Should Charity Begin with Bankruptcy

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Jul/Aug 1999

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Consumer Corner

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The Religious Liberty and Charitable Donation Protection Act of 1998 ("Religious Liberty

Act") was the latest move in the battle between the Supreme Court and Congress over a debtor's

right to tithe in bankruptcy. The Act directly targets a trustee's ability to avoid such transfers

as fraudulent conveyances, to object to donations as an unreasonable monthly expense in a

chapter 13, and to consider donations when determining a case is substantial abuse of chapter 7.

The history behind the Religious Liberty Act sheds light on Congress's motivations in

enacting it. The Bankruptcy Code previously allowed trustees to avoid charitable donations as

fraudulent transfers on the basis that the debtor did not receive "reasonable equivalent value"

for the transfer. In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… Div., Dept. of Human Resources of Oregon vs. Smith, 494 U.S.

872, 110 S.Ct. 1595, 108 L.Ed.2d 876 (1990)</a>, the Supreme Court held that neutral,

generally applicable laws could be applied to religious practices, even in the absence of a

compelling government interest, thus supporting the trustee's right to avoid tithes. Charitable

organizations and religious groups then urged Congress to amend the Code to protect tithes and

other donations from avoidance. In 1993, the Religious Freedom Restoration Act (RFRA) was enacted, imposing a "compelling government interest" test on government

actions. This test required government actions that substantially burden the exercise of religion

be the least restrictive means of furthering a compelling government interest. The

constitutionality of the RFRA was in dispute until <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… of Boerne vs. Flores, 521 U.S. 507,

117 S.Ct 2157, 138 L.Ed. 2d 624 (1997)</a>, in which the Supreme Court declared the RFRA

unconstitutional, as applied to state laws, because it exceeded Congress' Fourteenth Amendment

power to "enforce" constitutional rights. As Justice Kennedy wrote:

<blockquote>When the exercise of religion has been burdened in an incidental way by a law of general

application, it does not follow that the persons affected have been burdened any more

than other citizens, let alone burdened because of their religious beliefs.</blockquote>

While the question of the constitutionality of the RFRA as to federal laws was left undecided

by the Boerne case, Senators Orrin Hatch and Edward Kennedy nevertheless immediately

announced plans to develop new legislation to meet the Supreme Court's objections.

In June 1998, the Religious Liberty Act was signed into law. Essentially, the Act amends the

Bankruptcy Code to allow debtors to donate up to 15 percent of their gross income to religious

or charitable organizations and prohibits bankruptcy trustees from including that amount in

the bankrupt estate. In support of the Act, President Clinton said, "It is a great loss to all of our

citizens for creditors to recoup their losses in bankruptcy cases from donations made in good

faith to their churches and charitable institutions." Despite Congress' outright amendment of

the Code to protect tithing, however, recent cases and commentary show the debate is far from

over.

<h3>Chapter 13</h3>

The debtors in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Buxton, 228 B.R. 606 (W.D. La. 1999)</a> proposed a monthly charitable

contribution of $280. The debtors' prior contributions had been irregular and averaged

approximately $63 per month. The trustee objected to confirmation of the plan on the basis that

the debtors did not propose to pay all of their disposable income into the plan.

In analyzing the trustee's objection, the court noted that many prior cases found that

charitable contributions could never be considered "reasonably necessary" expenses.

However, the Religious Liberty Act overturned those rulings. Amended §1325(b)(2)(A) states:

<blockquote>For purposes of this subsection, "disposable income" means income which is received by

the debtor and is not reasonably necessary to be expended—(A) for the maintenance or

support of the debtor or a dependent of the debtor, including charitable contributions...in

an amount not to exceed 15 percent of the gross income of the debtor for the year in which

the contributions are made...</blockquote>

The trustee in Buxton argued that although tithes are considered proper expenses in a chapter

13, the amount of the contribution itself must still be reasonable. The debtors, on the other

hand, contended that the Religious Liberty Act permitted an unquestionable donation of up to 15

percent of a debtor's income.

In agreeing with the trustee's interpretation, the court held that Congress "must have intended

some limitation on a debtor's right to make charitable contributions." Therefore, while such

contributions may be included as part of a debtor's living expenses, this expense must be

reasonable. This reasoning comports with a line of cases decided before the Religious Liberty Act

which found that, under certain circumstances, debtors were entitled to a reasonable level of

charitable contributions.

