Judd M. Treeman, Blessed Be the Name of the Code: How to Protect Churches from Tithe Avoidance Under the Bankruptcy Code's Fraudulent Transfer Law

• Publication year: 2011

BLESSED BE THE NAME OF THE CODE: HOW TO PROTECT CHURCHES FROM TITHE AVOIDANCE UNDER THE BANKRUPTCY CODE'S FRAUDULENT TRANSFER LAW

To him that worketh is the reward not reckoned of grace, but of debt.

-Romans 4:4, King James Version

ABSTRACT

The Bankruptcy Code treats debtors' tithes as constructively fraudulent transfers per se and disgorges them from unsuspecting churches drawn into debtors' bankruptcies. Unlike most creditors, churches rely on tithes for their financial wellbeing and thus have unique and important interests at stake when a tithing debtor files bankruptcy. Courts and Congress have tried to prevent the Code's fraudulent transfer law from disgorging tithes, but they have failed to protect the unique church interests most sharply affected in such cases. Their approaches leave church interests dependent upon debtors' conduct and subordinate to creditors' interests. This Comment explains how courts and claimants should use existing federal religious liberty law as a simpler and more direct approach to protecting churches' interests in tithe avoidance cases.

INTRODUCTION

Churches¹bear a peculiar economic vulnerability. They exist not for private profit, but for public good. They depend on the tithes²they receive from benevolent contributors, not from commercial contractors. Because their income is irregular and not guaranteed, churches lack the economic assurances and legal protections commercial income bestows. Pledges to tithe are not enforceable promises, and tithes collected in one month might dwindle by half in the next.

American law acknowledges this vulnerability and protects churches. The most well-known of these protections, perhaps, resides in federal tax laws, which encourage taxpayers to tithe by allowing tax deductions for tithes given to qualifying nonprofit churches.³These tax laws also protect churches by exempting collected tithes from tax liability.⁴But what if churches could not rely upon the tithes they have already received? What if suddenly, unexpectedly, and through no fault of their own, these organizations had to relinquish already collected tithes to unknown third parties?

Such is the specter haunting churches under modern developments in the Bankruptcy Code's fraudulent transfer law. The Code's fraudulent transfer law protects creditors' interests by avoiding, or undoing, transfers where debtors receive little or no value in return to pay their creditors.⁵Because tithing debtors give voluntarily and rarely receive anything-much less anything of value-in return, their creditors have found recent and frequent success avoiding tithes as fraudulent transfers. Thus, by simple operation of the Code's fraudulent transfer law, churches are now surprised that, through no

Leviticus 27:32 (New Revised Standard). This Comment uses the term generally to refer to charitable contributions made to churches and religious organizations described above. See supra note 1.

Id. fault of their own, they must relinquish tithes they received in good faith to a tither's creditors, even after spending those monies long ago. Moreover, churches cannot protect their tithes from avoidance by exchanging goods or services in return without jeopardizing their tax exemption. Though fraudulent transfer law plays an important role in bankruptcy and debt collection, it works unintended consequences when it avoids tithes to innocent churches. In such circumstances, these churches and charities may find that what a debtor has given, creditors will take away-all in the blessed name of the Code.

Most parties, legislators, and courts considering the problems tithe avoidance poses have thus far focused only on the interests debtors and creditors have at stake. Unfortunately, they have largely neglected the important interests and unique vulnerability churches have in tithe avoidance cases. Although Congress sought to protect tithes from avoidance with the Religious Liberty and Charitable Donation Protection Act of 1998, the recent opinions In re Zohdi and Universal Church v. Geltzer render that protection uncertain at best, and nonexistent at worst. A more prudent approach to solving the problem of tithe avoidance minimizes these unintended catastrophes yet respects the legitimate and conflicting interests of debtors, churches, and creditors. Such an approach, however, requires parties, legislators, and courts to consider how tithe avoidance in a given case directly affects churches' rights and interests, and not merely those of debtors and creditors. Although largely ignored until now, existing federal statutory and constitutional laws protecting religious liberty provide parties, legislators, and courts with the framework necessary to take this approach and examine church interests directly in tithe avoidance cases.

