptcy trustee opposed the bankruptcy petition on the ground that the contributions were for less than reasonably equivalent value. The court agreed, and concluded that the trustee could recover the contributions so long as the first amendment guaranty of religious freedom was not violated. The court looked to the Supreme Court’s decision in Employment Division v. Smith, 494 U.S. 872 (1990), in which the Court ruled that a “general law of neutral applicability” can be applied to religious practices without offending the first amendment even if the law is not supported by a “compelling government interest.” This ruling repudiated the Supreme Court’s longstanding position that a law that offends religious freedom is valid only if it is supported by a compelling government interest. The Court ruled that its prior decisions “have consistently held that the right of free exercise does not relieve an individual of the obligation to comply with a valid and neutral law of general applicability on the ground that the law proscribes (or prescribes) conduct that his religion prescribes (or proscribes).”
The bankruptcy court concluded that the Smith decision stood for the proposition that “an individual cannot escape a valid and neutral law of general applicability by merely asserting that the law violates his or her religious beliefs.” It further observed that a bankruptcy trustee’s authority to deny bankruptcy relief on the basis of “fraudulent transfers” for less than reasonably equivalent value was “a neutral law of general applicability,” and that “[t]he purpose of the statute is to enlarge the pool of funds for creditors by recovering gratuitous transfers made on the eve of bankruptcy by insolvent debtors.” The court, therefore, dismissed the church’s constitutional challenge, and allowed the trustee to recover the debtors’ contributions from the church.
Round 2-the Religious Freedom Restoration Act
In 1990, the United States Supreme Court ruled that a “neutral law of general applicability” that burdens the exercise of religion need not be supported by a “compelling governmental interest” to be permissible under the first amendment’s free exercise of religion clause. Employment Division v. Smith, 494 U. S. 872 (1990). In so ruling, the Court repudiated a quarter of a century of established precedent and severely diluted this basic constitutional protection. The results were predictable. Scores of lower federal courts and state courts sustained laws and governmental practices that directly restricted religious practices. In many of these cases, the courts based their actions directly on the Smith case, suggesting that the result would have been different had it not been for that decision.
Congress responded to the Smith case by enacting the Religious Freedom Restoration Act of 1993. The Act restored the “compelling interest test” through the following provision: “Government shall not burden a person’s exercise of religion even if the burden results from a rule of general applicability [unless] it demonstrates that application of the burden to the person (1) is in furtherance of a compelling governmental interest; and (2) is the least restrictive means of furthering that compelling governmental interest.” In explaining this provision, the Senate Judiciary Committee commented that the Act “permits government to burden the exercise of religion only if it demonstrates a compelling state interest and that the burden in question is the least restrictive means of furthering the interest.”
Round 3-the Second Young Case
The church and debtors involved in the original Young case (discussed above) appealed the district court’s ruling to a federal appeals court. The appeals court acknowledged that the debtors received valuable benefits in exchange for their contributions to the church, including preaching, teaching, and counseling. But, it concluded that these benefits were provided to members whether or not they tithed, and as a result they were not provided “in exchange” for the debtors’ contributions. Therefore, under the bankruptcy law the trustee had the authority to recover the debtors’ contributions from the church. However, the court further concluded that allowing the trustee to do so would violate the rights of the church and debtors under the newly enacted Religious Freedom Restoration Act. This Act, as noted above, specifies that the government may not “substantially burden” a person’s religious practices unless a compelling governmental interest exists. In effect, the Act overturned the Supreme Court’s decision in the Smith case (discussed above). The court noted that the debtors believed in tithing, and faithfully tithed up until the time they filed for bankruptcy. It concluded that the practice of tithing was a religious practice that would be substantially burdened if the trustee could recover the debtors’ tithes since it would discourage persons from tithing to their church if they suspected that they might file for bankruptcy within the next year. Further, the court concluded that there was no compelling governmental interest that would justify the substantial burden on the practice of tithing. In re Young, 82 F.3d 1407 (8th Cir. 1996).
