INCORPORATING CHURCHES AFTER THE FALWELL DECISION

by Mark N. Reed*

INTRODUCTION

For over two hundred years religious congregations and judicatories in Virginia could not incorporate. This changed two years ago when the well known conservative religious activist, Jerry Falwell, won his case against the State Corporation Commission ("SCC") over its refusal to incorporate his Lynchburg congregation, the Thomas Road Baptist Church. In its decision in Falwell v. Miller, 203 F. Supp. 2d 624 (W.D. Va. 2002), the court found that the SCC's refusal to incorporate Falwell's congregation violated the First Amendment to the United States Constitution. As a result of this decision, religious bodies can now be incorporated in Virginia. The purpose of this article is to examine the possibilities this decision created and to look at the benefits and detriments of incorporation for a religious body in Virginia.

STATUS UNDER PRIOR LAW

Prior to the Falwell decision, all religious bodies in Virginia were classified for legal purposes as unincorporated associations. In addition, state law divided all religious bodies into two structural models for purposes of holding title to property. The choice of which model a religious organization could use was based solely on the organization's ecclesiastical structure.

The first of these models, which was utilized by most Protestant denominations, was the "trustee" model. Under this model, title to a religious body's property was held by trustees, who were appointed by the local circuit court at the request of the religious body in accordance with VA. CODE §57-8. These trustees had no discretionary authority or powers with regard to the property they held in trust and could only take such actions regarding the property as the circuit court approved based on the wishes of the religious body.

The second model was the "ecclesiastical officer" model. A religious body could choose this model pursuant to VA. CODE §57-16 if the religious body's laws "commit[] to its duly elected or appointed bishop, minister or other ecclesiastical officer authority to administer its affairs." Under this model the ecclesiastical officer holds title to the religious body's property in his or her own name on behalf of the religious body. No court appointment or confirmation of the ecclesiastical officer was required under this model; nor was any court action required for that officer to transact business involving the property under his or her care. This model was generally employed by Roman Catholic congregations and other hierarchal denominations.(1)

THE FALWELL DECISION

Virginia's prior prohibition on the incorporation of religious bodies and its court appointed trustee system for religious bodies is unique to Virginia and West Virginia. The prohibition on incorporation of religious bodies is contained in §14(20) of Article IV of the Constitution of Virginia, which reads in part, "The General Assembly shall not grant a charter of incorporation to any church or religious denomination . . ." This constitutional provision traces its roots to Thomas Jefferson's Virginia Statute for Religious Freedom, and appears to have been enacted to prevent the establishment of a state religion. (2) While the constitutionality of this provision was questioned by the Virginia Commission on Constitutional Revision in 1969, it was never successfully challenged until the Falwell decision. (3)

In his decision in Falwell, Judge Norman K. Moon employed the test established by the United States Supreme Court in Church of the Lukumi Babalu Aye v. City of Hialeah, 508 U.S. 520 (1993), to determine the constitutionality of a state statute under the Free Exercise Clause of the First Amendment, applicable to the states via the Fourteenth Amendment. In Lukumi, the Court held that non-neutral laws which are not generally applicable must be narrowly tailored to advance a compelling governmental interest. Applying this test to §14(20) of Article IV of the Constitution of Virginia, Judge Moon found that the this provision was neither neutral nor generally applicable stating, "unlike other groups in Virginia, members of `a church or religious denomination´ are unable to incorporate the organization to which they belong. They are therefore denied the benefits of incorporation because of their religious status. As a result, §14(20) is neither non-neutral, nor generally applicable; it denies incorporation to defined individual solely on account of their religion." Falwell, 203 F. Supp. 2d at 631. He then went on to hold that the State "has presented no governmental interest - compelling or otherwise - to justify the existence of §14(20). Therefore in this case, the Virginia constitutional provision does not withstand strict scrutiny, and must be invalidated." Id. at 632. Thus, in an ironic twist of events, a provision of the Virginia Constitution that derived its origins directly from Thomas Jefferson's Virginia Statute for Religious Freedom, one of the cornerstones upon which American religious freedom was laid, was found to violate the First Amendment's right to the "free exercise" of religion. Immediately following this decision, the SCC started incorporating religious organizations on the same basis as it does other entities.

