Tag: church finances

SUING CHURCH EMBEZZLERS

During 35 years in private practice, one law school lesson was demonstrated true over and over. Wrongdoers are usually “gone, dead or insolvent.” In the case of church embezzlers, usually two out of the three. Charity and church embezzlers usually flourish when trust and faith supplant business common sense altogether. Embezzlers can make a church, charity or business look like a failure when in fact it was at least marginally successful if not completely successful.

In Agape Family Worship Center, Inc. v Gridiron, Order Granting in Part and Denying in Part Plaintiff’s Motion for Summary Judgment (USDC, CD Cal. 2018), Agape was (and probably still is) a large non-denominational church that allowed Gridiron to ascend from assistant to the position of Chief Financial Officer (“CFO”) in fact if not in name. Gridiron was permitted to hire a bookkeeper and Gridiron recommended that Agape stop hiring third party auditors. Trust and faith supplanted business common sense altogether. From 2008 to 2014 Gridiron diverted checks and cash in the amount of $4,815,963 to feed a gambling addiction. Most charities and churches are so embarrassed when confronted with such a situation, if they survive it financially, they remove the wrongdoer from employment or position of trust and quietly separate that person altogether. Some use the word “excommunication” and some do not. But, Agape did not do only that. Agape also did not simply call local law enforcement. In small towns (and in some big ones) local law enforcement is not equipped to handle financial crimes. Agape notified the Federal Bureau of Investigation and, so it seems, the FBI engaged the criminal division of the Internal Revenue Service. Gridiron was charged with wire fraud and filing fraudulent tax returns. (Whatever other criticisms the IRS may deserve, almost no one handles financial crime as thoroughly once their attention has been obtained.) Gridiron was sentenced to 57 months in prison and ordered to pay restitution of $4,815,963. Agape also had some insurance coverage for the loss which was a second way Agape’s response was better than most. Agape or its subrogated insurance carriers, it is not stated in the opinion which, sued Gridiron for the amount stolen as well as punitive damages, treble damages, attorney’s fees spent chasing Gridiron in his bankruptcy as damages and attorney fees for the case. The Court granted summary judgment to Agape for the actual damages of $4,815,963 but denied relief as to punitive damages, treble damages, and a third of a million dollars in attorney fees. While the intricacies of the denials is outside the scope of this report, it is interesting to note the Court concluded punitive damages was too much punishment when added to the prison time. It seems likely Gridiron was judgment proof but such a judgment might have had other purposes. One such purpose might have been to allay doubts about whether some or all of the money was recoverable, i.e., church leadership may have needed the judgment for internal political purposes, especially if church leadership needed to regain trust with the giving members or avoid their own lawsuits.

If a full blown annual audit is too expensive, then at least an annual review makes sense if entrusted to a hired, non-member, Certified Public Accountant. Alternatively, auditing one month of a year, randomly chosen, might be enough to dissuade a thief. Offerings should be counted and deposited by a rotating leadership of no less than two leaders not related by blood or marriage that also leave a written record for each collection counted. Check writing, credit cards and wire transfer authority should be structured for security and not just convenience. No single church leader, including the pastor, should have non-transparent uninspected financial control. Financial controls should be reviewed periodically by a Certified Public Accountant because what may be appropriate for a start up charity or church might have been outgrown. Once trust is lost, it is very hard to ever get again.

BLESSED SHACKLES – GOVERNMENT AID TO CHURCHES

We have reported on this type of tar baby before.  In these situations, a public funding program to accomplish a governmental purpose attracts a variety of public and private participants.  We reported in 2017 on a United State Supreme Court opinion regarding Trinity Lutheran Church v Comer, 137 S. Ct. 2012 (2017) regarding a program that paid for rubber surfacing on concrete play “ground” surfaces and a subsequent decision in Taylor v Town of Cabot, 2017 VT 92 in which a town granted money for restoration of a historic church building.  In the Vermont Taylor opinion, the case was remanded to the trial court and a risk the church ran in the case was that the church might have to refund the grant money.  In Comer, the church prevailed so that the playground upgrade need not be repaid by the church.

