Catholic Diocese of Tucson Files Plan of Bankruptcy Reorganization

By Jack Siegel
Charity Governance
September 22, 2004

http://charitygovernance.blogs.com/charity_governance/2004/09/catholic_dioces.html

Under Federal bankruptcy law, a non-profit corporation cannot be forced into bankruptcy by its creditors (an involuntary bankruptcy). Section 303(a) of Title 11 of the United States Code, provides as follows:

An involuntary case may be commenced only under chapter 7 or 11 of this title, and only against a person, except a farmer, family farmer, or a corporation that is not a moneyed, business, or commercial corporation, that may be a debtor under the chapter under which such case is commenced.

However, nothing precludes a non-profit from voluntarily filing for bankruptcy. And the Catholic Diocese of Tucson, Arizona took the extraordinary measure of filing for bankruptcy under Chapter 11 of the Bankruptcy Code on Monday, September 20, 2004. The Diocese seeks a voluntary reorganization of its affairs.

The Diocese claims it was forced to take this action because it simply did not have the resources to deal with lawsuits and claims arising from child sex abuse allegations. According to an article in the September 21st edition of the Arizona Republic there are currently 22 suits pending against the Diocese, with 34 victims making claims.

Under the plan, the Diocese would create a settlement fund, victims would submit claims, and if a victim's claim had merit, the victim would receive compensation from the fund, presumably over some period of time. Victims would have the right to opt out of the settlement fund procedure, but would then bear the risks of contested litigation. Against that background, the bankruptcy could be viewed as one large settlement offer.

The Archdiocese of Portland filed a voluntary petition for reorganization on July 6, 2004, but has not yet filed a plan of reorganization.

These two cases raise groundbreaking issues. In a business bankruptcy, the creditors are entitled to payment before the shareholders if the bankruptcy involves a liquidation of the entity. If the bankruptcy involves a reorganization of the entity, the creditors often become equityholders in the reorganized entity, with the shareholders often receiving no interest in the reorganized entity. We are in relatively unchartered water with respect to the Tucson and Portland filings because non-profit entities don't have equityholders.

When we think about the Catholic Church, we think of a monolithic entity. However, the Catholic Church is configured using a series of "parent-subsidiary" relationships. Parishes are the lowest entity in the hierarchy, consisting of a church and school under the direction of a priest. The next tier up in the hierarchy is the diocese. A diocese is comprised of a number of parishes that are under the control of a bishop. The city in which the bishop for a diocese is located is referred to as the see-city. The bishop of each diocese controls the member parishes. However, certain important dioceses are referred to as archdioceses and their bishop is referred to as an archbishop. These super dioceses (referred to as "capital sees") are really no different from the generic diocese, but typically several dioceses (referred to as subsidiary sees) are "attached" to an archdiocese. This relationship is purely for administrative purposes. Finally, at the top of this hierarchy is the Holy See. This is the Pope and Vatican City. For additional information regarding the Catholic Church, visit the Catholic Information Network's website.

Issue 1. Why did the Tucson Diocese file for bankruptcy rather than the individual parishes where the accused priests resided? Why didn't the archdiocese that includes the Tucson Diocese file for bankruptcy rather than just the Tucson Diocese? We suspect the entity chosen to file for bankruptcy is the one named in the child-abuse lawsuits. So the real question is why didn't the plaintiffs in those suits file against an entity higher up in the Catholic Church hierarchy? We don't know the answer to that question, but we suspect that filing against the Holy See in Vatican City posed some difficult jurisdictional issues.

Issue 2. What we do know is that the Tucson Diocese did not include any parish property as part of its plan of reorganization. The Arizona Republic in its September 21, 2004 edition notes that the Tucson Diocese proposed placing $3.2 million in the settlement fund, but left somewhere between $43 and $50 million of parish property (mostly land and buildings) outside of the bankruptcy estate. This strikes us as a tenuous position because in a parent-subsidiary relationship, the value of the subsidiary is considered an asset of the parent. Furthermore, the sexual abuse claims against the Tucson Diocese arise out of parish activities. We suspect the creditors will contest the exclusion of parish assets from the plan of reorganization.