CHOICE OF ENTITY - TO INCORPORATE OR NOT TO INCORPORATE

As a result of the Falwell decision, Virginia religious bodies now have a choice: they may either stick with their current trusteeship or ecclesiastical officer structural form or they may incorporate, presumptively as a Virginia non-stock corporation. (4) Traditionally, choice of entity decisions are based upon such issues as (1) governance-operational considerations, (2) tax considerations, (3) liability considerations, (4) continuity or longevity considerations, and (5) costs. In addition to these traditional choice of entity issues, the decision of whether or not to incorporate a religious body in Virginia is currently complicated by the complete lack of statutory provisions and case law concerning incorporated religious bodies.

GOVERNANCE - OPERATIONAL CONSIDERATIONS

Any attorney who has represented a religious body that operates under the trustee model in a real estate transaction can attest to the inconvenience and time required in these transactions. First, the attorney must determine whether the current trustees of the congregation have all been appointed by the local circuit court to their position. If this has not been done, then a petition must be filed with the circuit court to accomplish the appointment. Once the correct trustees have been appointed ( i.e. the religious body's elected trustees match the court records), a petition must be filed by those trustees to obtain the permission of the circuit court in which the property is located "to sell, exchange, encumber, extend encumbrances, make a gift of, or improve the property or settle boundaries by agreement" the religious body's real property. (5) VIRGINIA CODE §57-15 sets forth the procedure to be followed to obtain this permission. Generally all that is required is a showing that the requested action is in accordance with the "wishes" of the congregation or church body. (6)

In contrast to these time consuming and sometimes expensive requirements, religious bodies utilizing the ecclesiastical officer model under VA. CODE §57-16 or incorporating under the Falwell decision do not have to follow any of these requirements, and they are free to acquire, sell, encumber, and improve their real estate without having to seek the permission of a circuit court. (7) This flexibility or freedom of action is one the major advantages to incorporation.

Another problem that frequently arises with congregations operating under the trustee model is the lack of clear documentation in the public records as to the congregation's correct name, which can result in difficulty in distinguishing between congregations with the same or similar names. Likewise, if a congregation operating as an unincorporated association changes its name, there is no central location where this may be recorded or noted in the public records. Virginia congregations that are incorporated do not experience these identification problems because of the SCC's registration procedures.

In sum, incorporated religious bodies have significant operational advantages over unincorporated bodies operating under the trustee model. On the other hand, they will have little or no significant advantage in these areas over religious bodies operating under the ecclesiastical officer model, since these religious bodies already enjoy significant flexibility and ease of operation.

TAX CONSIDERATIONS

Since most religious bodies are tax exempt entities, the form of entity they adopt will probably not be a major consideration regarding tax issues. However, in its articles of incorporation and corporate documents, the religious body should be careful to ensure that these documents comply with the IRS's requirements for tax exempt organizations. Religious bodies used to be limited by statute to the amount of real and personal property they could own; however, these Code provisions were abolished by the General Assembly in 2003 in the wake of the Falwell decision. There is now no limitation on the amount of property a religious organization may own in Virginia.

LIABILITY CONSIDERATIONS

Under common law, members of an unincorporated association were jointly and severally liable for the debts and liabilities of the association. However, VA. CODE §8.01-220.1:3 now provides that

No member of any church, synagogue or religious body shall be liable in tort or contract for the actions of any officer, employee, leader, or other member of such church, synagogue or religious body solely because of his membership in such church, synagogue or religious body. Nothing in this section shall prevent any person from being held liable for his own actions.

Likewise, VA. CODE §8.01-220:1:1 grants civil immunity (or limits their liability to the amount of their compensation) to directors, trustees and officers of organizations exempt from income taxation under §501 (c) of the Internal Revenue Code (which should include most religious bodies) for actions taken in their official capacities. However, this immunity does not extend to "willful misconduct or a knowing violation of the criminal law," nor to liability which derives from the operation of a motor vehicle.

While these statutes grant members and officers of unincorporated religious bodies broad immunity from liability from contracts and torts, some older case law in the field suggests that the immunity may not be as broad as it would appear. See Catlett v. Hawthorne, 157 Va. 372 (1931); Forsberg v. Zehm, 150 Va. 756 (1928). This line of cases suggests that a person acting on behalf of an unincorporated religious body may be liable for contracts that he or she signs unless he or she or a court has expressly excluded personal responsibility for the obligation Likewise they suggest that church members may be personally liable for a church's liabilities, if the member authorizes or ratifies the contract which gives rise to the liability. However these cases pre-date the aforesaid immunity statutes and their applicability today is questionable.

