Charitable But Bankrupt

by Pessin Katz Law, P.A.

Over the last few years, bankruptcy has reared its head in venues one never thought possible.  From churches to education and health organizations and, most recently to local government, in the form of Detroit’s filing, one possibly could not have envisioned the bankruptcy scenario for such organizations as recently as a decade ago.  Blame it on the economy or the burden of lawsuits filed to correct wrongs or just plain poor judgment, bankruptcy filing for not-for-profit organizations, once believed unthinkable, has taken place.

Whether “for profit” or “not for profit”, an organization’s decision to file for bankruptcy still centers on the same core issues: under what circumstances are filings permitted; what happens during the bankruptcy proceeding; how will assets be martialed and accounted for; and how will those assets be disposed of?

Essentially, if a non-profit is organized as a business entity or a “business trust” under state law it will be eligible to file under the U.S. Bankruptcy Code (the “Code”). Additionally, unincorporated associations may avail themselves of protection under the Code, subject to an interpretation of the law relating to involuntary filings and conversions from a Chapter 11 bankruptcy filing to Chapter 7 liquidation.  As far as Maryland is concerned, a noteworthy case regarding involuntary bankruptcy filings against non-profits is In re Allen University, 497 F.2d 346 (4th Cir. 1974) as discussed in In Re The Centre for Management and Technology, Inc., USDC, Maryland, Baltimore Division, Case No. 07-19486-NVA, 2007, (Memorandum Decision and Order on Motion for Appointment of Emergency Chapter 7 Trustee).

A determination must be made as to what assets will be included in the non-profit’s bankruptcy estate.  This issue is one of state law, even though the language of the Code sweeps broadly.  A keystone question is to what extent assets available to the non-profit are through government grants and donor-restricted gifts.  Restrictions on grants and gifts may force a non-profit to seek the approval of government agencies, donors, and, possibly the courts, before committing assets to the bankruptcy estate.  Exclusion of such pre-bankruptcy restricted assets, which might be pledged as collateral to other creditors, would generally diminish the estate available to creditors generally in the bankruptcy filing.  In addition to the foregoing factors, one must examine the titular relationship between the asset holder and the non-profit institution to determine whether that relationship forestalls the ability to include all assets of the institution in the bankruptcy estate, e.g. are such assets held “in trust” for the entire institution by a single individual.

Another issue in the context of the composition of the bankruptcy estate of a non-profit is the possible demand by government agencies for overpayments.  Demands for overpayment by governmental authority may not be subject to the Code’s “automatic stay”.

While the Code specifically authorizes the sale of assets, an issue arises as to whether the authority of the bankruptcy court to authorize a sale conflicts with other provisions of law.  Among those provisions are state statutes that prevent a non-profit becoming a “for profit” institution and oversight by state officials over the sale of assets.  Whether the Code preempts state law on the subject of its ability to constrict a bankruptcy court in authorizing the sale of assets may be open to interpretation by the courts.

Insofar as Maryland is concerned, non-profits have not been immune to bankruptcy.  In August, 2012 the Jeanne Bussard Center, in Frederick, Maryland, a 47-year-old nonprofit that provided employment opportunities for people experiencing disabilities, was placed in receivership.  The request for the appointment of a receiver was made by the State of Maryland.  The Center was subsequently taken over by the Maryland Department of Health and Mental Hygiene’s Developmental Administration, as ordered by the Frederick County Circuit Court.

In December, 2012, Baltimore Behavioral Health filed for Chapter 11 protection under the Code.  The non-profit, which deals with mental health rehabilitation and treatment, owed a substantial amount of debt, including a large amount of payroll taxes due the IRS.

Maryland statutes regarding non-profit entities, such as non-stock corporations, generally follow the doctrine of “cy pres”.  In that regard the disposition of a non-profit’s assets in dissolution ought to generally be made to other non-profit organizations with similar goals to that of the dissolving entity.

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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