When the church enters bankruptcy

Daniel P. Dalton

Crystal Cathedral and Archdiocese of Milwaukee are recent examples of churches taking Chapter 11 on their financial woes.

Churches were long considered good credit risks.

Weekly collections tend to be steady, even during recessions, and churches feel a moral tug to pay debts. Most of the nation’s churches carry little or no mortgage debt, and are based in buildings that were paid off long ago.

But some churches, especially those not affiliated with major denominations, borrowed briskly to build or expand in recent years. Spending on construction of houses of worship rose to $6.2 billion in 2007 from $3.8 billion in 1997, according to the U.S. Census. Now, churches are seeing congregants lose jobs and savings.

The financial problems are crimping a church building boom that began in the 1990s, when churches multiplied, turning many houses of worship into suburban “social centers” complete with bookstores, gyms and coffee bars. Lenders say mortgage applications are down, while some commercial lenders no longer see churches as a safe investment.

Cathedral defaults
On October 18, 2010 the once “unthinkable” event occurred. Crystal Cathedral, the birthplace of the televangelist program “Hour of Power,” filed for Chapter 11 bankruptcy in Southern California after struggling to emerge from debt that exceeds $43 million.

This is not the first prominent bankruptcy of a church. Faced with the possibility of having to pay millions in damages to alleged sexual abuse victims, the Archdiocese of Milwaukee
filed for Chapter 11 bankruptcy on January 4, 2011, following the lead of the Archdiocese of Portland, the first of many Archdioceses to have filed bankruptcy since 2004.

So what happens when a church files for Chapter 11 bankruptcy? To begin with, the purpose of Chapter 11 bankruptcy is to allow a church, or other debtor, to reorganize its debts in an attempt to repay creditors in an amount that is generally less than what is owed. This type of bankruptcy is often the chosen course religious organizations take because it does not limit the amount of debt that is to be reorganized. And there are few qualifications.

Trustee may oversee
Generally, the debtor will be its own trustee. However, if the court believes the church is acting wrongly in the case, it may appoint a trustee to oversee the case. The debtor will usually file monthly operating reports with the court. These will show income and payments made, profit and loss statements, and a balance sheet.

The debtor generally then has four months after filing to create a repayment plan. After that time, the creditors can also make a plan. Creditors are generally divided into classes based on the characteristics of their claims against the debtor, and are given votes based on the amount of their claim. The plan can be approved when the creditors vote in the affirmative to it.

Sometimes the creditors will not agree to the plan. In this case, if the debtor meets certain qualifications, a plan can be set in place without creditor approval. This process is known as “cramming down” the plan on the creditors, and it requires court approval. While in Chapter 11 bankruptcy, a church would continue operating, paying creditors from their earnings or the sale of any assets.

Priority claims in these cases include back taxes and secured claims. These must be paid in full, while those that are not priority claims may be repaid in part. In most situations, a religious organization is able to keep its core assets under bankruptcy protection. This generally allows the church to continue operating as usual, although it usually operates under bankruptcy court supervision to ensure creditors are getting paid as outlined in the restructuring.

Churches are different
What money would the church use to pay off its “creditors”? In a typical reorganization procedure, a business might cut back on its less productive or cost-efficient operations to increase its cash flow. But it’s hard to apply concepts like productivity to a religious entity. The church might have to liquidate some of its assets. Having said this, with bankruptcy filings involving religious entities, courts are reluctant to exercise much control over the day to day affairs of the church given the First Amendment Free Exercise and Establishment Clause concerns.

These concerns are weighed in light of the obligations owed to creditors. Thus, a bankruptcy court may stay out of the decision concerning mission work, but may weigh in on salaries, land purchase or sales and the business aspect of running a church. At the end of the day, the court, or trustee, if appointed, would retain the final authority over major financial decisions, such as what land, buildings and other assets the church might sell.

Depending on state law, individual parishes are constituted as their own corporations. This could mean that assets – investments, churches, and other facilities – are protected from lawsuits directed at the church.

Thus, the primary benefit of bankruptcy is that it allows the church to continue operating as it attempts to restructure and work its way out of debt. Since the church will continue running, assets are also protected under the bankruptcy code. It also can allow the debtor to discharge some debts without paying them in full.

Civil lawsuits
The other advantage of a bankruptcy filing is the stay the civil lawsuits have against the church. When a bankruptcy petition is filed, the filing constitutes an automatic federal court stay that bars anyone from proceeding with a suit against the debtor. So a bankruptcy court – instead of a civil court – would determine what a vendor’s claims were worth, if anything. The bankruptcy court’s decision is final unless the proceeding is prematurely dismissed, at which point the collection cases could resume in civil court.

And this in turn becomes the biggest disadvantage of filing for bankruptcy. If the bankruptcy court decides the church owes a vendor a large sum of money, it is going to be obliged to pay them as typical Chapter 11 “creditors” and not necessarily on its own terms. The church would get the opportunity to put forward an initial payment plan, but if the proposed settlement isn’t acceptable to the vendor, the bankruptcy court could go with a payment plan much less advantageous to the church.

What will happen with the Crystal Cathedral matter? Only time will tell concerning the repayment plan, the sale of assets, the internal management and the leaseback of buildings to find a fair resolution to the matter. Until then, the church will continue to operate and one day regain the financial footing that it now lacks.

Daniel P. Dalton is lead partner with Dalton & Tomich PLC, Bloomfield Hills, MI. [ www.daltontomich.com ]