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Seventh Circuit Holds Free Exercise of Religion Is Not a Shield against Avoidance Actions

The Seventh Circuit Court of Appeals held that the First Amendment and the Religious Freedom Restoration Act (RFRA) do not protect religious organizations from avoidance actions brought by unsecured creditors' committees. Listecki v. Official Committee of Unsecured Creditors, Nos. 13-2881 et al, 2015 U.S. App. LEXIS 3669 (7th Cir. 2015). Before the Archdiocese of Milwaukee filed its Chapter 11 bankruptcy petition, it transferred $55 million from the Archdiocese's general accounts to a trust earmarked for maintaining Milwaukee area cemeteries. After the bankruptcy filing, the Archbishop, as trustee, filed a declaratory judgment action seeking to protect the trust funds from avoidance actions. The Archbishop argued that any claim by the Debtor or Committee to recover the trust funds would impose a substantial burden on his religious beliefs in violation of his free exercise rights under the First Amendment and the RFRA. The Bankruptcy Court granted a motion brought by the Committee and dismissed the First Amendment and RFRA claims. The District Court reversed, finding that recovery claims would substantially burden the Archbishop's free exercise of religion under the First Amendment and RFRA, and that the Committee was acting under color of law for purposes of the RFRA. On appeal, the Seventh Circuit first determined that the RFRA is not applicable if the government is not a party. The Seventh Circuit then reversed the District Court's finding that the Committee was acting as the government under color of law under the RFRA. Although the Committee is formed by the United States Trustee's Office and is subject in some ways to oversight by both the U.S. Trustee and the Bankruptcy Court, the Seventh Circuit determined that the Committee represents and owes a fiduciary duty to private unsecured creditors, not to any governmental actor. For the same reason, the Committee is not performing a traditional public function -- the Committee can be adverse to the U.S. Trustee when representing the creditors' interests. Similarly, the Committee did not become a public actor by obtaining derivative standing to bring avoidance actions on behalf of the Debtor-in-possession -- prosecution of avoidance actions is not traditionally a government function whether performed by a debtor or a committee. Because the Committee is not a governmental actor, the RFRA does not apply. The Seventh Circuit also dismissed the Archbishop's claims that the First Amendment's Free Exercise clause protected the funds from Committee actions even if the Committee was not acting under color of law. The Court agreed that the Free Exercise Clause applies, but that it did not protect the trust funds because the bankruptcy code's avoidance provisions serve a compelling government interest and are sufficiently narrowly tailored to achieve that interest. Even if the avoidance provisions impose an undue burden on the Archbishop's religious practice, the Committee's compelling governmental interest in protecting creditors overcomes that burden under the Seventh Circuit's balancing test. Therefore, neither the First Amendment nor the RFRA apply to protect transfers by religious institutions from avoidance actions under the Bankruptcy Code.

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