VIRGINIA CODE §57-15.1 provides that

Any order entered pursuant to [VIRGINIA CODE] Sections 57-14 and 57-15 may provide that any instrument evidencing a debt secured by a deed of trust . . . made on behalf of a church . . . may be signed without personal liability by the treasurer or other fiscal officer . . . and thereupon become the obligation solely of the church named therein.

While this Code section provides for a means for a church officer to avoid personal liability when signing a note for a church, its suggests by implication that if a court order does not expressly limit the signatory's liability, the signatory may have personal liability for this obligation. (8)

Even if the law in Virginia was crystal clear on the issue of church member and trustee liability, the relative uniqueness of Virginia's religious laws present additional liability questions in the context of interstate transactions. For example, a complicated choice of law question might arise in the tort context when members of a unincorporated Virginia religious congregation are involved in an automobile accident in another state while traveling on church business. If the state in which the accident occurred applied the common law provision that held members of an unincorporated association jointly and severably liable for the actions of the association, which state's laws on liability would apply?

In marked contrast to above, the law concerning the liability of members of non-stock corporations and their officers and directors is generally well settled and recognized throughout the United States. Absent highly unusual circumstances, members of incorporated religious bodies should not have any personal tort or contractual liabilities under Virginia law for the actions of the corporation, nor should its officers or directors, as long as they were acting within the scope of their authority and were not negligent in carrying out their duties. The certainty of the corporate shield - in contrast to the more uncertain nature of the law regarding the liabilities of unincorporated associations in Virginia - makes incorporation the clear winner on the issue of liability.

CONTINUITY OR LONGEVITY CONSIDERATIONS

Unincorporated associations and corporations are both capable of operating in perpetuity, so the continuity issue is not a major concern in the decision about whether or not to incorporate. However, the actions that need to be taken to maintain the religious body's legal existence will vary depending on the choice of entity, and more importantly the consequences on the religious body's existence for its failure to take the required actions are very different and significant.

Religious bodies operating under the trustee model need only update their trustees when they change trustees. There is no term of office or time frame for trustees specified under Virginia law, so a trustee's term of office is determined solely by the religious body. Failure to obtain the court's appointment of new trustees will not effect the religious body's legal existence, and there are no legal consequences for a failure to do so in a timely fashion. (9)

Similarly, religious bodies operating under the ecclesiastical officer model do not need to file any documents or take any actions to maintain their body's legal existence. If the ecclesiastical officer has changed from the last time the body's property was acquired, transferred, or encumbered, a mere recital in the new deed or deed of trust identifying the old and new ecclesiastical officer along with a statement as to when the new officer took office is generally sufficient to update the property records. This updating would normally only be done at the time some business is transacted with regard to the religious body's property, and not every time the ecclesiastical officer is changed.

The largest drawback to the ecclesiastical officer model with regard to its continuity occurs during periods of transition, when the ecclesiastical office is vacant. VIRGINIA CODE §57-16(2) provides that in those circumstances, the body's governing documents will determine who has the authority to carrying out of the duties of the office during the vacancy. However, if the body's polity does not provide for such contingencies, then it will be unable to transfer or encumber its property until a new officer is appointed.

In contrast, like all corporations, incorporated religious bodies must file an annual report with the SCC and pay a franchise fee to maintain their legal existence. While the effort required to maintain corporate existence is minimal, the legal consequences to an incorporated religious body for its failure to do so can be devastating. VIRGINIA CODE §13-914 provides that the failure to pay the required fee or file the annual report within four months of it being due will automatically terminate the corporation's existence. Thereafter its properties and affairs automatically pass to the directors as trustees in liquidation. If the entity continues to operate thereafter, its officers and directors may be personally liable for the debts and obligations of the entity that were incurred thereafter, and they could be guilty of a class 1 misdemeanor and be subject to injunctive action by the SCC. (10)

COSTS

From a cost perspective, the ecclesiastical officer model is the least expensive model to operate under since it does not require the filing of circuit court petitions to appoint trustees or transact business with its property; nor does it require payment of incorporation costs and annual fees. Between the trustee model and the incorporation model, the number of property related transactions that the organization transacts will determine which model is least expensive to operate. The more transactions a religious organization conducts, the higher its cost of operation is under the trustee model in relation to the incorporation model.