Round 4-the Supreme Court strikes down the Religious Freedom Restoration Act
In 1997, the United States Supreme Court struck down the Religious Freedom Restoration Act on the ground that Congress exceeded its authority in enacting the law. City of Boerne v. Flores, 521 U.S. 507 (1997). The Court began its opinion by noting that the federal government “is one of enumerated powers.” That is, each branch (legislative, executive, judicial) can only do those things specifically authorized by the Constitution. The Court concluded that nothing in the Constitution gave Congress the authority to enact a law overturning the Supreme Court’s interpretation of the first amendment in the Smith case. The Court acknowledged that section 5 of the fourteenth amendment gave Congress the authority to “enforce” the provisions of the first amendment, and therefore Congress can enact legislation “enforcing the constitutional right to the free exercise of religion.” However, the Court then observed that “[l]egislation which alters the meaning of the free exercise [of religion] clause cannot be said to be enforcing the clause. Congress does not enforce a constitutional right by changing what the right is.”
Round 5-the third Young case
Following its decision in the City of Boerne case striking down the Religious Freedom Restoration Act, the Supreme Court vacated and remanded the federal appeals court ruling in the second Young case summarized above. Presumably, the Court assumed that its decision would cause the appeals court to reverse its earlier decision that had been based squarely on the Religious Freedom Restoration Act. On remand, the appeals court reaffirmed its earlier decision rejecting the bankruptcy trustee’s attempt to compel the church to return the bankrupt debtors’ tithes. The court based its decision on a provision in the Constitution giving Congress broad authority to enact bankruptcy laws. It observed:
We conclude that RFRA [the Religious Freedom Restoration Act] is an appropriate means by Congress to modify the United States bankruptcy laws. In attempting to [recover the [debtors’] tithes to the church, the trustee relied on an affirmative act of Congress defining which transactions of debtors in bankruptcy may be [recovered]. RFRA, however, has effectively amended the Bankruptcy Code, and has engrafted the additional clause to section 548 … that a recovery that places a substantial burden on a debtor’s exercise of religion will not be allowed unless it is the least restrictive means to satisfy a compelling governmental interest. The trustee has not contended, and we can conceive of no argument to support the contention, that Congress is incapable of amending the legislation that it has passed. Neither can we accept any argument that allowing the discharge of a debt in bankruptcy and preventing the recovery of a transfer made by insolvent debtors is beyond the authority of Congress. We therefore conclude that Congress had the authority to enact RFRA and make it applicable to the law of bankruptcy. In re Young, 141 F.3d 854 (8th Cir. 1998).
The third Young case is controlling (unless later reversed by the Supreme Court) in the eighth federal circuit, which includes the states of Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota. In these states, a bankruptcy trustee cannot recover tithes made by bankrupt debtors to their church-so long as the debtors consider tithing to be an important religious practice that would be “substantially burdened” if bankruptcy trustees had the power to recover debtors’ contributions. However, this was a very limited ruling: (1) it only applied in states in the eighth federal circuit; (2) it only applied to debtors who regarded tithing as a central religious practice; and (3) it is a controversial ruling that probably will be reversed at a later time by the Supreme Court.
Round 6-the Religious Freedom and Charitable Donation Protection Act of 1998
In response to the developments summarized above, the Religious Freedom and Charitable Donation Protection Act was introduced in the Senate by Senator Grassley and in the House of Representatives by Congressman Packard. In introducing the House bill, Congressman Packard observed:
Mr. Speaker, how much of the work done by your church or favorite charity depends on the generous donations of parishioners and contributors like yourself? Did you know that creditors can take already donated money from them because current bankruptcy law allows them to do so? It’s unbelievable, but it’s true. In a recent case, a United States Federal Bankruptcy Trustee brought an action against the Crystal Evangelical Free Church of New Hope, Minnesota. In doing so, this unprecedented case reinterpreted the Bankruptcy Code to mean that if an individual gives money to a non-profit group within one year of declaring bankruptcy, creditors can come after the group to re-claim this money. Why? Because an individual must receive something of “reasonable equivalent value” in return for a monetary donation. Mr. Speaker, current law essentially says that if an individual has filed for bankruptcy, he cannot simply donate money to a charitable organization or to the church. However, because the Bankruptcy Code allows for certain “entertainment exemptions,” taking a luxury vacation, purchasing liquor, buying a new car, or making 1-900 calls to psychics, are all reasonable expenditures. This case outraged me and I decided to do something about it. I introduced legislation in early October to protect certain charitable contributions. Known as the Religious Liberty and Charitable Donation Protection Act, this legislation will amend U.S. Code to protect our nation’s churches and charities from the hands of creditors. Mr. Speaker, H.R. 2604, the Religious Liberty and Charitable Donation Protection Act, will allow your church or favorite charity to continue to thrive and prosper. Donations received in good faith from individuals will not be taken from their pockets by creditors. I encourage all of my colleagues to co-sponsor this important legislation. As the holidays quickly approach, we must work to address the needs of our churches, charities and the less fortunate who rely on their vital services. H.R. 2604 will do just that.
