On July 6, 2004, the Archdiocese of Portland, Ore., became the first Catholic diocese in the history of the United States to seek the protection of the bankruptcy court. On Sept. 20, 2004, the Diocese of Tucson became the second. Both of these filings resulted from the wave of lawsuits brought against the church because of the sexual abuse of minors by members of the Catholic clergy. Other dioceses are reported to be considering filing. Chapter 11 of the Bankruptcy Code is uniquely suited to address some of the issues raised by the sexual abuse crisis. I offer here some of the history, philosophy and policies underlying Chapter 11 and point out some of the issues that are likely to arise in the pending cases.
Debt in the Scriptures
The sources of American bankruptcy law are many and varied. They include Hebrew, Christian and Arabic Scriptures and customs, Roman law and the laws of England. The Hebrew Scriptures contemplate the sale of ancestral lands and of persons in payment of debts but provide for remission of debts and release from slavery at the end of every seven years (Dt 7:15). In addition, every 50th year was to be a jubilee year, in which lands were returned to their ancestral ownership (Lev 25). The Christian Scriptures include a number of references to debts and debtors. The Lord’s Prayer includes a petition for forgiveness of indebtedness. The parable of the two debtors in Matthew 18 indicates that slavery, imprisonment and torture were possible remedies for debt under the Roman occupation (Mt 18:23-35).
There are some interesting differences between the treatment of debt in the Hebrew and Christian Scriptures and in the Roman Empire. The Hebrew people and the early Christians were more likely to be debtors than creditors. So, it is not surprising to find that the emphasis in Scripture is upon relief from indebtedness, rather than enforcement of obligations. As Christians moved into positions of power and wealth, however, greater emphasis was placed upon the nonpayment of debt as a form of dishonesty rather than as a misfortune. Imprisonment for debt was abolished in the United States in the 1830’s and 1840’s. Even today, however, it is not unusual to find people who believe that bankruptcy is at least a quasi-criminal proceeding and that debtors are (or should be) punished. In this climate, it is very difficult for the manager of any business entity, generally a person who has been successful and expects always to be successful, to face the prospect of financial failure. In fact, in my experience, it is one of the most spiritually trying events that anyone can face.
The Development of the Bankruptcy Code
The forerunner to the present Chapter 11 of the Bankruptcy Code, the chapter that deals with reorganization, arose in response to the financial crisis in the railroad industry in the late 19th century. State remedies proved inadequate to deal with the problems of interstate railroads. The solution at that time was court-supervised receiverships, called equity receiverships, which remained the predominant means of corporate reorganization until the Great Depression. The court-appointed receiver was empowered to run the troubled railroad until a buyer could be found for its assets.
Another predecessor to modern reorganization was the composition agreement. A debtor proposed to repay a portion of his debts over a period of time while retaining his property. The plan was approved, provided that the debtor was able to obtain the consent of a majority in number and three-fourths in value of his creditors. The best interests test protected dissenters, as it required that all creditors receive as much as they would have received if the debtor’s assets had been liquidated.
The modern reorganization case is a combination of features from the equity receivership and the composition agreement. It permits a debtor to maintain its property and business while repaying some portion or all of its indebtedness over time. Unlike the old equity receivership, however, the goal is not always the sale of the business enterprise. Many entities have emerged from reorganization to continue in business for years thereafter as a reorganized debtor.
The Bankruptcy Code Today
The present Bankruptcy Code, which became law in 1978, combines three previous reorganization chapters into one, Chapter 11. Chapter 11 is designed to be a flexible tool for the reorganization of the business and debts of corporations, partnerships and individuals. The goals of the reorganization process are many: to maintain the going concern value of the enterprise; to protect workers, their jobs and their retirement benefits; to realize greater value for creditors than a straight liquidation of assets would make possible; to avoid the ripple effects of a failed enterprise. In exchange for opening its books and records, a debtor obtains an automatic stay of any action to commence or continue civil litigation, or to collect an indebtedness, by any creditor in any court anywhere in the United States. Upon the filing of a petition, the previous entity or person becomes a new legal entity, called the debtor in possession, which is charged with fiduciary responsibility for the proper administration of the case for the benefit of creditors and equity holders. A trustee is appointed in a Chapter 11 case only if the debtor in possession is found to have engaged in fraudulent activities or gross mismanagement. The goal and purpose of the reorganization process is the filing of a plan of reorganization that will provide for the repayment of claims on a fair and equitable basis while at the same time permitting the debtor entity to continue its operations.
