Here is a bankruptcy story in keeping with the spirit of the season. It concerns charitable giving.

In the holiday spirit, it is worth noting that the concept of bankruptcy itself has origins in the Bible which refers to the "jubilee" - a celebration held every 7 years. During the jubilee creditors were to forgive all debts. The concept has carried over into current law which allows debtors to receive a fresh start through filing for bankruptcy protection once every seven years. Just how far charity can extend has now been made clear by a new law.

While many people regularly give to charity, whether debtors can claim charitable giving as a legitimate cost of living has been an open question.

One expense line on the bankruptcy schedules asks how much a month the debtor donates to charity. Many religious groups, of course, ask that members tithe and there are many times when debtor's schedules show donations of large parts of the debtor's monthly income to a church despite the fact that the debtor can not pay his creditors. Until this year it was not clear whether such charitable giving could be included as a legitimate, necessary, expense.

Two potential problems have been associated with charitable giving in a bankruptcy context. Fist, bankruptcy petitions require that the debtor list all his income and expenses. If income exceeds expenses the debtor has "disposable income." When disposable income exists in a Chapter 7, the Chapter 7 Trustee, or other interested parties, might object to the bankruptcy filing and insist that the debtor pay his disposable income into a Chapter 13 Plan. Such a Plan would provide that creditors receive a pro rata reimbursement. Can charitable giving be the expense which tips the scale between the existence or non-existence of disposable income?

Secondly, bankruptcy trustees have the power to avoid fraudulent transfers. In other words, if a debtor has transferred money and the trustee can show that the transfer was not made in good faith, the trustee can recover that money and use the recovered funds to repay creditors. There have been cases where trustees have argued successfully that money given to charities was transferred to avoid payments to creditors and the trustee's have been able to recover those funds from the benefiting charities.

In my own practice, I have never had any objection made to charitable giving although I was always concerned that an objection might be raised and upheld in court.

Now, Senator Charles E. Grassley (R-Iowa) has sponsored the "Religious Liberty and Charitable Donation Protection Act." - S 1244. The bill, which is now law, provides that any debtor may contribute up to 15% of his gross income to a qualified religious or charitable organization. If the debtor has made a habit of making larger gifts to charity, those larger gifts too are exempt. The bill directs that such contributions are to be considered legitimate expenses for both Chapter 7 and Chapter 13 filings.

The new law represents another example of how special interest groups (in this case, churches objecting to disgorging gifts) continue to erode a once cohesive bankruptcy scheme. Still, it hard to argue against charity.

Now even the bankrupt can help those less fortunate than themselves. Happy holidays.

December 1999.
Reprinted with permission of the The Orange County Register.