Bankruptcy Defeats

On Dec. 30, 2005, the Archdiocese of Portland, Ore., headed by Archbishop John Vlazny, lost an important preliminary round in its bankruptcy case. The diocese now finds itself facing hard choices, as does Spokane’s Bishop William Skylstad and his diocese, which suffered a major legal defeat in bankruptcy court on Aug. 26, 2005. These decisions not only hold severe consequences for the two dioceses; they set troubling precedents for future decisions as bankruptcy litigation continues. The Portland and Spokane experience should make other dioceses wary about seeking refuge in bankruptcy from the claims of sexual assault victims.

Portland was the very first diocese to seek bankruptcy, in July 2004, quickly followed by Tucson in September 2004. Spokane became the third Catholic diocese to file for bankruptcy, in the following December. All three dioceses sought the protection of the federal bankruptcy system from their creditors, who were victims of sexual abuse by members of the Catholic clergy. Each was seeking a corporate reorganization in Chapter 11 bankruptcy, just as have other financially ailing companies, like Enron, United Airlines and others.

In Chapter 11 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 likelihood of successfully continuing the enterprise. While it sounds illogical, one need not be insolvent (debts exceeding assets) to file bankruptcy. A number of solvent corporations facing mass tort liability suits 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 and is available because under the law all legal actions are consolidated in the bankruptcy court.

What Does the Diocese Own?

If in fact the dioceses lack the money to compensate their creditors with 100 cents for every dollar owed, the creditors must make do with less. That is unfortunate but frequently occurs in bankruptcy. Unlike Christ, who multiplied the loaves and fishes, a bishop cannot command the appearance of increased financial resources. But it was on the issue of what assets the diocese ownsthat are available for payment to the creditorsthat both Portland and Spokane suffered their legal defeats.

In their bankruptcy filings, both dioceses claimed to own a relatively small amount of property. (Tucson has emerged from bankruptcy, so it is excluded from this discussion.) They said that many properties held by name by the dioceses really belong to individual parishes, schools, cemeteries and other members of the diocesan family. An association made up of numerous parishes joined the dispute to argue in support of parish ownership of much of the property. Both the dioceses and the association cited church law in support of their arguments. But the creditors argued that under civil law all the property belongs to the diocese and is thus available to pay their claims.

The First Amendment Issue

Members of religious organizations and religious institutions are not immune from litigation. For over a century, civil courts have considered questions about when the First Amendment right to freely exercise religion requires a civil court to defer to a decision made by an ecclesiastical authority and when a civil court retains the final decision-making authority.

A series of U.S. Supreme Court decisions clearly hold that, when a dispute is intra-church or between members of the church body, it is an exercise of First Amendment rights for the highest religious authority within the body to make the final decision. The courts must recognize this religious jurisdiction. When the issue is purely a civil one, however, involving a law applicable to the general public, a civil court has the final say.

In the Spokane case, the bankruptcy judge characterized the issue as a question of civil law, a secular dispute between creditors and a debtor, and the fact that the debtor was a religious institution was incidental to the issue to be resolved. Significantly, she noted that the bishop had voluntarily entered bankruptcy. As an eleemosynary institution, the church cannot be forced into bankruptcy. But once it seeks the protection of the civil bankruptcy rules, it seems inconsistent for it to claim immunity from some portion of those rules. The bankruptcy court, the judge pointed out, is not bound by what canon law says about who is the owner of the property. The Portland judge agreed. She ruled that a decision about what property belonged to a debtor was not a matter of religious faith or doctrine. Canon law does not govern property ownership in the secular world.

Trust Law Issues

Both dioceses presented a variety of legal arguments. Having ruled against the diocese on the first, the Spokane judge then rejected the diocese’s second major defense. The diocese contended that under civil law in the State of Washington, the diocese was holding the property in trust for the benefit of the parishes and other entities. Thus, while the bishop might be listed in the legal records as the owner, the property really belonged to those entities and could not be taken by creditors of the diocese. This argument, however, failed when the judge examined the papers used to form the diocese back in 1915. Those documents provide that the property is indeed held in trust, but in trust for the use, purpose and benefit of the Diocese of Spokane. In other words, the property is held by the bishop for the benefit of the diocese, not for the benefit of the individual parishes, etc.

