A New Chapter

By Fred J. Naffziger
October 21, 2002

Could the gargantuan financial burdens from settling and losing the numerous sexual abuse cases force the Catholic Church in the United States into bankruptcy? Not if one thinks of “the” American Catholic Church as a national entity. But it is possible that a particular American diocese, or a part thereof, may need to enter into bankruptcy court in order to handle the financial consequences of the sexual abuse scandals.

Saying a diocese could go bankrupt is a very different issue from posing the question of whether one should or will go bankrupt. First let us look at the financial dimensions of the scandal. The dollar amounts are unknown, but they are huge. They are unknown because we do not know how many millions of dollars have already been paid out in confidential out-of-court settlements.

Since there is no national registry that tracks church- related sexual abuse cases, the exact number of lawsuits already filed is unknown. The Associated Press has reported that 300 lawsuits have been filed in 16 states since January 2002 alleging sexual abuse by clerics. The recent settlement in Boston awarded $10 million to 86 victims of the laicized priest John Geoghan. Previously the archdiocese had separately settled with some 50 other victims. An earlier accord in March for $15 million to $20 million was rejected by the archdiocesan finance council in May because it feared there would not be enough money to settle other suits that had been recently brought. The New York Times reports that there are 275 plaintiffs suing the Archdiocese of Boston. These figures hint at the large potential financial losses facing various dioceses, even factoring in the possibility that certain of the lawsuits will prove to be groundless.

There are more civil lawsuits coming. Some states, in response to public anger over the scandal, have extended the statute of limitations for pursuing sexual abuse charges. As a result, certain cases that were barred from being brought because of the passage of time will now be eligible for litigation. Given the present public hostility over the hierarchy’s handling of abuse claims, large awards of punitive damages can be expected when a jury determines that a claim has validity and awards money damages.

While dollar amounts involved in settling or paying the monetary awards from such litigation are the largest cost, attorneys’ fees are also substantial. On the horizon lurks the cost of defending dioceses and clerics against criminal charges related to the abuse allegations. A number of prosecutors around the nation have subpoenaed church records related to past abuse allegations.

Also unknown is the financial status of the various dioceses. What are the nature and value of their assets? What are their liabilities, in addition to those contingent upon sexual abuse litigation? The large decline in the stock market over the past two years has certainly had a negative impact upon church endowments. It remains to be seen what financial impact the abuse mess will have upon the giving pattern of members of the congregation.

In light of the facts that the church may be under severe financial distress from comprehensive financial liabilities and that the amount of its assets is to a large degree uncertain, is refuge to be sought in bankruptcy court? There are two forms of bankruptcy: Chapter 7 liquidations and Chapter 11 reorganizations. In a Chapter 7 bankruptcy, the debtor gives up his assets to be sold, the money is divided amongst the creditors, and the debtor’s remaining financial obligations are cancelled. (In these descriptions important exceptions are being ignored for the sake of simplicity.) In a Chapter 11 bankruptcy, the debtor proposes a plan that will allow the creditors to receive as much money as possible, cancel the remaining obligations and allow the debtor a reasonable chance to continue the enterprise successfully.

As an eleemosynary institution, the church cannot be forced into an involuntary bankruptcy. A decision to seek bankruptcy is therefore a voluntary one, which lies solely with a bishop. While it sounds illogical, one need not be insolvent (debts exceeding assets) to file bankruptcy.

A Catholic church is unlikely to file for Chapter 7 liquidation. It does not want to sell its assets and go out of business; it desires to continue its existence and provide assistance to its members in their search for eternal life. But an argument could be made for employing such a strategy, however unlikely the occurrence and however dubious its ethics. Its assets, mostly parish churches and schools, are not likely to attract many bidders. Well-to-do Catholics could win in the bidding for such assets in an auction at bargain-basement prices and then turn around and donate them to a newly formed diocese.

A number of solvent corporations facing mass tort liability suits (as is the church with the many sexual abuse cases) have sought Chapter 11 reorganization as a tactic to force a global settlement of all the litigation. That feature of such a bankruptcy filing is quite attractive. Yet there are also many drawbacks that a debtor must consider.

