Pledges By Debtors To Nonprofits May Not Be Enforceable After Bankruptcy

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Is a bankrupt pledgor legally bound to fulfill its promise to pledge a gift; or will a nonprofit have a successful claim against a pledgor if there is a subsequent failure to make payment because of a bankruptcy filing? A district court in Arizona recently held that St. Joseph’s, a nonprofit hospital, did not have an enforceable claim in Bashas’ Inc.’s bankruptcy for Bashas’ $50,000 charitable pledge because of Bashas’ bankruptcy. In re Bashas’ Inc., 2012 WL 5289501 (D. Ariz. Oct. 25, 2012). The decision, if followed elsewhere, could present concerns for nonprofit organizations.

The District Court’s Reasoning

The district court found that St. Joseph’s did not have a valid claim for breach of contract or promissory estoppel. The court explained, in sum, that Bashas’ charitable pledge was not supported by consideration (as required for a valid contract), St. Joseph’s did not rely on the pledge (as required for a claim for promissory estoppel) and this was not a case in which injustice can only be avoided by enforcing the pledge. To the contrary, the district court felt enforcement of the pledge would have been the true injustice. The court characterized St. Joseph’s efforts as "greedy" because, though the pledge was made when the debtor could pay, now that Bashas’ was in bankruptcy, it was inappropriate for St. Joseph’s to pursue payment. If St. Joseph’s were successful, it would harm Bashas’ creditors, those who actually provided goods and services. Indeed, the court felt that a decision enforcing St. Joseph’s claim would deter future pledgors from ever wanting to make a charitable pledge because "[w]ho would ever want to make a charitable pledge to St. Joseph’s if one thought St. Joseph’s would chase you to the end of the world even after a change in circumstance makes fulfillment of the pledge unjust?"

St. Joseph’s promissory estoppel argument, which was rejected by both the bankruptcy court and district court, was premised upon section 90 of the Restatement (Second) of Contracts. That provision provides that if a party engages in certain conduct or forebears from doing something due to a promise made, then that party may be entitled to a remedy if that promise is later broken. Subsection 2 specifically applies this rule to charitable subscriptions. Notwithstanding that analysis, both the bankruptcy court and district court refused to apply the subsection because injustice to the pledgor is a prerequisite to its application, and both courts believed that enforcing the pledge would cause more harm to the creditors than to St. Joseph’s. The bankruptcy court and district court conducted their legal analysis under Arizona law. It is likely that a different court in a different state interpreting a different state’s laws could reach the opposite conclusion. Many state courts have found valid consideration for a debtor’s pledge made to a nonprofit organization.

Lessons of In re Bashas’ Inc.

Based upon the logic of the district court, an argument can be made that the harm to creditors of a bankrupt pledgor outweighs the harm to nonprofit organizations, because the former provide goods and services, while the latter do not. Arguably, this would create a per se rule against upholding enforcement of a pledge where the pledgor is a bankrupt entity. On the other hand, a scenario could exist where the nonprofit justifiably relied on the funds being donated. For example, in many jurisdictions healthcare facilities are nonprofits, which rely on donations for capital improvements and the like. If a healthcare facility were to purchase equipment necessary to run its day-to-day operations in reliance on a pledge, a court may find sufficient justifiable reliance so as to enforce the pledge. The bankruptcy case law is sparse on this issue; thus, it remains to be seen whether courts will follow In re Bashas’ Inc., or whether they will carve out exceptions. Nonetheless, in situations where consideration in exchange for the pledge exists, or where the nonprofit organization justifiably relies on the pledge and no harm exists to any other constituency, courts in other jurisdictions may reach a different conclusion than the one the courts did in In re Bashas’ Inc.

"Clawing Back" Pledges

Although the decision did not address this issue, there are instances where a "gift" by a bankrupt entity will be subject to "claw back" by a bankruptcy trustee or by the debtor after a bankruptcy case is filed because a gift can be deemed a constructively fraudulent transfer. Section 548 of the Bankruptcy Code allows a trustee or a debtor to "avoid" or "claw back" transfers that were made by a debtor within two years (or longer under state law) of the debtor’s bankruptcy if the recipient did not provide "reasonably equivalent value" to a debtor. However, Section 548 of the Bankruptcy Code also includes a provision that precludes the trustee from avoiding certain charitable contributions to qualified religious and charitable entities. Specifically, transfers of charitable contributions to a religious or charitable entity or organization cannot be "clawed back" so long as that contribution does not exceed 15 percent of debtor’s gross annual income for that year. If the contribution did exceed the 15 percent threshold, a trustee may not avoid the pledge if the transfer was consistent with the practices of the debtor in making charitable contributions. Of course, in the In re Bashas’ Inc. case, the payment of the pledge was never actually made by the debtor, thus the issue of whether there was a fraudulent transfer was not an issue.

The issues that arose in In re Bashas’ Inc., as well as the issues surrounding charitable contributions to qualified religious and charitable entities, vary from state to state. Advice from counsel could assist a pledgor or a nonprofit organization in avoiding any of the pitfalls mentioned above.

For more information, please contact Marc E. Hirschfield, mhirschfield@bakerlaw.com or 212.589.4610; Marc Skapof, mskapof@bakerlaw.com or 212.847.2864; George Klidonas, gklidonas@bakerlaw.com or 212.589.4625 or any member of BakerHostetler’s Bankruptcy, Restructuring and Creditors’ Rights Team.

Topics:  Clawback Agreements, Pledges

Published In: Bankruptcy Updates, General Business Updates, Health Updates, Nonprofits Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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