A Surprising Defendant in Bankruptcy Avoidance Litigation

Peter Califano*

Can religious tithes be avoided as a fraudulent conveyance when a member of a church files for bankruptcy? In the first reported case of its kind, in 1992 a bankruptcy trustee successfully recovered funds donated to a church by members of the congregation who had filed for personal bankruptcy. The court ruled that the tithes were fraudulent transfers pursuant to 11 U.S.C. § 548, 550 since the debtors failed to receive "reasonably equivalent value" in exchange for their tithes. The church was therefore required to disgorge the funds to the trustee for distribution to the debtors' creditors. Whether or not this action was the result of an overzealous bankruptcy trustee is beside the point. This development signals a new battleground over religious activity and the implementation of public policy. In 1996, three courts addressed the issue. The results should make any member of a church, synagogue, or any other worshipping body, sit up and pay serious attention.

In In re Young1, a husband and wife filed for bankruptcy and had tithed approximately $13,000 to their church in the one year preceding the filing of their bankruptcy petition. The debtors actively participated in church programs, tithed regularly, and even held positions within the church. There was no question as to the debtors' religious beliefs and commitment. The bankruptcy trustee nonetheless filed a lawsuit seeking the return of all monies paid to the church during the one-year period before the petition. The trustee claimed that the transfers were fraudulent conveyances, since the payments were made while the debtors were insolvent, and the debtors had received less than reasonably equivalent value in exchange for the transfer. Since the debtors received no money, property or other consideration in return for their tithes, the trustee claimed that the contributions to the church were fraudulent transfers. The trustee argued that debtors' intent was irrelevant.

The Bankruptcy Court in Minnesota agreed. The Court, in a tortured analysis in which the tithes were analyzed as mere economic transactions, opined:

In making their contributions, the debtors received unbargained for benefits, i.e. the privilege to participate in religious worship. While this worship may have yielded the feelings of association, comfort, affection, companionship and love, these subjective emotional benefits cannot be bargained for [cites omitted]. Thus, any benefits received by the debtors were mere gratuities lacking consideration and deemed valueless [cites omitted]. (p. 893).

The Young case was appealed2 and later reached the Eighth Circuit.3 Various religious organizations such as the Catholic League for Religious and Civil Rights and the Church of Jesus Christ of Latter-Day Saints filed amicus curiae briefs. In May 1996 the Court issued a split decision holding that the trustee could not avoid the tithes. Although the Court initially agreed that a strict reading of the fraudulent conveyance statutes made the contributions avoidable, it held that nonetheless the Religious Freedom Restoration Action of 1993 (RFRA) prevented recovery against the church. Under RFRA, any government act that substantially burdens the exercise of religious freedom must be justified by a compelling state interest. The Young court found that the trustee's recovery of contributions did substantially burden the debtors' free exercise of their religion since it effectively prevented them from tithing for the one year preceding the filing of the bankruptcy petition. Since the trustee was unable to articulate a compelling state interest for upholding the avoidance, the church was allowed to retain the tithes.