Proceeding in six parts, this Comment explains the unresolved problems tithe avoidance law poses for churches and demonstrates how existing federal law can resolve these problems directly by focusing on churches' special religious rights. Part I explains what fraudulent transfer law is, why it was made, and how it avoids certain transfers made by a debtor. Originally designed to prevent debtors from intentionally defrauding their creditors, fraudulent transfer law now avoids good faith transfers, like tithes, as "constructively fraudulent" transfers. Part II explains how courts' early attempts at preventing tithe avoidance failed and ironically exposed churches to newer and more serious problems under the Bankruptcy Code and the Internal Revenue Code. Part III explains how Congress addressed these problems with statutory protections and how two recent judicial opinions now render those protections as uncertain as ever. Part IV explains why Congress's and courts' approaches to the problem of tithe inadequately protect churches by allowing church interests to depend upon debtors' conduct and to remain subordinate to creditors' interests. Part V explains how churches possess unique statutory and constitutional protections from tithe avoidance and how courts applying these protections nevertheless continue to neglect churches' independent and unique interests in tithe avoidance cases. Part VI demonstrates how existing federal religious liberty law provides a simpler and more direct approach to protecting churches from tithe avoidance by examining whether avoiding tithes in a given case would substantially burden a church's right to the free exercise of religion.

I. FRAUDULENT TRANSFER LAW'S ORIGIN, APPROACH, AIMS, AND REACH

Fraudulent transfer law provides important and powerful tools in modern debt collection and bankruptcy. When debtors file for bankruptcy, they lose control of their assets to a bankruptcy estate administered by a bankruptcy trustee for the benefit of the debtors' creditors.⁶Conscious of losing this control, debtors nearing bankruptcy often harm their creditors' secured or unsecured claims to their assets by transferring away those assets before filing bankruptcy. By avoiding such transfers, fraudulent transfer law helps creditors and trustees lessen the harm these prepetition transfers cause.

When fraudulent transfer law "avoids" a transfer, it forces the recipient of the transferred assets (the transferee) to return those assets to the party who transferred the assets (the transferor).⁷After avoiding a transfer, the Bankruptcy Code may give the transferee some type of unsecured claim for the amount of the transfer, but the transferee will not be able to keep the particular assets avoided in the transfer.⁸Usually the assets from the avoided transfer become part of the bankruptcy estate, which holds them for distribution to the debtor's creditors.⁹In short, fraudulent transfer avoidance allows the debtor's harmful transfers¹⁰to be undone for the benefit of interested creditors.

Fraudulent transfer law is both well established in its history and expansive in its coverage. Originally designed to prevent intentionally fraudulent activity, fraudulent transfer law has broadened its reach to regulate transfers that are completely above board and free of any fraudulent intent. As it developed, this law assumed a broader economic function by providing creditors more protections for their economic interests, regardless of whether the debtor had fraudulent intent. This first Part thus provides a short summary of the origins, approach, aims, and reach of fraudulent transfer law and avoidance.

A. Origins of Fraudulent Transfer Avoidance

The origins of fraudulent transfer avoidance date back to 1571, when the Statute of Fraudulent Conveyances¹¹was passed in England to fine fraudulent conveyors and set aside their conveyances.¹²The statute's drafters aimed to prevent debtors from evading their creditors' collection attempts by transferring away their property in hopes of receiving the transferred property back at a later date.¹³Through legislatures and common law courts, American state and federal law gradually adopted the statute.¹⁴By 1918, the National Conference of Commissioners on Uniform Laws drafted the Uniform Fraudulent Conveyance Act to resolve contradictions and obscurities resulting from the haphazard American adoption of fraudulent conveyance law.¹⁵The Commissioners then replaced the 1918 act with the Uniform Fraudulent Transfer Act (UFTA) in 1984. Adopted in forty-one states, UFTA preserves the basic approach to fraudulent transfers initiated in the older acts.¹⁶

B. The Approach of Modern Fraudulent Transfer Law

Modern fraudulent transfer law applies to transfers that are either actually fraudulent or constructively fraudulent. Actually fraudulent transfers occur when a debtor "made the transfer or incurred . . . [an] obligation . . . with actual intent to hinder, delay, or defraud any creditor."¹⁷In contrast, constructively fraudulent transfers occur where an insolvent debtor transfers her assets for less than "reasonably equivalent value."¹⁸The term "constructively fraudulent...