Assets Held by Charitable Organizations Are Safe From Claims of Creditors in Bankruptcy Cases . . . Or Are They?

“Property of the Estate” is a very broad and sometimes vague term, which can often lead to disputes over held assets in a bankruptcy case. This ambiguity can be further complicated for charities, religious institutions, or non-profit organizations. While many believe that assets like donations and pension funds are protected from creditors in the event of liquidation, some recent cases have shown that this is not always the case. The following article by authors Ileana M. Hernandez, Ivan L. Kallick and Jill S. Dodd examines how charitable organization assets like donations may be treated in a bankruptcy case.
– Bill Waldorf

A charity, fulfilling its charitable mission, is successful in raising money for a variety of worthy projects – rebuilding after a natural disaster, medical education and care, summer camp experiences for disadvantaged children, or financial support for senior centers. Everyone agrees that these are worthwhile charitable endeavors — except perhaps some might suggest, the United States Bankruptcy Courts.

This article examines how assets donated to charitable organizations may be treated if such organizations were ever to file a
bankruptcy resulting from significant creditor claims. There is some, yet limited, legal authority determining what is ‘‘property of the estate’’ in a bankruptcy.

I. ‘‘Property of the Estate’’ in Recent Religious and Charitable Organization Bankruptcies

Recent bankruptcy cases filed by Catholic dioceses and archdioceses have raised issues regarding the extent to which the assets of non-bankrupt Catholic entities should be available for payment of creditor claims. Recent bankruptcy cases arise where abuse victims make monetary claims for damages arising out of alleged improper or illegal conduct. The decisions from these bankruptcy cases may have far-reaching implications for charitable institutions that hold donated assets or participate in pooled investment accounts. In each of these cases, focused on religious institutions and their charitable assets, the bankruptcy courts have been asked to determine whether certain assets held by the debtor are considered ‘‘property of the estate.’’ Courts have consistently held that the scope of the term ‘‘property of the estate’’ is very broad. Property of the estate does not include ‘‘any power that the debtor may exercise solely for the benefit of an entity other than the debtor,’’ 11 U.S.C. § 541(b)(1), or ‘‘[p]roperty in which the debtor holds, as of the commencement of the case, only legal title and not an equitable interest . . . .’’ 11 U.S.C. § 541(d). Similarly, the estate does not include property containing ‘‘[a] restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law. . . .’’ 11 U.S.C. § 541(c)(2); see In re Cutter, 398 B.R. 6, 18-19 (9th Cir. BAP 2008). Although the Bankruptcy Code defines what is property of the estate, ‘‘[p]roperty interests are created and defined by state law.’’ Butner v. U.S., 440 U.S. 48, 55; 99 S. Ct. 914, 918 (1979); see also In re Mantle, 153 F.3d 1082, 1084 (9th Cir. 1998) (bankruptcy courts must look to state property law to determine whether property is to be included in bankruptcy estate).

II. California Attorney General’s Role in Protecting Charitable Assets

The California Attorney General has primary responsibility for regulating, enforcing and supervising organizations and individuals that administer and solicit charitable funds or assets in California. The Attorney General has the duty to protect donors to charities, charities themselves and the beneficiaries of charities. It has broad authority to regulate charitable organizations and trusts and to commence law enforcement investigations and legal actions to protect the public interest. See California Corporations Code §§ 5250 and 9230 and Government Code §§ 12588 and 12598.1

Because the Attorney General’s oversight jurisdiction extends to charitable organizations, it is likely that the Attorney General may
take legal steps to protect charitable funds and represent the intended ‘‘beneficiaries’’ of the charitable missions if the charitable funds are at risk of diversion. In a bankruptcy, for example, the Attorney General may likely become involved and take legal action if restricted funds held by a bankrupt charitable organization could be subjected to the claims of creditors.

III. Funds Held by Charitable Organizations and Potential Treatment in the Bankruptcy Context

Charitable organizations may receive and hold assets in various forms. An analysis as to how these assets may be treated in a bankruptcy case is limited to the few published bankruptcy cases that address whether certain assets maintained by charitable organizations would be subject to the claims of creditors and an understanding of the California Attorney General’s policy of protecting charitable assets.

Hernandez, Ileana M., Ivan L. Kallick, and Jill S. Dodd. “Assets Held by Charitable Organizations Are Safe From Claims of Creditors in Bankruptcy Cases . . . Or Are They?” Manatt. Manatt :: Phelps & Phillips, LLP, 30 Sept. 2013. Web. 11 Sept. 2014.

Waldorf Risk Solutions will be attending the 2014 DFMC.
September 21-24, 2014
Booth #304
Hyatt Downtown Chicago
Chicago, IL.