A reorganization plan must be accompanied by a disclosure statement that has been approved by the bankruptcy court as containing adequate information to enable a creditor to make an informed decision to vote to accept or reject the plan. As in the old composition agreements, confirmation of the plan requires that the majority in number but only two-thirds in amount of creditor claims in each impaired class must vote to accept it. If a debtor is unable to achieve the requisite number of votes to obtain acceptance of its plan by the acceptance method, it may ask the court to confirm the plan over the objections of creditors. The court must evaluate whether the plan is fair and equitable and does not discriminate unfairly with respect to each class of claims impaired under the plan. Upon confirmation of a reorganization plan, property of the estate vests in the reorganized debtor, and the plan becomes a new contract between the debtor and its creditors.
Chapter 11 reorganization has come to be seen as the vehicle of choice for addressing mass tort claims. Cases have been filed, for example, by manufacturers of asbestos-containing building materials, Agent Orange, and the Dalkon Shield birth control device. The focus of these cases was the development of a process that would permit all interested parties, including victims, lenders, debtors and shareholders, to come together to develop an equitable method of compensating victims while permitting the debtor to continue in operation. The formation of various official committees, each with its own advisers, facilitates the process.
Chapter 11 and the U.S. Catholic Church
These are the principles that have led to the filing of the diocesan reorganization cases. In each case, the bishops have cited the need for a process that permits equitable and compassionate treatment of victims while permitting the diocese to return to its role as a church. From its first pages, the disclosure statement in the Tucson case emphasizes that the purpose of the filing was to fairly, justly, and equitably compensate the victims of sexual abuse by clergy or others associated with the Diocese and bring healing to victims, parishioners and others affected by the past acts of sexual abuse committed by clergy and others while allowing the Diocese to continue its ministry and mission. The proposed plan provides for the creation of two trusts to be funded by settlements from insurers and the liquidation of certain diocesan assets, exclusive of parish and school property. Trustees for each of these trusts are to be given responsibility for resolving all pre-petition tort claims, investing and managing settlement funds, and making payments to holders of allowed claims.
One issue that has received much attention in these cases is whether the assets of the parishes are assets of the bankruptcy estates. While it does not define property rights, the Bankruptcy Code does prescribe which assets become property of the bankruptcy estate upon the filing of a petition for relief. Property of the estate is very broadly defined to include all legal and equitable interests of the debtor in property as of the commencement of the case. There are certain exceptions to this broad definition. Property of the estate does not include property in which the debtor holds, as of the commencement of the case, only legal title and not an equitable interest. Pursuant to canon law, all clerics and lay persons who take part in the administration of ecclesiastical goods are bound to fulfill their functions in the name of the church according to the norms of law. But the Code of Canon Law does not specify how title to the temporal goods of the church is to be held, and the practice varies from state to state.
It has been argued that pursuant to canon law, the bishop’s interest in parish assets is a bare legal title and that parish assets are therefore not property of a diocese’s bankruptcy estate. This is far from clear, however, and trial and appeal of this issue could take years. But through the plan negotiation process, it may be possible for interested parties to agree upon an adequate amount to fund a plan in lieu of liquidating parish assets. Victims and parishes, through their representatives, may fully participate in the plan negotiation process.
Other questions have arisen about the role of the bankruptcy judge in supervising diocesan activities and the administration of diocesan assets, and whether this would impermissibly interfere with the free exercise of religion. In point of fact, the bankruptcy judge has no responsibility for case administration under the present Bankruptcy Code. That role is placed upon the trustee. While it is possible under the Bankruptcy Code for a judge to appoint an operating trustee for a nonprofit debtor in the event of gross mismanagement or fraud, it is more likely that a judge would first address specific creditor concerns through the appointment of an examiner. An examiner may be a lawyer or an accountant, but need not be, and is charged with investigating allegations concerning fraud, dishonesty, incompetence, misconduct, mismanagement or irregularities in the management of the affairs of the debtor, and with making a report of his findings to the court and other interested parties. If the report of the examiner reveals the need for the appointment of a trustee, a person is elected to serve as trustee by non-insider creditors holding allowable, undisputed, fixed and liquidated unsecured claims.
In a Chapter 11 case, however, there ordinarily is no trustee. Rather, the debtor in possession is clothed with the rights, duties and powers of a case trustee. So long as a diocese remains in possession of its property, the bishop of that diocese, together with his consultors, will continue to make decisions concerning the operation of the diocese. While a debtor may not use, sell or lease property outside the ordinary course of its business without the approval of the bankruptcy court, this approval is routinely given where there are no objections to the proposed action by affected parties. Whether in connection with obtaining confirmation of a plan or during the administrative phase of a case, the role of the bankruptcy judge is limited to deciding whether a proposed action does or does not meet the requirements of the Bankruptcy Code. In deciding that question, the judge generally has no power to compel an alternative action.
Bankruptcy law is certainly not the solution for all problems, and I am not urging a rush to the bankruptcy courts. But more Catholics need to become familiar with the reorganization process and value it for the creative solution it can provide for some very difficult problems now being faced by the church in the United States.