Like any other organization, a church can run into money problems, with debts that are too great for the church to bear. Bankruptcy provides churches that are deep in the financial red with a means of getting out from under creditors’ collection efforts and, one hopes, move forward with a clean slate.
Bankruptcy is a creature of federal law with several variations named after the corresponding chapter of the U.S. Bankruptcy Code. Most churches that are in financial trouble will want to look at Chapter 11 bankruptcy. In most circumstances a Chapter 11 bankruptcy offers the debtor church the advantage of continuing to operate as normal, as the so-called “debtor in possession.” This means, for example, that the church does not need to immediately vacate premises that are subject to a mortgage that is in arears.
A major feature of Chapter 11 bankruptcy is that the debtor enters into a court-supervised plan to restructure its operations and repay its debts. In some cases a Chapter 11 reorganization plan can simply involve the debtor selling off its assets and winding down operations, with a court-supervised process that ensures creditors are protected. In other circumstances, a church may be allowed to propose a plan that allows it to continue running, albeit with significantly reduced expenses and probably with the sale of assets.
In a Chapter 11 bankruptcy the court overseeing the process acquires a significant amount of control over the debtor’s assets and operations. Without court approval a church in bankruptcy can’t enter into or cancel major contracts, like property leases or employment contracts. It also can’t sell assets or borrow money. Any time a church in bankruptcy wishes to do major transactions the court will hold a hearing and allow creditors to offer objections or request changes to the proposed deal.
When a church comes out of the other side of a Chapter 11 process it will often be a much leaner operation, with clear debt obligations and a bad mark on its credit history that likely will make future borrowing significantly more expensive. But the process may also have saved the church as an organization, allowing it to continue serving its mission despite financial mistakes.
The Church Law Center of California provides legal counsel to secular and religious nonprofits on a broad range of governance matters. Our experience working with churches gives us insight into the unique challenges congregations can face. Call us at (949) 689-0437 or reach out to us through our contact page.