UNANSWERED QUESTIONS REGARDING
THE INCORPORATION OPTION

The foregoing analysis of the benefits and detriments of incorporation is based upon the assumption that an incorporated religious organization will be treated in the same manner as other Virginia corporations. However, this is only an assumption. Currently there are no statutory provisions or regulations regarding incorporated religious bodies in Virginia. All of the state's current code provisions dealing with religious entities do so from the perspective that they are unincorporated associations.

In addition, the order issued in Falwell merely required the SCC to issue a corporate charter to the Thomas Road Baptist Church, and it did not specify the terms or conditions that may be imposed by the SCC on these corporations. Furthermore, the author has been advised by the SCC that no regulations or guidelines of any type have been issued by the SCC on this question, other than an internal e-mail advising its charter examiners to accept articles of incorporation from religious organizations based on the Falwell decision.

As a result of this lack of statutory authority, questions have arisen as to whether or not incorporated religious bodies can hold real or personal property in Virginia in their own name or whether they continue to need to have trustees appointed to hold legal title to their property as may be required by VIRGINIA CODE §57-7.1. Likewise can they sell, encumber, gift, or improve their property without court approval as required by VIRGINIA CODE §57-15? While attorneys can speculate as to the answers to these questions, at the present time we have no definitive answers.

House Bill No. 1466, introduced by Delegate J.M. Scott in this year's General Assembly, addressees most of these issues. (11) The bill expressly authorizes the SCC to incorporate religious organizations, and amends the various provisions of Title 57 of the Code of Virginia to provide for incorporated religious organizations. It permits these corporations to acquire and hold real and personal property and to transfer, improve, and encumber it without the appointment of trustees or the permission of the circuit court. The bill also permits the transfer of property by the trustees of an unincorporated religious organization to an incorporated religious organization (as part of the organization's conversion to a corporation) without circuit court approval of the transfer. Unfortunately, this bill did not get out of committee and it has been continued by the General Laws Committee to the 2005 session. Therefore, until the General Assembly acts on this matter, religious organizations that choose to incorporate will be operating in uncharted waters, with the risks inherent in such an operating environment.

Nevertheless, the title insurance industry in Virginia appears to believe the risks regarding ownership and transfer of real property by incorporated religious bodies are acceptable. First American Title Insurance Company, one of the leading insurers in the Commonwealth, will issue both owners' and lenders' title insurance coverage on real property owned or conveyed by newly incorporated religious organizations in Virginia, on the same basis as it does for any other corporation. Palma Collins, Vice President and regional legal counsel for First American, told the author that her company's only special requirement regarding religious corporations concerns the procedures for transferring the organization's real estate during its conversion from an unincorporated association to a corporation. She stated that First American requires that the trustees of the unincorporated religious organization obtain circuit court approval to transfer title to the organization's real estate to the corporation pursuant to VA. CODE §57-15, and that they thereafter record a deed from themselves as trustees to the corporation. Likewise, for organizations operating under the ecclesiastical officer model, a deed from the ecclesiastical officer to the corporation is required to transfer title to the property to the corporation. However, once the property is in the corporation, no additional court approval or action will be required to transfer, sell, or encumber the property.

CONCLUSIONS

In conclusion, incorporation is (or should be in the future) the best choice for a legal structure for most Virginia religious organizations. It offers a religious organization much more flexibility with regard to the ownership and management of its real and personal property, particularly over the current trustee model. In addition, incorporation provides superior liability protection for members and officers of religious organizations than do the trustee and the ecclesiastical officer organizational models. Furthermore, it provides these benefits without jeopardizing any favorable tax treatment or continuity of existence treatment that unincorporated religious organizations currently enjoy under Virginia law. The cost and administrative actions necessary to incorporate and maintain that status are relatively small. They might even be cheaper than operating under the current trustee model, depending on the number of property related transactions the organizations will be conducting.

The two largest drawbacks to incorporation appear to be the potentially severe consequences that could occur to the religious organization and its members resulting from its failure to maintain the corporation in good standing, and the current uncertainty caused by a lack of statutory authority in Virginia law regarding incorporated religious organizations. The former issue is faced by all corporations; however, any religious organization that decides to incorporate must realize that if it fails to follow through with the statutory requirements to maintain its corporate status, that it could find itself in a much worse position than it would if it had never incorporated. Accordingly, small congregations or loosely organized religious bodies that lack the ability to closely monitor their legal affairs may wish to remain unincorporated associations.

