March 11, 2015 – In a case involving the Archdiocese of Milwaukee, the U.S. Court of Appeals for the Seventh Circuit has ruled that protections on religious freedom won’t protect a $55 million transfer that diminished the Archdiocese's bankruptcy estate.

In 2008, the Archdiocese of Milwaukee transferred $55 million to a trust fund designated to maintain cemeteries it owned in Milwaukee, after seeking approval from the Vatican.

According to court records, a letter to the Vatican indicated that the transfer would protect funds from legal claims and future liability. The Vatican approved the transfer.

In 2011, amidst civil fraud lawsuits that stemmed from sexual abuse by priests, the Archdiocese filed for bankruptcy protection. 

Sexual abuse victims sought to void the $55 million transfer as fraudulent, in violation of the Bankruptcy Code, in order to make those funds reachable by them as unsecured creditors with claims against the Archdiocese’s bankruptcy estate.

The Archdiocese argued that the $55 million was protected as necessary to maintain cemeteries under Canon Law obligations. Specifically, the Archdiocese argued that the Religious Freedom and Restoration Act (RFRA) barred application of the Bankruptcy Code provisions, because the transfer was made for religiously protected purposes.

RFRA prohibits the “government” from placing substantial burdens on a person’s exercise of religion, without a compelling interest achieved by the least restrictive means, even if the government’s law or regulation is generally applicable to everyone. The government includes government officials or persons acting “under color of law.”

The Archdiocese argued that RFRA applies because the U.S. Trustee, which oversees the administration of bankruptcy cases, appointed a Creditors’ Committee – consisting of sex abuse victims – to represent the Archdiocese’s unsecured creditors in the case.

Thus, the Archdiocese argued, the Committee was acting “under color of law.” The Archdiocese also argued that the transfer is protected by the First Amendment.

The appointed Committee of victims argued that RFRA did not apply because the Committee is not a government actor. It also contested the Archdiocese’s First Amendment defense, and argued the district court judge should have recused himself because he has family members buried at cemeteries owned by the Archdiocese.

District Judge Rudolph Randa ruled that RFRA and the Free Exercise Clause barred application of the Bankruptcy Code provisions against the $55 million.

In Listecki v. Official Committee of Unsecured Creditors (March 9, 2015), a three-judge panel for the Seventh Circuit Court of Appeals rejected the Archdiocese’s RFRA and First Amendment defenses to the transfer, but did not rule on the recusal issue.

First, the panel said RFRA did not apply because the Committee is not a government actor, and RFRA only protects government actions that substantially burden religion.

“Although each determination of an entity’s governmental actor status is fact- and case-specific, our conclusion that the Committee is not a governmental actor is supported by the Supreme Court’s precedent,” wrote Judge Ann Claire Williams. “There might be a ‘nexus,’ between the Committee and the government, but it is not a close one.”

The panel also ruled that the First Amendment’s free Exercise of Religion Clause does not bar application of the Bankruptcy Code provisions to the $55 million transfer, even though the First Amendment can apply in private civil suits.

“The Code and its relevant provisions are generally and neutrally applicable and represent a compelling governmental interest in protecting creditors that is narrowly tailored to achieve that end,” Judge Williams wrote for the panel.

The Bankruptcy Code may be used to void certain transactions, including fraudulent and “preferential” transfers that would allow the debtor to avoid inclusion of certain funds into the bankruptcy estate, which is subject to creditors. The Archdiocese said certain Code provisions are not neutral because they target religious organizations.

But the panel explained that such provisions do not prohibit the practice of religion and do not single out religious practice. “Anyone, regardless of religion or beliefs, can donate money to a qualified religious or secular charitable organization under the Code and qualify for avoidance – no religion or religious practice is required,” Williams wrote.

Even assuming the Bankruptcy Code’s provisions substantially burdened the Archbishop’s religious belief by disallowing a monetary transfer that supports cemetery maintenance, the panel said the government had a compelling reason.

“The Committee’s asserted compelling governmental interest is the protection of creditors. We agree that this is a compelling governmental interest that can overcome a burden on the free exercise of religion,” wrote Judge Williams, noting that the Bankruptcy provisions are narrowly tailored to protect the creditors’ interests.

The panel did not rule whether the $55 million transfer actually violated the Bankruptcy Code provisions, only that RFRA and the First Amendment do not prevent the code’s application: “[I]f the case reaches that stage, the adjudicator can consider the issue of whether the transfer of the Funds ran afoul of any of the Challenged Provisions.”

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