In Caplan v Town of Acton, Slip Op. (Mass. 2018), taxpayer protesters sued town because a church received two grants.  The appellate court split the difference, to a point.  One grant was for payment of an architect to draw up a “Master Plan” for restoration of the church building and two outlier buildings.  The main church sanctuary building was built in 1846.  The Town of Acton was founded in 1735 and the church formed part of the town square.  The other grant was to repair stain glass windows first installed in 1898.  In order to obtain the money, the church had to convey a “historic preservation restriction” on the buildings, the money could only be obtained in reimbursement on invoices for work consistent with the preservation proposed in the church’s applications for the grants.  The court remanded the “Master Plan” grant for further consideration and barred the grant for the stain glass windows.  The total value of both grants was less than $110,000, a little over $50,000 each.

The opinion is valuable for its historic review of the reason Massachusetts amended its Constitution in the Nineteenth Century by adding an “anti-aid amendment.”  The court reported that in the Nineteenth Century the pressure to provide public resources to churches caused “fear” the public coffers would be drained by competing churches and denominations.

But, historic preservation is almost too expensive for private resources to unilaterally achieve because private capital usually must chase profit.  Profit is obtained not through preservation but through maximizing return on capital.  Thus, the government purpose of preservation might be thwarted because part of the history to be preserved, which was built before several states in the union became states and is very expensive to keep, included a church.  There might be a hidden lesson in this opinion, too.  The “historic preservation restriction” might be more costly in the long run than the church presently anticipates because taking the government’s money is always risky.

FAIRWELL HOUSING ALLOWANCE TAX EXEMPTION

There may not be any housing tax exemption for pastors.  Such an exemption has existed since 1954.  Most pastors lived at the “parsonage” owned and provided by the church.  As churches became more affluent, the involuntary vow of poverty became less appealing.  Pastors wanted to build up equity and own their own home.  The parsonage began to slip into history.  To aid pastors in acquiring a home churches turned to the “housing allowance.”  The “housing allowance” began to form a significant part of the compensation of pastors.  The allowance allowed the minister to buy a home near enough to the church to allow rapid access to the church but not owned by the church.  The “housing allowance” was not included in taxable income.  The “housing allowance” will remain a viable tax exemption for anyone, including pastors, that are required to live at a certain place by their employer just like any other secular employee.  But, the “housing allowance” may not continue in the absence of the employer’s mandate if this decision stands.

In Gaylor v Mnuchin, Opinion and Order (WD Wis. 2017), 26 USC §107(2) has again by the same federal court been held to be in violation of the Establishment Clause.  The Court held that the statute discriminates against secular employees because they cannot qualify for the exemption.  The Court held the exemption does not have a secular purpose.  The argument that the statute was enacted to implement the constitutional entanglements clause was rejected.  The Court held the legislative history indicated the motive behind the statute was a preference for ministers over secular employees.  The Court noted that taxes have been held to be neutral and not a burden on free exercise of religion, otherwise every tax would have to be inapplicable to employees of religious organizations.  Housing allowances for pastors required to live on church grounds will not be effected because that is governed by a different section of the statute.  The opinion of the Court runs to 47 pages.

Tax preparers that try to apply this decision should be cautioned that the Court expressly omitted from its ruling the other sections of the statute.  Only 26 USC §107(2) is the subject of the decision.  The practical loss of the housing allowance will only occur in those situations in which the housing allowance is used to shelter part of the income of the pastor.  It will not be lost under this decision if the religious organization requires its pastor to live in a certain location or in a church owned parsonage.  Any housing allowance that would be permitted to a secular employer’s employee will still be allowed for a religious organization employee.