The key to the Act was 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.
• Key point. Note that there are two separate protections here: (1) bankruptcy trustees cannot recover contributions made by a bankrupt debtor for less than reasonably equivalent value within a year prior to filing for bankruptcy if the contributions amount to 15 percent of less of the debtor’s gross annual income; and, (2) bankruptcy trustees cannot recover contributions made by a bankrupt debtor for less than reasonably equivalent value within a year prior to filing for bankruptcy if the contributions exceed 15 percent of the debtor’s gross annual income, and the amount of the contributions are consistent with the debtor’s giving practices.
• Key point. It is critical to note that this provision only amends the second type of “fraudulent transfer” described at the beginning of this article-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.
Congress enacted the Religious Freedom and Charitable Donation Protection Act by unanimous vote of both houses, and so this important provision is now the law. Its meaning was addressed in a committee report accompanying the Act. The report reads, in part:
[The Act] protects certain charitable contributions made by an individual debtor to qualified religious or charitable entities within one year preceding the filing date of the debtor’s bankruptcy petition from being avoided by a bankruptcy trustee under section 548 of the Bankruptcy Code. The bill protects donations to qualified religious organizations as well as to charities … [The Act] is not intended to diminish any of the protections against prepetition fraudulent transfers available under section 548 of the Bankruptcy Code. If a debtor, on the eve of filing for bankruptcy relief, suddenly donates 15 percent of his or her gross income to a religious organization, the debtor’s fraudulent intent, if any, would be subject to scrutiny under … the Bankruptcy Code. This fifteen percent “safe harbor” merely shifts the burden of proof and limits litigation to where there is evidence of a change in pattern large enough to establish fraudulent intent. As Professor Laycock explained during the subcommittee hearing on this bill: “If I have been going along for years putting $5 a week in the collection plate and all of a sudden, before I file for bankruptcy, I clean out my last account and give 15 percent of my last year’s income to my church, the trustee and the bankruptcy judge will look at the timing, the amount, the circumstances, the change in pattern, and they will say those are all badges of fraud. They will say I had the actual intent to hinder or defraud my creditors, and that is recoverable under section 548(a)(1). The fraud scenario is not going to happen.”
Likewise, Senator Grassley … stated: “[T]he bill does not amend section 548(a)(1) of the Bankruptcy Code. This section lets bankruptcy courts recover any transfer of assets on the eve of bankruptcy if the transfer was made to delay or hinder a creditor. Therefore, if the bill is enacted, we don’t have to worry about a sudden rash of charitable giving in anticipation of bankruptcy. Such transfers would obviously be for the purpose of hindering creditors and would still be subject to the bankruptcy judge’s powers. In other words, there really isn’t much room for abuse as a result of [this] legislation.”
In addition, [the Act] protects the rights of certain debtors to tithe or make charitable contributions after filing for bankruptcy relief. Some courts have dismissed a debtor’s chapter 7 case (a form of bankruptcy relief that discharges an individual debtor of most of his or her personal liability without any requirement for repayment) for substantial abuse under section 707(b) of the Bankruptcy Code based on the debtor’s charitable contributions ….
Let’s illustrate the impact of this provision with some practical examples.