Issue 3. Another interesting question will involve the claims of the creditors to financial assets and future collections. Here we have a potential clash between bankruptcy law and charity law. We suspect someone will argue that certain assets were given to the Tucson Diocese as charitable gifts, and therefore are beyond the reach of creditors. The Tucson Diocese is the logical entity to invoke the "charitable trust" doctrine, and this doctrine may be the basis for the exclusion of parish assets. If the creditors argue that restricted assets currently listed as being outside of the bankruptcy estate should be brought back into the estate, will the donors of these restricted gifts be granted standing to enforce the restrictions? If the donors lack standing, will the Arizona Attorney General (we assume the AG is charged with protecting charitable assets) dispute the claim that the assets are part of the bankruptcy estate?

Issue 4. People will presumably continue to fill the collection plates each Sunday morning. This is future revenue. Will the Tucson Diocese attempt to exclude this revenue from the reach of creditors by structuring the collection so that the assets received are clearly subject to a charitable trust? As we currently understand the plan of reorganization, future collections will be used to fund payments to creditors, meaning that the Tucson Diocese apparently doesn't have such a plan. However, could donors write restrictions on their future gifts that keep the gifts out of the bankruptcy estate? For example, the $10 bill in the collection plate might be wrapped in a note that provides, "This ten dollars is only to be used to feed the poor, and is given on the condition that no money that would otherwise be devoted to feeding the poor will be diverted from such use because of this gift."

Issue 5. There may be donors who have made pledges to the Tucson Diocese who object to the bankruptcy filing and the child abuse allegations. Is there some basis for these individuals to revoke their pledges? Under the laws of certain states, pledges are viewed as enforceable contracts. But the Tucson Diocese (and other future bankruptcy filings coming out of similar events) involve such extraordinary circumstances that there may be an argument for permitting someone to revoke a pledge. How does tithing fit into this scheme?

Issue 6. As we understand the facts, the Tucson Diocese will be the debtor in possession, meaning that it will continue to operate the Tucson Diocese during the bankruptcy proceedings. If the creditors become dissatisfied with how the bishop is running the Tucson Diocese, could they petition the court for his replacement? Doesn't that create a clash between the Vatican's power to appoint bishops and the bankruptcy courts power to name the debtor in possession?

As you can see, this bankruptcy cases poses some very fundamental questions under the laws of bankruptcy, charitable gifts, and church-state relations. While the underlying facts are tragic, we will nevertheless follow the legal proceedings with great interest.

As we learn more about this case, our views should become more focused.

LESSONS:

The Tucson and Portland Dioceses' bankrutpcy filings involve admittedly unusual events. So the lessons for other non-profits in these filings may not be obvious at first. However, our society is increasingly relying on debt financing. This trend includes non-profits. That means that those making grants and contributions to non-profits should be thinking about what happens to their money and commitments in a the event of financial difficulties, including a bankrutpcy.

The Tucscon and Portland Dioceses are not the only non-profits seeking bankruptcy protection. In a July 12, 2004 article, the Oregonian reported that National Benevolent Association, a large St. Louis-based nonprofit, had filed for bankruptcy. The National Benevolent Association had $200 million of bonds outstanding. Even though the Association's mission was to help abused children, the disabled and the elderly, the Oregonian points to a new mission, as expressed by the bankrutpcy judge handling the case. The Oregonian writes:

In its first bankruptcy court hearing in Texas, Judge Ronald B. King made it clear that the nonprofit has a new top priority. "They have a mission, and the new mission is to pay the creditors," said King, according to a transcript of a Feb. 18 hearing.

If you made gifts to National Benevolent or are committed to provide future funding under a grant, you may have second thoughts when you read the above quote. The question is whether you can walk away from your commitment to the non-profit or demand that the money be used as you contemplated once the nonprofit is in bankrutpcy. We will be interested in whether grants and restricted gifts start to reflect bankrutpcy concerns in light of these cases.

We don't know the current status of the National Benevolent case.