Bankruptcy Court Lacks Power To Substantively Consolidate Nondebtor, Nonprofit Entities With Archdiocese Debtor

Author:Mr Charles Oellermann and Mark G. Douglas
Profession:Jones Day
 
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In the wake of scandal-driven bankruptcies filed by nearly 20 U.S. Roman Catholic dioceses and religious orders, scrutiny has been increasingly brought to bear on the benefits and burdens that federal bankruptcy laws offer to eleemosynary (nonprofit) corporations. Nonprofits seek bankruptcy protection for a variety of reasons. In the case of the dioceses and religious orders, chapter 11 has been a vehicle to head off (at least temporarily) thousands of pending and potential clergy sexual-abuse cases seeking hundreds of millions of dollars in damages. Other nonprofit filings have been designed to restructure balance sheets bloated with debt, to facilitate sales of nonprofits' assets, to effect orderly liquidations, to give nonprofits a needed breathing spell in a climate of regulatory change and uncertainty, or to more effectively manage claims of fiduciary infractions or fraud.

One issue that commonly arises in nonprofit bankruptcies—the scope of the debtor's bankruptcy estate—was recently addressed by the U.S. Court of Appeals for the Eighth Circuit in Official Committee of Unsecured Creditors v. Archdiocese of St. Paul and Minneapolis (In re Archdiocese of St. Paul and Minneapolis), 888 F.3d 944 (8th Cir. 2018). The court affirmed lower court rulings that the assets of parishes and other entities associated with an archdiocese were not, by means of "substantive consolidation," available to fund bankruptcy settlements with clergy abuse victims. According to the Eighth Circuit, a bankruptcy court's authority to issue "necessary or appropriate" orders does not permit it to order substantive consolidation of the assets and liabilities of a debtor archdiocese with the assets and liabilities of nondebtor entities that also operated as nonprofits because the remedy would contravene the prohibition of involuntary bankruptcy filings against nonprofits.

Eligibility of Nonprofits for Bankruptcy Relief

One of the threshold issues that must be considered is whether a nonprofit can file for bankruptcy in the first place. A related issue is whether a nonprofit's bankruptcy case, once filed, is subject to conversion to a case under another chapter of the Bankruptcy Code.

Section 109 of the Bankruptcy Code sets forth the eligibility requirements for a bankruptcy filing, including requirements for filings under certain chapters. Section 109(a) provides that "only a person that resides or has a domicile, a place of business, or property in the United States, or a municipality, may be a debtor under [the Bankruptcy Code.]" The Bankruptcy Code defines "person" to include (in addition to certain governmental units) any individual, partnership, or corporation.

Other subsections of section 109 expressly make some entities ineligible for certain kinds of bankruptcy relief, including railroads (which can file only for chapter 11); municipalities (which can file only for chapter 9); and domestic insurance companies, banks, and savings and loan associations, all of which are subject to different legislative schemes enacted for their reorganization or dissolution.

Corporations qualifying for nonprofit status under applicable state law are eligible to file under both chapter 7 and chapter 11 of the Bankruptcy Code. See Collier on Bankruptcy ¶ 109.02 (16th ed. 2018) ("A nonprofit corporation, like a for-profit corporation, is eligible to file for relief under the Bankruptcy Code despite the fact that its assets may be subject to the beneficial ownership of governmental agencies."). Even unincorporated nonprofit enterprises may qualify. However, where a nonprofit enterprise is not organized as a corporation, a business trust, a joint stock company, or an association with the power or privilege of a private corporation, it will not be eligible for relief under the Bankruptcy Code. See 11 U.S.C. §§ 101(9) and 109.

Prohibition of Involuntary Nonprofit Bankruptcies

Section 303 of the Bankruptcy Code provides that an involuntary bankruptcy case may be commenced under chapter 7 or chapter 11 "only against a person, except a farmer, family farmer, or a corporation that is not a moneyed, business, or commercial corporation," if the requisite number of eligible creditors files an involuntary petition against the entity. Although the Bankruptcy Code does not define "moneyed, business, or commercial corporation," the legislative history of section 303 indicates that "churches, schools, charitable organizations and foundations" are exempt from involuntary bankruptcy. H.R. Rep. No. 95-595, 321 (1977); S. Rep. No. 95-989, 33 (1978). Courts, which generally decide whether this exemption applies by examining the charter of the entity, as well as its activities and its characteristics and powers under state law, have interpreted the provision to exclude nonprofits from involuntary bankruptcy filings. See Archdiocese of St. Paul, 888 F.3d at 952 ("We agree with the bankruptcy court's interpretation that 'not a moneyed' is equivalent to the modern-day terms 'not-for-profit' or 'non-profit.' ").

Conversion of Nonprofit Chapter 11 Case to Chapter 7 Liquidation Prohibited

The Bankruptcy Code provides for the conversion...

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