• Example 1. Bob has attended his church for many years. For the past few years, his contributions to his church have averaged $50 per week, or about $2,500 per year. Bob’s gross annual income for 1998 and 1999 is about $40,000. On May 15, 1999, Bob files for bankruptcy. A bankruptcy trustee contacts the church treasurer, and demands that the church turn over all contributions made by Bob from May 15, 1998 through May 15, 1999. The Religious Freedom and Charitable Donation Protection Act of 1998 applies directly to this scenario, and protects the church from the reach of the trustee, since: (1) the amount of Bob’s annual contributions in both 1998 and 1999 (the years in which the contributions were made) did not exceed 15 percent of his gross annual income (15 percent of $40,000 = $6,000); and (2) the timing, amount, and circumstances surrounding the contributions, as well as the lack of any change in the debtor’s normal pattern or practice, suggest that Bob did not commit intentional fraud, and so the trustee cannot recover contributions on this basis. See step #4 in the sidebar.
• Example 2. Same facts as example 1, except that in addition to his weekly giving Bob made a one-time gift to the church building fund on December 1, 1998, in the amount of $5,000. Bob’s total giving for the year preceding the filing of his bankruptcy petition now totals $7,500, or nearly 19 percent of his gross annual income. As a result, he is not eligible for the 15 percent “safe harbor” rule described in step #4 of the sidebar. The trustee will be able to recover the $7,500 in contributions made by Bob to the church within a year of filing the bankruptcy petition, unless Bob can demonstrate that giving 19 percent of his gross annual income is consistent with his normal practices in making charitable contributions. It is unlikely that Bob or the church will be able to satisfy this condition, since the gift to the building fund was a “one time” extraordinary gift for Bob that was unlike his giving pattern in any prior year.
• Example 3. Barb believes strongly in giving to her church, and for each of the past several years has given 20 percent of her income. On June 1, 1999, she files for bankruptcy. A bankruptcy trustee contacts the church treasurer, and demands that the church turn over all contributions made by Barb from June 1, 1998 through June 1, 1999. The Religious Freedom and Charitable Donation Protection Act of 1998 applies directly to this scenario, and protects the church from the reach of the trustee, since: (1) the amount of Barb’s annual contributions in both 1998 and 1999 (the years in which the contributions were made) exceeded 15 percent of her gross annual income, but she had a consistent practice in prior years of giving this amount; and (2) the timing, amount, and circumstances surrounding the contributions, as well as the lack of any change in the debtor’s normal pattern or practice, suggest that Barb did not commit intentional fraud, and so the trustee cannot recover contributions on this basis. See step #5 in the sidebar.
• Example 4. Bill has attended his church sporadically for the past several years. For the past few years, his contributions to his church have averaged less than $1,000 per year. Bill’s gross annual income for 1998 and 1999 is about $80,000. Bill is facing a staggering debt load due to mismanagement and unrestrained credit card charges. He wants to declare bankruptcy, but he has a $15,000 bank account that he wants to protect. He decides to give the entire amount to his church in order to keep it from the bankruptcy court and his creditors. He gives the entire balance to his church on June 1, 1999. On July 1, 1999, Bill files for bankruptcy. A bankruptcy trustee contacts the church treasurer, demanding that the church turn over the $15,000 contribution. The Religious Freedom and Charitable Donation Protection Act of 1998 does not protect Bill or the church. The timing, amount, and circumstances surrounding the contribution of $15,000 strongly indicate that Bill had an actual intent to hinder, delay, or defraud his creditors. This conclusion is reinforced by the fact that the gift was contrary to Bill’s normal pattern or practice of giving. As a result, the trustee probably will be able to force the church to return the $15,000. See step #2 in the sidebar.
• Key point. Whenever a donor makes a large gift of cash or property to a church, church leaders should be alert to the fact that a bankruptcy trustee may be able to recover the contribution at a later date if the donor files for bankruptcy within a year after making the gift and none of the exceptions described in this article applies.
Making charitable contributions after filing for bankruptcy
Up until now, this article has addressed the authority of bankruptcy trustees to recover contributions made by bankrupt debtors within a year prior to filing a bankruptcy petition. There is a second bankruptcy issue that is of direct relevance to churches-can church members who file for bankruptcy continue to make regular contributions to their church? This issue was also addressed by the Religious Freedom and Charitable Donation Protection Act of 1998.