While a similar argument was made in Portland, the matter was handled somewhat differently, but the outcome was the same. The bishop selected real estate held by nine parishes and one high school to use for a legal test. But for each piece of property, the diocese was listed as the owner in the legal records. The trust argument was rejected; and the judge noted that as part of the diocesan property, one would expect it to be used by church employees, parishioners, students and so on of the diocese. But the fact that a person used a particular property does not make that individual the owner. The court also pointed out that civil law allows a bishop to establish parishes, schools, hospitals, cemeteries and so on as separate legal entities to own and control specific property. In fact, one parish in the diocese was created as a separate corporation. The judge noted that holding a church organization to the legal consequences of its choices about how it organizes its affairs in the secular world does not substantially burden the exercise of religion.

The Religious Freedom Restoration Act

One important issue in the Portland case that was not addressed in the Spokane case is the applicability to bankruptcy rulings of the federal Religious Freedom Restoration Act. In reaction to Supreme Court decisions holding that the application of neutral laws of general applicability to persons does not interfere with their First Amendment right to freely practice their religion, Congress passed this legislation in order to give religious bodies greater protection. The Act holds that the government cannot impose a substantial burden on a person’s exercise of religion without a compelling governmental interest.

The Portland Archdiocese argued that this law requires the court to recognize parish assets as separate from the diocese, as canon law stipulates. Second, it argued that failing to recognize the ownership rights of individual parishes and schools substantially burdens the exercise of religion by parishioners and students.

The Religious Freedom Restoration Act is complex. One could argue that the law itself is unconstitutional, since it violates the First Amendment’s prohibition on the establishment of religion. By according a religious person more rights than a nonreligious person, does not the government grant religion preferential treatment? The federal court governing the Portland and Spokane bankruptcy courts has said the act is not unconstitutional as applied to federal law. But the Supreme Court has said it is unconstitutional as applied to the states.

The Portland bankruptcy judge held that, since ownership of property is controlled by state law, the civil law, not canon law, determines ownership. She ruled, however, that a trial will be necessary to determine whether giving the creditors of the diocese all of the parish and school properties would place a substantial burden on the free exercise of religion by parishioners and students, presumably accepting that there is no compelling interest of the government in ruling out exceptions to bankruptcy law.

What Property Can the Creditors Obtain?

The answer to this question differs for the two dioceses. In Spokane the creditors can theoretically seize and sell any or all diocesan-owned real estate to satisfy their financial claims. In the law, property consists of two types: real property and personal property. Real property is land and things firmly attached to the landfor example, buildings, a stand of timber, the oil, gas, coal, water, etc. contained in the land. Personal property is everything that is not real propertyfor example, motor vehicles, cash, stocks and bonds, furniture, etc. The ruling says that the real property belongs to the diocese, because the diocese is listed as the owner.

It is important to note that even if the bankruptcy judge had ruled the opposite way on the legal issues, the diocese and its parishes would still face financial peril. Suppose the judge ruled that she was bound by canon law, and under canon law the assets belonged not to the diocese, but to the various religious entities within that diocese. Suppose further that she said that the civil trust law also provides that the bishop is merely the owner in name, with the real owners being the parishes and schools. The diocese would still face giving up its own property to the creditors. The parishes and other church entities would not necessarily be free of any further claims by creditors. Why not? Under civil law, an entity that employed a wrongdoer can be held liable for the acts committed by the wrongdoer. A parish that had employed a pedophile priest could find itself held accountable and its assets sought as damages to the injured parties.

The decision in Spokane does not settle who is the actual owner of the various items of personal property as opposed to real property. There is conflicting evidence on the matter. A parish could show that its parishioners contributed money toward expansion of its school and that the parish merely turned its funds over to the diocese to be pooled with the funds of other church entities to be invested. When sufficient funds are available through additional contributions and investment returns to begin construction, they are to be returned to the parish as the rightful owner. Other funds may have been entrusted to the bishop for general diocesan purposes; and these funds would be available to satisfy the claims of the diocesan creditors.

There is additional uncertainty about funds needed to repair and rehabilitate various church properties. Suppose a diocese, in light of the legal turmoil created by the diocesan bankruptcy filings, found parishioners reluctant to continue to contribute funds for needed projects out of a fear that these funds would be diverted to legal settlements. A bishop could incorporate a new legal entity to raise, hold and supervise the use of those funds for specific parish projects. This would immunize the funds from seizure by creditors of the diocese.

In property law, however, the concept of fixtures would remain a source of difficulty. A fixture is an item of personal property that becomes permanently attached to a piece of real property, thereby becoming real property. If a court has ruled that a church, as real property, belonged to the diocese and the judge opined that the monies raised by members of the church were personal property belonging to the particular parish, should the funds be spent on enhancing the church’s real property? Consider the possibility of expending the funds to refurbish the hardwood floors of the building, repaint its interior walls and repair the lovely stained glass windows, only to see the refurbished church sold by the diocese to pay its creditors. The church may be located in an area of the city undergoing regentrification, and a developer might find it attractive for conversion into expensive condos. Utilization of the separate entity for fundraising has now all gone for naught. It may be wise for dioceses to allow the legal dust to settle from major litigation prior to undertaking major rehabilitation projects for which funds have been raised.