In In re Newman,4 a husband and wife filed for bankruptcy and in the preceding year had tithed approximately $2,500 to their church. It was undisputed that the debtors had no fraudulent intent with respect to the transfers and that their belief in tithing to their church was a sincere and firmly held belief. Nonetheless, the Bankruptcy Court in Kansas ruled in favor of the bankruptcy trustee. It found that the tithes were fraudulent transfers since the debtors had received no value for their contributions and there was no "exchange" of any consideration between the debtors and the church. The Court went on to hold that the debtors' claims of infringement of their First Amendment rights were unfounded. With respect to RFRA, the Court ruled that the debtors had failed to show that their free exercise of religion had been substantially burdened since they had already tithed their money to their church. Even if avoidance of the tithes was a substantial burden, the Court also ruled that the government had a compelling state interest in maintaining the integrity of the bankruptcy system and ensuring the maximum distributions to the creditors in the bankruptcy case. The Newman ruling was appealed and upheld by the District Court5 in November 1996. The Court's opinion in closing acknowledged the tension between deeply held religious beliefs and the demands of civil authority, but reminded the parties that even the Bible directs us to "render thereto unto Caesar, the things that are Caesar's; and unto God, the things that are God's" (p. 24). In an extensive opinion in In re Hodge,6 a Bankruptcy Court sitting in Idaho avoided approximately $5,000 in contributions that a husband and wife had contributed to their church before the filing of their bankruptcy. As in the previous cases, it was undisputed that the debtors were sincere in their religious belief in tithing and that the debtors were long-standing members of their congregation. The Court nonetheless ruled that since there was no quid pro quo in the exchange of services for the debtors' contributions and the debtors had been insolvent for a period of two years proceeding the filing of their bankruptcy petition (expanded under state law from the typical one-year period), the tithes could be avoided. Although the Court found that RFRA prevented the bankruptcy trustee from avoiding the tithes, it went on to find that RFRA was unconstitutional. It claimed that in passing RFRA, Congress had usurped the Judicial Branch's role in determining how constitutional questions involving the Free Exercise Clause of the First Amendment should be analyzed. Since RFRA was therefore inapplicable, the tithes could be recovered from the church.

As evidenced by these cases, a troubling trend has emerged in the bankruptcy courts. From a strict reading of the Code's fraudulent conveyance statutes, religiously-motivated contributions made to any religious organization are clearly at risk. Even though the reported cases to date involved smaller sectarian Christian churches, there would be nothing to prevent a bankruptcy trustee in pursuing the more traditional and mainline groups. An aggressive creditor may even consider the avoidance of tithes in state court based on state law fraudulent conveyance statutes.

One would not expect religious tithing to fit within the parameters of a typical commercial transaction that would normally be subject to a fraudulent conveyance analysis. Apparently, a number of courts have found otherwise. Although RFRA has given some protection to the avoidance of tithes, albeit imperfectly, this term the U.S. Supreme Court will rule on the constitutionality of RFRA (in an unrelated religious case in Boerne v. Flores, 95-2074) which many commentators believe will not survive intact.

Without the limited protection of RFRA, and considering the bankruptcy courts' unwillingness to apply the First Amendment protections of the Free Exercise or Establishment Clauses, religious organizations will need to devise a new strategy in responding to this growing threat. One simple, but effective, response would be to amend the fraudulent conveyance statutes contained in the Code by providing an exception to avoidance when there is evidence to show that the transfer occurred in connection with the practice of sincerely held religious belief (as evidenced by the member's past religious activities), and was without fraudulent intent (an approach suggested by the Hodge Court). Without this change or the protection of a vigorously applied RFRA, it appears that all religious organizations are at risk with respect to contributions received from members who subsequently file for bankruptcy. The Bankruptcy Review Commission, which is now considering proposals to amend the Code, should be alerted to this situation and take the appropriate steps to ensure that legitimate religious donations are not subject to avoidance actions. Good public policy is not served by maintaining that tithing is a fraudulent activity.

*Mr. Califano is a partner at the law firm of Cooper, White & Cooper in San Francisco, CA and is a member of the firm's Bankruptcy and Creditors' Rights Group.

  1. Christians v. Crystal Evangelical Free Church, 148 B.R. (Bkrtcy. D. Minn. 1992).
  2. Aff'd, In re Young, 152 B.R. 939 (D. Minn. 1993).
  3. In re Young, 82 F.3d 1407 (8th Cir. 1996).
  4. Morris v. Midway Southern Baptist Church, 183 B.R. 239 (Bkrtcy. D. Kan. 1995).
  5. In re Newman, 1996 U.S. Dist. LEXIS 18357 (November26, 1996).
  6. Fitzgerald v. Magic Valley Evangelical Free Church, 200 B.R. 884 (Bkrtcy. D. Idaho 1996).

2001 The Federalist Society