Complex Legal Issues Will Accompany Filing

By Greg Moran
February 28, 2007

By seeking shelter in bankruptcy court from scores of lawsuits alleging sexual abuse of children by priests, the Roman Catholic Diocese of San Diego takes an extraordinary step into largely uncharted legal territory.

As the case unfolds, both sides will battle over complicated legal questions dealing with civil law and church law, and whether constitutional claims of religious freedom trump the bankruptcy code.

For example, some rulings by the court that tell the diocese what to do in the bankruptcy proceedings could trigger a battle over how far the state can reach into the affairs of a religious organization, experts said.

"It opens a whole Pandora's box of issues," said Charles Zech, an economics professor at Villanova University who has written about church finances.

San Diego would be the nation's fifth Catholic diocese to file a Chapter 11 reorganization petition in the federal courts. The diocese, which serves nearly 1 million Catholics in San Diego and Imperial counties, is by far the largest to seek refuge in the courts.

The diocese's biggest benefit of filing under Chapter 11 is that it immediately stops all litigation in the courts. The first of about 150 lawsuits was scheduled to go to trial today in San Diego, but now the trial will be postponed indefinitely.

All of the sexual-abuse claims would be consolidated under one judge, in one bankruptcy proceeding. That centralized process could work to the benefit of the diocese. All claims would be paid, but settlements could be lower than what a jury which could hand out punitive damages could award.

Experts said there will be a host of legal issues in play.

"You're going to get corporate law issues; you're going to get real estate law issues, trust law issues," said Fred Naffziger, a business law professor at Indiana University South Bend who has studied other bankruptcies by dioceses in the country.

There is no requirement in Chapter 11 that liabilities, or what you owe, exceed assets, or what you have, Naffziger said.

Instead, Chapter 11 exists to allow a corporation to postpone paying claims so it can reorganize in a way that all the claimants can be paid some amount.

"It's an opportunity for a firm with lots of claims against it to to keep those claims at bay, reorganize and figure out a way to pay them," said Scott Ehrlich, a law professor and bankruptcy expert at California Western School of Law in San Diego.

Determining what assets are available to pay claims could be the first big battle in the bankruptcy case. That has been true in dioceses that filed Chapter 11 petitions in Spokane, Wash., and Portland, Ore.

Those dioceses claimed that under canon law the law of the church most of the real estate belonged to individual parishes, and the properties are held only in trust by the diocese.

That would mean that the diocese could not sell those assets to pay a settlement drastically lowering the potential pool of money available to pay claimants.

Plaintiffs' lawyers would contend the diocese effectively controls all the assets. Moreover, they would argue that once the church voluntarily goes into bankruptcy court, civil law not church law should control.

In Portland and Spokane, judges ruled in favor of the plaintiffs on the property ownership issue. But the issue could be raised again and is not entirely settled.

"We don't have any real authority from a higher court as to who these assets belong to," Naffziger said.

Plaintiffs' lawyers have pegged the assessed value of the diocese's holdings at $600 million.

However, property records through December 2005 compiled by The San Diego Union-Tribune of six Southern California counties showed that the diocese's real estate portfolio has an assessed value of about $400 million.

Some of those properties deemed essential to the core mission of the diocese could be exempt from being tapped to pay settlements.

The diocese also has insurance, but how much would be available to pay settlements is unknown.

Determining the value of the diocese's assets will be a key element in the bankruptcy case.

Del Mar lawyer Irwin Zalkin, who represents about two dozen sexual-abuse plaintiffs in San Diego, scoffed at the notion that the diocese does not have enough available assets to pay.

"They clearly have enough assets in nonexempt properties, and they can easily borrow against their real estate holdings," he said. "Plus, they have ample insurance and reinsurance to satisfy all of these claims."

There are other potentially explosive legal issues in the bankruptcy. As part of the process, the diocese will have to reveal much financial information. Also, any significant business decisions would have to be approved by a judge.

Eventually, the diocese would have to draw up a reorganization plan a document that spells out how claims will be paid and that would have to be approved by all the creditors.

But the people with claims against the diocese can request that an examiner be appointed if they suspect mismanagement or fraud. In more serious cases, a trustee can be asked to step in.

Having a court-appointed official looking at church financial records raises pointed issues of church-and-state separation, said Jonathan Lipson, a law professor at Temple University and the University of Pennsylvania who has studied the diocese bankruptcy cases.

"If you read the decisions in the Spokane and Portland cases, the judges are very sensitive and really trying hard to balance unbelievably hard sets of competing claims," he said.

The diocese also could be opening itself up to new claims of sexual abuse. All of the claims stem from 2003, when a special state law allowed people to file lawsuits alleging abuse from years earlier, even though the normal legal time limit had long expired.

The Portland bankruptcy judge ruled that new sexual-abuse claims could be filed. That could also happen here, experts said.

Picking through this legal minefield could take time, likely more than a year. A battery of lawyers would have to be employed at the diocese's expense.

The coming battle will be carefully watched around the countrybecause many of the issues that will surface while addressed in other bankruptcies are still novel.

"This is all something which didn't come up until very recently," said Ehrlich of California Western. "We've been doing this a long time, but it never occurred to anyone that we would have religious institutions declaring Chapter 11."

Staff writer Mark Sauer and research analyst Danielle Cervantes contributed to this report.

Greg Moran: (619) 542-4586;


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