|Archdiocese on Uncharted
Legal precedent is evolving as few nonprofits, especially large ones such as Portland's Catholic organization, file for bankruptcy
By Jeff Kosseff
July 12, 2004
The Archdiocese of Portland's nonprofit status may provide the Roman Catholic organization with more bankruptcy protection than businesses receive, according to legal experts.
Last week's filing for Chapter 11 bankruptcy protection temporarily shields the archdiocese from claims by lenders and more than 60 plaintiffs in priest abuse cases. But the degree of protection ultimately will depend on the U.S. Bankruptcy Court and how it defines the organization and its assets.
The vast majority of organizations that file for bankruptcy protection are for-profit. Statutes and abundant case law set clear priorities for the court as it straightens out companies' finances: Creditors come first, shareholders second.
Nonprofits are different in several important ways.
They don't have shareholders. They are exempted from taxes in exchange for meeting a mission such as housing the poor or, in the archdiocese's case, operating a church. And, when a nonprofit files for bankruptcy protection, the court faces a tough decision: Can money donated to serve a charitable mission be used to pay off creditors?
"There's always the tension in these cases between repaying creditors and the mission of the charity," said Howard Seife, a New York attorney with Chadbourne & Parke LLP who represents a creditor in the prominent bankruptcy case of National Benevolent Association, a large St. Louis-based nonprofit.
Legal precedent on the conflict is evolving as large nonprofits such as National Benevolent Association, the Portland archdiocese and hospitals file for bankruptcy protection.
Because so few nonprofits, especially large ones, file for bankruptcy, there is no clear-cut rule for balancing the interests of creditors and charitable donors. To protect assets from creditors, bankruptcy lawyers said, nonprofits often argue that donations are intended for a specific charitable purpose -- and not to pay off creditors.
"You run into the question of which takes precedence: the restrictions donors place on money or creditors," said Seth Perlman, a New York lawyer who specializes in nonprofit law.
The archdiocese bankruptcy is unusual not only because the debtor is a church but also because it is a nonprofit.
Numerous government agencies, bankruptcy researchers and nonprofit associations said they don't know of any tallies of nonprofit bankruptcies. But such filings are rare, they said.
Chapter 11 bankruptcy protection gives organizations leeway to reorganize without completely liquidating. That's attractive to owners who want to salvage at least part of their business while paying off debt.
Nonprofits in financial distress often simply close and cease operations, said G. Ray Warner, a law professor and bankruptcy expert at St. John's University in New York.
"Nonprofits' need for reorganization may be substantially less than a business," Warner said. "There's no true owner, so there's not the shareholder interests."
In addition, although the courts can force troubled for-profit companies to file for bankruptcy, they don't have such powers with nonprofits.
"You can't force a nonprofit into bankruptcy," Perlman said. "It has to be a voluntary decision."
Some troubled nonprofits, instead of shutting down or filing for bankruptcy, merge with another nonprofit with a similar mission, said Craig Stevens, the officer in charge of the association and nonprofit practice at Aronson & Co., a Maryland accounting firm.
Courts feel their way
But as nonprofits have grown and taken on more characteristics of the for-profit world, courts have had to feel their way on how to handle their bankruptcy cases.
The National Benevolent Association bankruptcy is one of the highest-profile nonprofit bankruptcies in the works today. The association, which serves abused children, the disabled and the elderly, filed for bankruptcy in February after issuing more than $200 million in bonds.
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.
Seife, who represents creditor KBC Bank, said the statement was telling. "If there is a trend, it is to put the interests of the creditors as paramount," he said.
But Stephanie Wickouski, a bankruptcy attorney with Gardner Carton & Douglas in Washington, D.C., said there isn't enough legal precedent on nonprofit bankruptcies to draw broad conclusions. "These arguments are still somewhat groundbreaking on both sides," she said.
A critical test, she said, is whether a nonprofit's assets fall under the "charitable trust doctrine." The doctrine, part of common law, holds that if money is donated to a charity for a specific purpose, it cannot be used in any other way.
"One controversy is whether the not-for-profit corporation is essentially a charitable trust," Wickouski said.
If assets of the Portland archdiocese qualify under the doctrine, she said, local Catholics may argue that their donations should not be used to pay creditors.
In a letter posted on the Portland archdiocese Web site, Archbishop John G. Vlazny wrote that among assets being claimed by plainiffs' attorneys are "various trust funds holding charitable contributions." But Vlazny wrote that he would not and cannot use assets held in charitable trust.
Purpose of donations important
An important factor in determining the fate of donations is whether they were set aside in a fund for a certain purpose, said Harold Kaplan, an attorney with Gardner Carton & Douglas' Chicago office.
"The argument is whether it should be used for a specific purpose, providing for soup kitchens, providing for construction, whatever," said Kaplan, chairman of an American Bar Association working group on health care-related bankruptcies. "It's often the way the monies are held."
But Kaplan warned if nonprofits successfully argue that their money should not be available to creditors, they'll have trouble getting new loans.
"There's a sword of Damocles about making that argument too strongly," Kaplan said. "Who's going to loan them money or extend credit?"
Jeff Kosseff: 503-294-7605; email@example.com
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