Church Ordered to Repay Over $500,000 to Bankruptcy Estate

As readers of this blog know, donations can bring with them a host of issues. These can include will disputes, naming rights conflicts, and of course donors seeking to perhaps unduly interfere with a charity’s operations. The latter is illustrated by recent clashes between donors and universities relating to the Israel and Gaza; see, for example, the Philadelphia Inquirer story headlined  “Penn’s donor backlash raises questions about how much influence philanthropists should have” (subscription required).

A recent federal bankruptcy court case highlights another issue, and one that can result in the charity having to repay a major donation. In Arrowsmith v. First United Methodist Church Centre, Alabama (In re: Health Diagnostic Laboratory, Inc.), the Liquidating Trustee alleged to have traced between $550,000 and $850,000 as fraudulently transferred from the debtors to intermediaries and then from there to the defendant church (pictured here). After trial, the court ruled that the initial transfers were recoverable by the bankruptcy estate and that of those initial transfers $569,435 made its way to the church using accepted tracing methods.

Once that was proven, the main defense the church raised was an exception to recovery for a “transferee that takes for value, . . . in good faith, and without knowledge of the voidability of the transfer avoided.” It was uncontested that the church had acted in good faith and without such knowledge, leaving the only open issue whether the church had provided anything of value in return for the funds it received. The church had issued the standard donation receipt stating it had not provided any goods or services in return for the donations, but the church argued that the donor had received intangible emotional benefits from contributing and, alternatively, that church members had provided (volunteer) services to  utilize the funds to further the churches charitable activities. The court found neither assertion demonstrated return value.

The church also argued that because it had spent the funds on its charitable activities, there were “changed circumstances” that should excuse the donations from recovery. However, the court noted that Congress has decided that the changed circumstances defense is not available when there has been a fraudulent convenience. The court also concluded the church could not invoke equity to allow this defense, since Congress had enumerated the available defenses.

Lloyd Mayer