Section 707(b) of the bankruptcy code provides for the dismissal of chapter 7 bankruptcy petitions in the case of debtors who can pay their debts from their excess disposable income. Consider the following examples.
In re Breckenridge, 12 B.R. 159 (S.D. Ohio 1980). A court denied confirmation of a chapter 13 plan because the debtors had not presented the plan in good faith. In determining good faith the court looked to the overall picture presented by the debtors. The court considered several factors: (1) the “reasonably recent prior bankruptcy of [the debtor], combined with the low percentage dividend to unsecured claimants; (2) retention of imprudently purchased assets; and (3) the devotion of a significant portion of the debtors’ income to the payment of an entirely discretionary expenditure, a church tithe ….” While stating that tithes are not automatically objectionable, the court stressed that because of the debtors’ severe financial condition they should “devote maximum resources” to the repayment of their obligations and leave tithing to a time when they could better afford it. The court also noted that without the tithing allocation the debtors could propose a chapter 13 plan whose dividend to creditors would be well over 70%. The court, therefore, denied confirmation of the plan.
In re Curry, 77 B.R. 969 (S.D. Fla. 1987). The debtor presented a chapter 13 plan for confirmation in which he proposed monthly payments of $125 and tithes to his church of $103. The debtor was an ordained minister employed by the church as a teacher. The church did not require the donations. The court emphasized that the contributions constituted almost half of the debtor’s disposable income. While the court did not question the sincerity of the debtor’s religious convictions and recognized that the contributions had also been made before the bankruptcy, the court held that the contributions were not a necessary living expense. The court reasoned that the contributions would have the effect of requiring the debtor’s creditors to contribute to his church and refused to confirm the plan.
In re Green, 73 B.R. 893 (W.D. Mich. 1987) aff’d, 103 B.R. 852 (W.D. Mich. 1988). A debtor’s budget included a payment of 10% of her gross monthly income to her church. The debtor testified that “her church and her own religious beliefs require her to tithe.” The creditor did not contest the sincerity of the debtor’s belief. The court referred to the United States Supreme Court decision in Hobbie v. Unemployment Appeals Commission of Florida, 480 U.S. 136 (1987). In Hobbie, an employer discharged an employee who had recently converted to become a Seventh Day Adventist and so could no longer work Friday nights or Saturdays. After the employee’s termination, the state refused to grant her unemployment compensation benefits. The Supreme Court found that the state’s denial of benefits violated the employee’s right to the free exercise of religion because the state required her “to choose between following the precepts of her religion and forfeiting benefits, on the one hand, and abandoning one of the precepts of her religion in order to accept work on the other. Governmental imposition of such a choice puts the same kind of burden upon the free exercise of religion as would a fine imposed against [her] for her Saturday worship.” The Supreme Court, in the Hobbie case, also held that:
Where the state conditions a receipt of an important benefit upon conduct proscribed by a religious faith, or where it denied such a benefit because of conduct mandated by religious belief, thereby putting substantial pressure on an adherent to modify his behavior and to violate his beliefs, a burden upon religion exists. While the compulsion may be indirect, the infringement upon free exercise is nonetheless substantial.
The Green court reasoned that chapter 13 relief is at least as important as unemployment benefits. The court held that “[t]o deny confirmation of this plan solely because Mrs. Green tithes would be to deny her the benefits of the Bankruptcy Code because of conduct mandated by her religious beliefs.” The court concluded that in the absence of a compelling state interest, it must confirm the plan.