On the other hand, while it appears from the Lukumi decision that the First Amendment of the UNITED STATES CONSTITUTION will most likely require Virginia to treat incorporated religious organizations in the same manner as it does non-religious type corporations, the matter has not been fully litigated. In addition, the General Assembly has not yet acted to amend Title 57 of the CODE OF VIRGINIA to recognize and accommodate incorporated religious organizations.

Accordingly, the most prudent action at this time for most religious organizations considering incorporation would be to hold off on incorporating until the General Assembly or the courts deal with these unresolved issues. Those religious organizations (and their lenders or other third parties dealing with them) that desire to assume the risks associated with the current uncertainty in the law, and incorporate at this time should consider protecting themselves by purchasing appropriate title insurance which is currently available. Once the aforesaid uncertainties have been resolved (especially if they are done in the manner anticipated in this article or in the manner proposed in 2004 Virginia House Bill 1466), incorporation will be the way to go for most Virginia religious organizations.

*Mark N. Reed is a principal in Reed & Reed, P.C., located in Luray, Virginia. His practice is concentrated primarily in the area of real estate and commercial law. He also serves as Vice President and Legal Counsel to the Virginia Synod of the Lutheran Church (ELCA) and many of its 166 congregations.

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End Notes

1 This two track system presents difficulty for those denominations such as the Lutheran, Episcopalian, or the Church of Jesus Christ of Latter Day Saints (LDS) that are neither strictly congregationally based nor hierarchical in nature. Such denominations generally end up having to choose the legal model that most closely resembled their polity. Thus, Lutheran and Episcopal congregations generally use the trustee model, and LDS congregations use the ecclesiastical officer model. As the Commonwealth=s religious community becomes more diverse with the growth of non-Christian religious bodies, this two structure model based on a traditional protestant/catholic division will most likely become even more out of date.

2 See CHARLES B. SANFORD, THE RELIGIOUS LIFE OF THOMAS JEFFERSON 30 (University Press of Virginia 1984) (citation omitted) (cited by Judge Moon in his decision in Falwell).

3 See VIRGINIA COMMISSION ON CONSTITUTIONAL REVISION, THE CONSTITUTION OF VIRGINIA: REPORT OF THE COMMISSION ON CONSTITUTIONAL REVISION 125 (A.E. Dick Howard, Exec. Dir., Michie 1969).

4 Charles L. Rogers, an attorney and chief charter examiner at the SCC, advised the author that since the Falwell decision makes no distinctions between stock and non-stock corporations, the SCC will issue a charter for a stock corporation to a religious organization if it filed the necessary articles of incorporation.

5 While it does not appear to be widely followed, VA. CODE §57-15 suggests that a congregation or religious body may have to have the circuit court's permission to "improve" its real estate, irrespective of whether or not the real estate will be encumbered to pay for the improvement. The consequences of not obtaining this approval are unclear.

6 The author has found the degree or level of proof required to obtain this approval varies widely between circuit courts. Some courts have preprinted fill-in-the-blank forms for the congregation to use, whereas others require detailed affidavits and supporting documentary evidence to substantiate the relief sought.

7 The following discussion concerning the relative merits of incorporation is based on the assumption that religious non-stock corporations will be treated in the same manner as non-religious non-stock corporations in Virginia. The author recognizes that at present there is no statutory provision in Virginia law indicating how such corporations will be treated. See the section of this article entitled "Unanswered Questions Regarding the Incorporation Option" for a fuller discussion of this issue.

8 But see Hawthorne v. Austin Organ Co., 71 F.2d 945 (4th Cir. ), cert. denied, 293 U.S. 23 (1934) (in which the Fourth Circuit Court of Appeals held that when the trustees of a church were authorized and requested to sign a contract for the purchase of an organ, the trustees were not personally liable for the debt).

9 The author has found that most congregations he has worked with only update their trustees at the time they are selling or refinancing property, or otherwise dealing with their property. VIRGINIA CODE §57-7.1 provides that transfers to religious bodies are valid provided the body is capable of securing the appointment of lawful trustees.

10 See VA. CODE §§13.1-812, -916.

11 H.B. 1466, 2004 Gen. Assem., Reg. Sess. (Va.).

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