No doubt this decision will be appealed as it has been in the past.  Ultimately, the issue will be decided by a federal appellate court and possibly someday by the US Supreme Court.  Several if not many tax years will come and go before then.  Technically, the reach of this decision is not outside of the Western District of Wisconsin.  But, the IRS could chose to insist it be followed nationally.

REMOVAL AND THE ECCLESIASTICAL ABSTENTION DOCTRINE

Generally, federal courts can only hear cases in which the Plaintiff is from a state other than the state from which the Defendant hails or if the case involves a federal law.  Generally, assuming the parties are from the same state, a federal court will review the state court Petition or Complaint that was removed by the Defendant to federal court to determine if the Petition or Complaint raises a question under federal law.  If none is found, the case will be remanded to the state trial court from which it came.  The Ecclesiastical Abstention Doctrine and the Ministerial Exception are federal constitutional law doctrines but typically they are raised in a case as defenses by the Defendant.  If the state trial court Petition or Complaint only mentions state law, unless there is a federal law lurking in the Petition or Complaint, the federal court will not have jurisdiction and will remand the case to state trial court.

In Savoy v Savoy, Slip Op., 2017 WL 1536158 (D. Nev. 2017), the Plaintiff demanded an accounting from the church corporation under the state law governing corporations.  The Plaintiff also alleged that the corporate officers breached their fiduciary duty of loyalty to the corporation as defined by state law.  The Defendant removed the case from state court to federal court based on the Defendants’ defensive assertion of the Ministerial Exception and the Ecclesiastical Abstention Doctrine.  But, following normal federal policy, the case was remanded to state court because the Plaintiff and Defendant were residents of the same state and because the Plaintiff did not assert a right under federal law.  That the Defendant asserted a right under federal constitutional law was not enough.

The facts of the case are not explicated in the Court’s opinion with sufficient detail to make a guess why removal to federal court was considered by the Defendant a good idea.  But, the Ecclesiastical Abstention Doctrine and the Ministerial Exception may be raised in a state court proceeding probably to the same or similar effect.  Indeed, state courts sometimes are more reluctant to delve into church splits than federal courts.

DONOR DO OVERS

In the typical church, fund raising to achieve an objective is not always successful.  To raise enough money to build a fellowship hall, or a youth facility, or some other adjunct facility is often started and not finished.  If insufficient money is collected to achieve a stated purpose what happens to the money that is collected can be a source of angst.  Returning the money may present administrative problems like identifying exactly who gave what because many donations are “anonymous.”  Most churches have a church treasurer sworn to secrecy but donations that have to be documented for tax purposes may make anonymity sometimes illusory.  Also, most churches do not have clear policies regarding whether donative intent is binding and if it is, for how long.  Also, if the money is returned to identified givers, must the money be returned with an IRS form 1099 requiring the church to have or obtain the donor’s social security number?

Rogers v St. John United Methodist Church, Slip Op., (unpublished) (Mich. App. 2017) was the reversal of a trial court’s grant of a Motion to Dismiss.  In most jurisdictions, obtaining a dismissal by motion based on the pleadings is problematic at best.  Also, at that stage, without discovery or a trial, the factual evidence is often not complete or cannot be considered.  However, it seems the donation for a new fellowship hall was probably not enough to build and additional fund raising was apparently not successful or for some other reason leadership decided not to build.  After a passage of time, the donors sought a refund.  Apparently the donors were sufficiently well identified and the money sufficiently segregated that it was identifiable as to amount.

The opinion of the court, again based on and reversing a trial court’s dismissal founded only on pleadings, was that “resolution of plaintiffs’ claims does not require a court to analyze questions of religious doctrine or ecclesiastical polity” and for that reason the trial court received the case back on remand for further proceedings.  In other words, the court was holding donative intent could be determined without considering religious considerations.

