Diocese steps into uncharted territory

Catholic leaders of Eastern Washington are guiding their churches into the unknown.

On Monday, the Diocese of Spokane will file for Chapter 11 bankruptcy protection – a legal arena fraught with uncertainty and bound by the secular application of law.

Legal experts say the move is a leap of faith.

Normally, companies that choose bankruptcy understand the rules and can weigh the risks and rewards. There are always unexpected turns, but executives are usually afforded some idea of the outcome.

The Spokane Diocese case will be different. It will be unlike any bankruptcy case ever handled in Spokane County.

The unknowns are so great, in fact, that one expert likened the decision by the diocese to “shooting in the dark.”

“No attorney can tell their client with any degree of confidence which way this will turn out,” said Sam Gerdano, executive director of the American Bankruptcy Institute, a nonpartisan think tank in Alexandria, Va.

That’s because the bankruptcy will attempt to fit church law into federal civil law, which could test the constitutional separation of church and state, lawyers involved with the case say.

With all of those unanswered questions, “there are hidden traps and pitfalls that we can’t yet anticipate by the diocese choosing this path,” Gerdano said. “The risk is that a bad outcome could be catastrophic.”

Attorney Shaun Cross, representing the diocese, describes the case as “crossing into uncharted waters.”

He said the diocese had no choice.

Reeling from the priest sex-abuse scandal, the diocese is beset with lawsuits that threaten its financial health and ability to fulfill its religious mission.

It has settled a handful of cases. But as the number of cases mounted, church officials determined there wasn’t enough money to settle them all.

Corporate strategy

Chapter 11 of the federal bankruptcy code is used by corporations to reorganize. In business bankruptcies, assets are sold and workers are laid off. Creditors often receive pennies on the dollar for their claims, and stockholders usually are left with nothing. Companies then attempt to start over again – often appearing far different from the debt-ridden firm that failed.

Monday’s filing by the diocese will not include a reorganization plan, which Cross said would be premature with so many issues still to be decided.

The most important rulings in the case will determine if parish assets such as buildings and schools are the property of the diocese and therefore available to creditors.

The diocese will base its argument on canon law, or church law, which declares that parish assets belong to the individual parishes, not the bishop and the diocese, Cross said.

This separation is part of the diocese’s legal status as a corporate sole – a business structure established centuries ago under canon law that declares the office of the bishop as a one-person corporation. In effect, this status shields parish assets.

Whether a judge will or can accommodate canon law in a federal court, however, remains murky.

There’s no guidance available from the other two Catholic dioceses that have declared bankruptcy in the United States – Portland and Tucson – because neither of those cases is far enough along to have established precedent.

James Hayes, a law professor at Western State University in Orange County, Calif., said the issue needs to be resolved quickly. It could affect the legal rights of all churches by throwing into doubt the separation of church and state.

Any decision is likely to end up in front of the 9th U.S. Circuit Court of Appeals, another wild card for the diocese.

That panel is recognized as one of the most liberal in the nation. As Gerdano put it: “I cannot think of a less friendly forum for the Catholic Church.”

He doubts the parish assets will be shielded, setting up an early showdown.

There is a legal doctrine called substantive consolidation. Bankruptcy judges often follow this doctrine, which groups related assets as property of the bankruptcy estate – a company’s subsidiaries and affiliates, for example, often are combined under the umbrella of a corporation.

If narrowly applied to a particular bankruptcy, a federal judge can rule without attempting to set national precedent.

Parishes are key

Ford Elsaesser, a Sandpoint attorney retained by a group of Eastern Washington parishes, said the question of parish assets is a central issue in the bankruptcy, one that may ultimately have to be decided by a higher court.

There is no current court opinion or recognized authority to rely upon.

“I don’t know how closely the parishes acted like they were independent businesses,” Gerdano said. “It may be very hard to make that case.”

Cross believes he can. He points to annual audits by an independent accounting firm that he said will show the Spokane Diocese acted as a trust for parishes rather than a corporate parent.

Michael Pfau, a Seattle attorney representing dozens of alleged victims, calls the entire bankruptcy strategy a preconceived plan to protect parish assets rather than trying to treat victims fairly.

“This is not a diocese that’s insolvent,” he said. “Remember, those in Tucson and Portland paid out tens of millions in settlements before they were compelled (to file).”

“By going this route,” Pfau added, “the Spokane Diocese has decided to pay millions and millions of dollars to lawyers to run a bankruptcy case, and frankly, I’m not sure the diocese will even have enough money to do that for very long.”

Bankruptcy lawyers and the other professionals needed to execute a successful bankruptcy reorganization, such as accountants and turnaround specialists, are first in line for payment, ahead of creditors. With fees ranging from $200 to more than $500 an hour, complex bankruptcy cases quickly become multimillion-dollar endeavors.

The net worth of the diocese is about $8.3 million, according to Cross. He acknowledged that the costs of this bankruptcy could eclipse that amount in a matter of months.

Such a “burn rate,” he said, may be an inducement for everyone involved to settle.

The diocese’s liability insurance carrier may be dragged into the bankruptcy hearing if the judge rules the policy is an asset of the estate. The carriers have filed suit against the diocese, claiming sexual abuse is not a liability covered under the policies.