In re Navarro, 83 B.R. 348 (E.D. Pa. 1988). A court held that tithing was necessary for the support and maintenance of a debtor. A creditor objected to the confirmation of a chapter 13 plan because the plan provided for a tithe to the debtor’s church. The debtor testified that she and her family were devoutly religious and that she considered her obligation to tithe “central to her personal beliefs and tenets of her faith.” The debtor also stated that “she considered her obligation to tithe to be indispensable so that she would find a way to continue to do so no matter how the court rules in this matter.” The court reasoned that religious contributions are not luxury items because the debtors do not obtain a tangible benefit or increased standard of living. Rather the contributions arose “purely out of the debtors’ conviction that they are essential for the spiritual and moral well-being of the family.” The court also noted the debtor’s testimony that “tithing is a family practice of long-standing.” The court concluded that religious contributions may be “consistent with expenditures reasonably necessary for the maintenance and support of chapter 13 debtors” and allowed the tithes. The court criticized the Green decision (summarized above) for improperly comparing denial of unemployment benefits to a court’s decision to confirm a bankruptcy plan. The court reasoned that in chapter 13 bankruptcy proceedings the role of the court is “not to award or deny substantive governmental benefits, but rather to balance the interest of various private parties according to neutral principals [sic] emanating from Congress.” More importantly, the court held that the administration of the bankruptcy system and the protection of creditors are sufficiently compelling interests to outweigh the free exercise of religion.
In re Bien, 95 B.R. 281 (D. Conn. 1989). A court allowed a debtor to make religious contributions. The issue again was whether a tithe in a chapter 13 debtor’s plan is “reasonably necessary … for the maintenance and support of the debtor.” The relevant inquiry, the court stated, was “whether the proposed expense fulfills a bona fide personal commitment intended to serve or promote some religious or spiritual purpose, rather than an effort to hinder, delay or defraud creditors.” The debtor had been a full tithe-paying member of the Mormon church for five and one-half years. A full tithe-paying member must pay 10% of gross monthly income to the Church and in return may attend services and pray in the central church in Salt Lake City, Utah. Additionally, a full tithe-paying member enjoys eligibility for positions of service within the church. After examining the totality of the circumstances, the court upheld the religious contribution because “(1) [r]eligious participation is a fundamental part of many people’s lives … (2) [t]he church tithe is a condition precedent to full participation in the debtor’s religion, and (3) the … expense … serves a bona fide religious and spiritual purpose.”
In re Miles, 20 Collier Bankruptcy Cases 912 (N.D. Fl. 1989). Can a debtor who files a “Chapter 13” bankruptcy plan continue to make monthly contributions to his church? No, concluded a federal district court in Florida. The debtor filed a plan under which he proposed to pay only $50 per month for three years (a total of $1,800) against $90,000 in unsecured debts. The plan reflected monthly take-home pay of $1,150 out of which the debtor donated $160 to his church. The bankruptcy trustee objected to the debtor’s plan, arguing that by making the monthly contributions of $160 to his church the debtor was not applying all of his “disposable income” toward the payment of his debts. The issue, as stated by the court, was whether “the court, over the objection of the trustee, can confirm a plan which pays only a minimal dividend to unsecured creditors while the debtor continues to devote substantial amounts of his income to the support of his church.” The court concluded that the trustee was correct in objecting to the plan, and accordingly it denied the debtor’s bankruptcy petition. The court observed: “[We] reject the proposition … that the constitutional separation of church and state protects debtors who with the ability to make payments to their creditors choose instead to donate those funds to their church. While church donations may be a source of inner strength and comfort to those who feel compelled to make them, they are not necessary for the maintenance or support of the debtor or a dependent of the debtor” and accordingly the debtor failed to meet the “disposable income test required for confirmation of the plan.”
In re Tucker, 102 B.R. 219 (D.N.M. 1989). A bankruptcy court rejected a debtor’s bankruptcy petition on the ground that it called for monthly contributions of $100 to his church. The debtor filed a “Chapter 13” (wage-earner’s) bankruptcy petition that listed $22,000 in debts. The plan called for only 2% of unsecured debts to be satisfied over the next four years. The largest unsecured creditor (a local bank) objected to the petition on the ground that the plan did not provide for the payment of all of the debtor’s disposable income to the bankruptcy trustee. Among other things, the bank pointed out that the debtor’s plan called for monthly contributions of $100 to his church. The court observed: “By allowing a debtor to deduct contributions to any organization, the court necessarily is forcing the debtor’s creditors to contribute to the debtor’s church or favorite charity. Congress could have intended no such result.” Accordingly, the court rejected the debtor’s bankruptcy petition.