The opinion was silent about the law of donations in general, i.e., whether once donated the donor retains any authority over the use of proceeds.  The opinion was silent about the bylaws of the church.  Often well drafted bylaws clearly state a policy that donative intent is not binding on leadership and that no return of donated funds can occur even if a donative intent cannot be fulfilled.  Bylaws often also make donations religious by reciting Scriptural edicts regarding donations.

Thus, the opinion of the appellate court in Rogers should be viewed as provisional and not viewed as a general statement of law.  That intent could be determined may have been a projection based on the what the court had before it.  As the case proceeds, if it does, that intent may not be so easily determined.

UNINCORPORATED ASSOCIATIONS AND CHURCH CORPORATIONS

In the beginning, all churches were unincorporated associations.  The demands of modern accounting and property ownership, including liability risk management, pressed the unincorporated association to incorporate.  However, in order to successfully incorporate, the unincorporated association has to follow steps outlined in the law of the state of residence.  Even done amicably, such a transition can be challenging to volunteer led churches and pastors that do not also happen to be lawyers.  In the middle of a church split, the transaction cannot be completed in most states.

An example of this is Church of the First Born of Tennessee, Inc. v Slagle, Slip Op. (Tenn. App. 2017).  Church of the First Born outlived two generations of founders and desperately needed a new organizational structure that would ensure smooth leadership transitions going forward.  This was especially true after the church grew into a multi-campus church and established a church school sited on what probably was millions of dollars of real estate.

Before such an amicable restructuring took place, a church split arose.  The Court was unsure whether the split arose due to the financial pressures of supporting the church school or whether it was a doctrinal issue that arose because after the founders passed away, new leadership did not command the unanimity that the founders earned but surrendered upon their passing.  While the dispute roared around those issues, indeed, those issues were not terribly critical to the resolution.

The Plaintiff was a newly minted church corporation that tried to step into ownership of some of the church assets on behalf of one side of the split.  But, because asset ownership transfers are impossible unless all of the members of the unincorporated association have notice and vote to approve the transaction, the mere incorporation by one group in the split did not have the effect of transferring assets.  The Plaintiff was, therefore, without standing to bring any claim at all and the case was dismissed.

Church leaders have a duty to recognize their own mortality and plan for leadership succession in a fair process.  While many church leaders bristle at the idea of church bylaws or other written policies adopted as the governing rule of the church by a vote of the members, every church that does not have them and does not periodically review and update them increases the risk that a rift in the membership will shatter the peace of the church or in fact doom the church.  A church that can own millions of dollars of property should be able to hire a competent lawyer to lead the church to adopt bylaws or written rules.  Incorporation is a low cost and relatively well understood first step and makes asset management much easier.

YOU CAN’T FIGHT CITY HALL – OR THE BANK

A church split of “longstanding” resulted at the end in an interpleader action brought by a bank.  The bank paid the proceeds of the church accounts into the registry of the court.  For the interpleader action, the bank sought attorney fees, expenses, and a reservation of some of the proceeds (and maybe all of the remainder to be reserved) for future legal expenses.  One of the parties objected and alleged the bank was not an impartial stakeholder, and counterclaimed against the bank.  However, the court awarded legal fees and expenses to the bank.  Bank of America, NA v Jericho Baptist Church Ministries, Inc., Memorandum Opinion, (D. Maryland 2017).

A short Memorandum Opinion of this type does not usually contain detailed recitations of facts.  Thus, the actual fury of the church split was not detailed.  Resolution of the church split by the court, if the court did so, is not detailed in this opinion.

The only lesson that should starkly leap from the opinion is that a church split that results in litigation will not stay between the parties and will lead to legal expenses of substantial amounts in many instances.  Certainly, if the dispute forces a bank to choose sides, it will usually not do so and will usually ask a court to resolve its role.  If the parties resist, the bank will seek and typically obtain legal fees and expenses.  Although typically interpleader legal fee awards are modest, as such things go, but often they are not the only awards of legal fees possible.