In analyzing the reasonableness of a debtor's proposed tithe, the court looked to <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re

Andrade, 213 B.R. 765 (E.D. Cal. 1997)</a>, which ruled that a debtor's tithe is properly

considered an item of discretionary spending. According to that court, in approving some amount

of discretionary expense, the debtor is free to spend that money as he chooses. However, a debtor

who tithes is not permitted more discretionary income than a debtor who does not tithe. The

reasonableness of the amount of discretionary income is then based upon a totality of the

circumstances.

Under this analysis, the court in Buxton found the amount the debtors budgeted for tithing to

be unreasonable, considering their pre-petition donations and the prejudice to their creditors.

Recently, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re McDonald, 232 B.R. 818 (S.D. Fla. 1999)</a>, denied a tithe in its entirety,

although the court avoided a discussion of the Religious Liberty Act:

<blockquote>The court's intention is not to superimpose its values for those of the debtors' but certain

provisions of the Bankruptcy Code require the court to make decisions that unavoidably

are made based upon its sense of equity. Recognizing that the purpose of chapter 13 is to

provide the maximum recovery to creditors, this court believes that the allowance of

tithing as a necessary expense in the debtors' budget would frustrate such purpose.</blockquote>

As in Buxton, the court opined that creditors should not be forced to make a de facto contribution

to a debtor's favored charity. To do so would "substantially diminish" the integrity and

credibility of chapter 13.

<h3>Chapter 7</h3>

The Religious Liberty Act amended §707(b), which provides for dismissal for substantial

abuse, and states in relevant part: "In making a determination whether to dismiss a case under

this section, the court may not take into consideration whether a debtor has made, or continues

to make, charitable contributions." The debtors in <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Smihula, 1999 WL 342795 (D. R.I. 1999)</a> converted from a chapter 13 to a chapter 7 case and amended their schedules upon

conversion, raising their charitable contributions from $0 to $700 per month, virtually

eliminating all disposable income. The debtors admitted that they did not previously tithe prior

to filing their chapter 13 case and preferred to convert to a chapter 7 and donate to their

charity rather than pay their creditors though a chapter 13 plan. Using the Religious Liberty

Act for support, the debtors maintained that the court was prohibited, by amended §707(b),

from considering their tithes in determining substantial abuse. They also argued that it was

"highly discriminatory and perhaps even unconstitutional to interpret §707(b) so as to allow

an individual who 'found God' prior to bankruptcy...to escape payment of his debts in favor of

charitable and/or religious giving, yet deny the same relief to a debtor who 'found God'

subsequent to seeking bankruptcy protection." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… WL 342795 at 1.</a>

The court ordered the case dismissed for substantial abuse unless the debtors reconverted to a

chapter 13 case with a plan similar to that in their original case. In relying on the plain

language of the Religious Liberty Act, the court found a requirement that a debtor must have an

established pattern of charitable giving as of the petition date in order for the amended

provisions of §707(b) to apply. In looking to the legislative history of the Act, the court found a

clear intent not to allow debtors to begin making charitable contributions on the eve of

bankruptcy, or worse, in the court's opinion, to file a chapter 13 showing disposable income

and using the Act to convert to chapter 7 and pay creditors nothing. And, while the court did not

find these debtors to have an intent to defraud their creditors, their proposed expenses

nevertheless "rewrite the law in accordance with their personal wishes, to the detriment of

creditors who, under §707(b), have a vested interest in their disposable income...[J]ust when

a debtor commences charitable giving is very relevant to the §707(b) inquiry. Where the

debtor's charitable giving instinct arises shortly pre-petition, and surely where it arises

post-petition, as here, it is unthinkable that the court would not have the authority to examine

such circumstances." Id at 3 (emphasis added).

<h3>Fraudulent Transfers</h3>

The avoidance of fraudulent transfers under <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. 548</a> was probably the main reason for

the enactment of the Religious Liberty Act. That section allows a trustee to reach back and avoid

transfers for which, inter alia, the debtor did not receive "reasonably equivalent value." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; (11 U.S.C. 548(a)(1)(B))</a>. Pursuant to the Act, transfers to qualified organizations that do not

exceed 15 percent of the debtor's gross annual income are not subject to inquiry under the

"reasonably equivalent value" standard.<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; (11 U.S.C. 548(a)(2)(A))</a>. Such transfers are still subject to avoidance on the grounds that the transfer was intended to hinder, delay and/or

defraud creditors. Transfers of more than 15 percent are not considered subject to the

"reasonably equivalent value" standard only if: "the transfer was consistent with the practices

of the debtor in making charitable contributions.<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; 11 U.S.C. 548(a)(2)(B)</a>.