In re McDaniel, 126 B.R. 782 (D. Minn. 1991). The issue was not whether the court would allow the debtor to tithe, but whether the proposed plan contained excessive contributions to his church. While the debtor proposed to pay $540 per month to his church, the proposed monthly chapter 13 plan payment was $600. The court rested its analysis upon the assumption that an absolute ban on tithing would violate the first amendment guaranty of religious freedom. The court reasoned, however, that a determination that the contribution was excessive would not violate the first amendment. In its analysis, the court emphasized that contributions must be made in good faith and not in an effort to divert funds from creditors. The debtors met this requirement with evidence that they had tithed for several years prior to the filing of their petition. The court also noted that the debtors “felt a strong moral obligation to continue” tithing but “would not be denied full participation in their church if they did not tithe.” The court held that the debtors’ proposed contribution was excessive primarily because the tithe nearly equaled the amount the debtors proposed to pay under their chapter 13 plan. The court ordered that the debtors resubmit a plan with a smaller contribution provision.
“In re Packham, 126 B.R. 603 (D. Utah 1991). A federal court in Utah ruled that a church member’s bankruptcy plan could not be approved since he proposed to “tithe” or give 10 percent of his income to his church. The church member had debts of $50,000 and an annual household income of $25,000. He filed a “Chapter 13” wage-earners bankruptcy plan, under which he agreed to pay his creditors 20 percent of their debts. A creditor objected to the proposed plan on the ground that it listed the church member’s tithe to his church as a reasonably necessary living expense not available for distribution to creditors. Chapter 13 of the bankruptcy law requires that all of a debtor’s “disposable income” be made available for distribution to creditors, except an amount that is reasonably necessary for living expenses. The church member claimed that he believed tithing to be mandatory rather than optional. He testified that tithing “is a commandment from the Lord to pay as a debt to him for what he has done for us, for what God has done for us …. I believe that the tithing should be paid before the creditors. I believe that our greatest creditor is the Lord. He is the one that has given us the most.” The court rejected this argument, and ruled that the bankruptcy plan could not be approved unless the tithe was canceled and the funds made available to the creditors. The court emphasized that failure to tithe would not prevent the debtor from full participation in the activities of his church, and therefore the practice of his religion would not be adversely affected. The court emphasized that neither the debtor nor his church was “in a position to make the Lord a priority creditor in bankruptcy.”
In re Lee, 162 B.R. 31 (N.D. Ga. 1993). A debtor filed a bankruptcy petition under chapter 7 of the bankruptcy code. His bankruptcy petition showed total unsecured debts of $15,384.71, net monthly income of $3,581.43, and total monthly living expenses of $2,064.00 leaving a net disposal income of $1,517.43. In summary, the debtor had sufficient disposable monthly income to pay off his entire unsecured debts in less than 12 months. As a result, the bankruptcy trustee dismissed the debtor’s bankruptcy petition. A court agreed that allowing a discharge of debts in this case would constitute a substantial abuse of the bankruptcy law, since the debtor’s disposable income (not reduced by charitable contributions) was sufficient to pay his debts in a timely manner. The court concluded: “In those cases in which courts have found a constitutional right to tithe, the courts premised their decisions on a finding that the debtors had tithed consistently and that either the debtors’ church required tithing or the debtors had a strong commitment to continue tithing …. In [this] case, [the debtor has] not established a consistent practice of tithing. Neither [has he] introduced credible evidence of strong commitment to tithe. [He] failed to tithe in times of financial difficulty. Additionally, [he has] been a church member since June 1992, but has contributed only since January 1993 …. This court does not dispute the debtor’s commitment to his church or his honest desire to tithe. This court also does not deny the debtor’s right to tithe. He may choose to adjust his budget elsewhere and continue to tithe. It is inequitable to allow him to tithe at the expense of his creditors, when, in the past, he has been able to adjust his moral commitment to tithing to allow for his other financial commitments.”