The debtor must develop and present a viable plan for approval by the court in such a reorganization. The creditors, including the lawyers for the sexual abuse victims, play an active role in the bankruptcy. They question the management personnel of the debtor, comb through financial records looking for assets, seek to prevent preferential treatment of one group of creditors over the others and search for impermissible transfers of assets by the debtor to other entities controlled by or friendly to the debtor, and they can object to proposed actions by the debtor. The debtor is under the active supervision of the bankruptcy court and will need prior court approval for taking various actions, both large and small.

A bishop, who enjoys unquestioned religious authority to administer his diocese as he sees fit, could not be expected to take kindly to such supervision by a judge nor to the relentless inquiries of the creditors. The process will be severely intrusive. The creditors can be expected to hire not run-of-the-mill accountants, but rather forensic accountants skilled in tracing assets through highly complex series of transactions. Transactions will be viewed with a high level of skepticism and questioned accordingly until the auditors are satisfied that the true purpose of each transaction is understood and is supported by a sound rationale.

Since a diocese is a large, complex and independent entity, it is also reasonable to expect “creative” accounting in the church records. There may very well be assets that are “off the books,” known only to the bishop. Pastors sometimes engage in bookkeeping strategies of their own in dealing with the diocesan administration. Suppose a parish is struggling to meet an assessment imposed by a bishop that is based upon the yearly collection totals of the parish. The reported collection totals may begin to reflect only the amount received in contribution envelopes, disregarding the amounts contributed in cash. Financial practices such as these, considered private matters by the bishop, could end up being aired in a public court proceeding. Given the unusual nature of a church bankruptcy, the press will certainly provide coverage.

There will also surely be disputes over the allocation of assets and liabilities because of the complexity of the matter. Here too, speaking in terms of “the church” is very simplistic. A Catholic diocese is likely to consist of various legal entities, and the organizational structure can vary from one diocese to another. As in the secular world, one corporation may own other separate corporations, called subsidiaries; a diocese may be the legal parent of other wholly owned not-for-profit entities.

An individual parish may be part of the diocese, or it may be a separate legal entity. The distinction can be critical. If a parish is legally a part of the diocese, and the diocese is legally liable for a debt, the parish assets can be used to satisfy that debt. But if the parish is a separate entity, the diocese alone is liable for the debt; parish assets cannot be seized to pay the debt of a different church entity. Diocesan fund-raising may be done through a separate legal foundation. Still another corporation may own the real estate assets. All these issues will be explored in depth in the course of a bankruptcy proceeding. Under corporation law there is the concept of “disregarding the corporate entity,” which allows a court to hold one entity responsible for the actions of another entity in cases where they have not been operated independently. Given the influence and power possessed by a bishop, the creditors will certainly explore in the bankruptcy proceedings whether these church entities are separate in name only, or truly operate as independent bodies.

Despite the strong economy of the past decade and a half, the number of bankruptcies, both personal and corporate, has increased dramatically. That increase has been accompanied by a change in society’s view of bankruptcy as a sign of moral failure. Undoubtedly, however, the bankruptcy of a Catholic diocese in response to the financial consequences of the sexual abuse scandal would bring with it a degree of institutional shame.

Not addressed in this discussion is whether canon law would allow a bishop voluntarily to enter bankruptcy, a process in which he necessarily would cede elements of his authority to a lay court. Though it may not be publicly acknowledged, attorneys for the church have certainly examined the possibility of bankruptcy. Good lawyers would do that for any client facing the financial pressures that elements of the American Catholic Church unfortunately now face. Whether a Catholic bishop will feel compelled to seek bankruptcy shelter from the cascade of sexual abuse damage awards remains to be seen. Though it could happen, I remain skeptical.

Fred J. Naffziger is a professor of business law at Indiana University South Bend, South Bend, Ind. Click here for a sample of author's writings in America and for books by author at Link to "sample writings" is slow; link to amazon may list books by authors with similar names.


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