In <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Louisiana State University Foundation (In re Zodhi), 1999 WL 382404 (M.D.

La. 1999)</a>, the debtor made a single transfer of $10,000, which exceeded 15 percent of his

gross annual income by $3,450. The trustee contended that since the entire transfer was more

than 15 percent, it was all subject to the §548(a)(1)(B) "reasonably equivalent value"

standard. The debtor argued that only the portion of the transfer over 15 percent was

potentially avoidable.

Rejecting the debtor's argument, the court ruled that the plain language of the statute

characterizes transfers as either subject to the reasonably equivalent value inquiry or excluded

from it, depending on the amount of the transfer and prior practices of the debtor. Had Congress

intended only the portion over 15 percent to be exposed to §548(a)(1)(B)'s scrutiny, it could

easily have written the statute to make that intention clear. As written, however, the statute

broadens the exception for transfers less than 15 percent to include certain other additional

transfers over 15 percent, rather than portions of transfers over 15 percent. Further, the

court reasoned, because transfers over 15 percent consistent with past donations are protected,

"[S]ubsection (a)(2)(B) is talking about the entire transfer and is requiring that the entire

transfer fit the consistency requirement before it can be brought within the safe harbor of

amended §548(a)(2)." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…; at 3</a>.

The court found that even though a mere "peppercorn" can render a transfer subject to

avoidance, such bright-line tests are prevalent in the Code. "...[W]e readily admit that the

discernable significance of the 15-percent amount is only that Congress decided to "draw the

line" where it did. Because of the presumed authority to draw such a line...we are bound to abide

by that line." Id. at 8.

As these cases show, there is room for debate over the propriety and effectiveness of the

Religious Liberty Act. Moreover, the Act has been strongly criticized by those who fear it

created the potential for abuse by debtors. Commentary on the Religious Liberty Act highlights

significant problems with the Act. The first is that the 15 percent allowance for charitable

donations is excessive. A review of various surveys on tithing indicates that the average

contributing household donates less than 4 percent of its gross income to charity, with most in

the range of 2.2 percent.<a href="#1" name="1a">1</a> Even adding non-religious charitable donations to that, allowance for

a reasonable amount of tithing should be far less than the 15 percent permitted by the Act,

argue opponents.

Second, the language of the Act is arguably overbroad because it states that transfers are

exempt from the "reasonably equivalent value" standard if "the amount of that contribution

does not exceed 15 percent" of gross annual income. An ambiguity arises in determining

whether the 15 percent limit applies to each contribution made or to the total amount of a

debtor's contributions for the year. This section could be construed to allow a debtor to give

away all of his assets in increments of less than 15 percent, likely not the intent of Congress.<a href="#2" name="2a">2</a>

A third problem is one of public policy. Clearly, religious and other charitable organizations

are favored by the Act. A basic tenet of bankruptcy law is that that debtors should not be able to

avoid their debts by gifting away their property. It is argued, however, that the Act creates an

exemption for the debtor for an item not necessary for the debtor's maintenance or support as a

result of Congress' having unfairly placed a special interest above creditors and payment of

debts.<a href="#3" name="3a">3</a>

As these cases and commentary signal, the Religious Liberty and Charitable Donation Protection

Act does not appear to have resolved the issue of tithes in bankruptcy. Debtors continue to face a

dilemma as the courts struggle to balance competing interests mandated by the Code, while

Congress and the Supreme Court battle on.

<hr>

<h3>Footnotes</h3>

<a name="1">1</a> Note: Religious Liberty and Charitable Donation Protection Act of 1998, 7 ABI L.Rev. 235, 251-3 (Spring, 1999). <a href="#1a">Return to article</a>

<a name="2">2</a> Id. at 254. <a href="#2a">Return to article</a>

<a name="3">3</a> Id. at 256-7 and citations therein. <a href="#3a">Return to article</a>

Journal Authors

Alane A. Becket

Journal Date

Thursday, July 1, 1999 - 12:00