In Portland it remains uncertain what property the creditors may ultimately obtain. The judge ruled that the creditors can get the test properties. These include nine parishes out of a total of 124, and one high school out of three. The Portland rulings do not address personal property.

Will the creditors actually seize and sell all nine churches and the one school? It is highly unlikely. Creditors want their money and want to obtain it as quickly and simply as possible. Seizing money in a bank account, investments in stocks and bonds, or open, vacant land owned by a diocese will be the kind of property creditors first seize. Seizing and selling a church or school building will not only bring negative and hostile public reaction; it will also consume time and may not generate large bids from prospective purchasers.

What Does the Future Hold?

In the short term, we should expect more litigation and continuing legal expenses in both Spokane and Portland. Spokane has appealed the ruling, as has Portland. A decision in Portland is expected soon.

A voluntary settlement may still be possible, and such a settlement could benefit all concerned. The Diocese of Tucson successfully emerged from bankruptcy in less than one year (Am., 10/26/05); extremely fast for a sophisticated bankruptcy action. That it did so is evidence that the parties saw the benefit in working out an amicable solution, one that did not, and could not, yield for each party everything it desired.

There may be two obstacles, however, to a quick resolution in Spokane and Portland. On the creditors’ side, the sexual assault victims are probably enjoying the taste of victory and possibly visions of large dollar amounts to come. Their attorneys will need to let such attitudes dissipate somewhat before being able to convince them that it may be in their interest to take a little less in return for a quicker resolution of the legal action. On the debtors’ side, the bishops have suffered major defeats on their critical legal defenses. They may be frustrated that the judges misconstrued the bankruptcy law’s impact on the free exercise of religion and may be convinced that their appeal will be successful in vindicating their legal arguments.

In Spokane the diocese still has an argument to pursue over the ownership of personal property, and in Portland the bishop can argue that the religious freedom law should allow him to retain the bulk of the real estate. It may take both bishops some time to realize that a compromise could be in the overall best interest of their dioceses. To this outside observer, however, a settlement in the two cases is unlikely. It appears that all the parties are singing from the same page of the litigation hymn book and have chosen an Old Testament song, Smite Thine Enemy.

These rulings by bankruptcy judges, while only a first step in the legal process, are not favorable. The First Amendment issues are the same and the judges’ decisions are well reasoned, consistent with each other and reflect the well-established view of the U.S. Supreme Court on the issue.

Implications for Catholics in Other Areas

These decisions, though defeats for the bishops in these specific bankruptcy cases, reinforce the civil powers of bishops in other matters. The courts have recognized that bishops control church property. While there is discussion in Catholic circles of the Vatican ruling that the bishop in Boston improperly acted in closing certain parishes, because the assets under canon law belong to the respective parishes, have those parishes been restored to their full earlier operations? If Catholic parishioners challenge a bishop’s decision in handling or disposing of diocesan property in an American civil court, they are guaranteed to lose. The issue is legally very different in St. Louis with respect to St. Stanislaus Kostka Polish Roman Catholic Church. There Archbishop Raymond Burke is attempting to assert control over the parish property and has excommunicated members of a church board for refusing to place its property under his control. Apparently the property was originally titled in a parish entity controlled by parishioners. Under civil property law, then, that entity, not the archbishop, owns and controls the property. If the diocese is to become the owner, its current owner must voluntarily consent to the transfer of the property to the bishop.

If the Portland and Spokane decisions are upheld, they will cause serious harm to both dioceses. Parishes and schools may lose their buildings and real estate, putting their continued operation in question. Such a result would not only harm parishioners and students, it could also create hostility toward the victims of sexual abuse. The financial costs of continuing litigation would be gargantuan, diverting funds from needed church services to the profit lines of law firms. These financial costs, coupled with the investment of time and energy by diocesan personnel, should caution other bishops about the risks involved in filing bankruptcy. If the losses in these preliminary but vital rounds in church bankruptcy actions harden an adversarial position in future disputes over the claims of sexual abuse victims, the consequences could be damaging for all parties, leading to years of additional court battles. As has been true in so many different ways, the innocent continue to be the victims of the failure of church authorities to deal with the tragedy of sexual abuse.