The Religious Liberty and Charitable Donation Protection Act of 1998
The Religious Liberty and Charitable Donation Protection Act of 1998 directly addressed the ability of bankrupt debtors to continue making contributions to their church following the filing of a bankruptcy petition. The bankruptcy code says that a court may not approve a bankruptcy plan unless it provides that all of a debtor’s “projected disposable income to be received in the three-year period beginning on the date that the first payment is due under the plan will be applied to make payments under the plan.” In addition, a court can dismiss a bankruptcy case to avoid “substantial abuse” of the bankruptcy law. Many courts have dismissed bankruptcy cases on the ground that a debtor’s plan called for a continuation of charitable contributions.
The Act clarifies that bankruptcy courts no longer can dismiss bankruptcy cases on the ground that a debtor proposes to continue making charitable contributions. This assumes that the debtor’s contributions will not exceed 15 percent of his or her gross annual income for the year in which the contributions are made (or a higher percentage if consistent with the debtor’s regular practice in making charitable contributions).
The committee report accompanying the Act states:
In addition [the bill] protects the rights of certain debtors to tithe or make charitable contributions after filing for bankruptcy relief. Some courts have dismissed a debtor’s chapter 7 case … for substantial abuse under section 707(b) of the bankruptcy code based on the debtor’s charitable contributions. The bill also protects the rights of debtors who file for chapter 13 to tithe or make charitable contributions. Some courts have held that tithing is not a reasonably necessary expense or have attempted to fix a specific percentage as the maximum that the debtor may include in his or her budget.
Let’s illustrate the impact of this provision with some practical examples.
• Example. Brad files a “chapter 7” bankruptcy petition. Brad’s plan states that he will use all available “disposable income” to pay his creditors during the three year period following the approval of his plan. But the plan permits Brad to continue making contributions to his church, which in the past have averaged 10 percent of his income. Some creditors object to the plan, and demand that the court reject it, since Brad will be making contributions to his church rather than using these funds to pay off his lawful debts. The Religious Liberty and Charitable Donation Protection Act of 1998 specifies that the court cannot reject Brad’s bankruptcy plan because of the charitable contributions-since the contributions are less than 15 percent of his gross annual income.
• Example. Same facts as the previous example, except that Brad’s plan proposes to pay contributions to his church in the amount of 25 percent of his gross annual income. Brad would rather that his church receive all available income than his creditors. Several creditors object to this plan. The court probably will deny Brad’s request for bankruptcy protection, since the substantial contributions proposed in his plan exceed 15 percent of his gross annual income, and are not consistent with his prior practice of making charitable contributions.
The Religious Freedom and Charitable Donation Protection Act – A Checklist
Here is a checklist that will be a helpful resource in applying the new law:
Step #1. Did the bankruptcy debtor make one or more contributions of cash or property to a church within a year preceding the filing of a bankruptcy petition?
- If not, stop here. A bankruptcy trustee cannot recover the debtor’s contributions from the church.
- If yes, go to step #2.
Step #2. In making contributions to the church, did the debtor have an actual intent to hinder, delay, or defraud his or her creditors? In deciding if an intent to defraud exists, consider the timing, amount, and circumstances surrounding the contributions, as well as any change in the debtor’s normal pattern or practice.
- If yes, a bankruptcy trustee can recover from the church contributions made by the debtor within a year prior to the filing of the bankruptcy petition.
- If not, go to step #3.
Step #3. Did the debtor receive “reasonably equivalent value” for the contributions made to the church? Note that reasonably equivalent value will not include such “intangible” religious services as preaching, teaching, sacraments, or counseling.
- If yes, stop here. A bankruptcy trustee cannot recover the debtor’s contributions from the church.
- If no, go to step #4.
Step #4. Is the value of the debtor’s contributions 15 percent or less of his or her gross annual income?
- If yes, stop here. A bankruptcy trustee cannot recover the debtor’s contributions from the church.
- If no, go to step #5.
Step #5. Is the value of the debtor’s contributions consistent with the practices of the debtor in making charitable contributions?
- If yes, stop here. A bankruptcy trustee cannot recover the debtor’s contributions from the church.
If no, a bankruptcy trustee can recover from the church contributions made by the debtor within a year prior to the filing of the bankruptcy petition.
© Copyright 1999 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m08 m05 c0399