Nonprofits and Financial Trouble: Understanding the Bankruptcy Option

by Professor Brian Link

Severe financial distress has become part of the landscape for faith-based nonprofits in recent years. Nonprofit leaders, whether they are potential bankruptcy filers or bankruptcy creditors, should be familiar with basic concepts of bankruptcy and its impact on nonprofits.

Planning for Uncertainty

Faith-based nonprofit leaders know all too well that the financial future is “extraordinarily uncertain,” in the words of Federal Reserve Chairman Jerome Powell.  

The wise nonprofit leader should plan for this uncertainty by educating him or herself on the full spectrum of possible financial outcomes, including severe financial distress, and the organization’s options in each case. Doing so will inform the organization’s strategy and strengthen its ability to prevent a worst-case outcome.  

A first step toward this self-education is understanding the “worst-case scenario” response strategy—bankruptcy. Whether the nonprofit itself is a debtor or creditor, bankruptcy is likely to become a more significant part of the financial landscape for nonprofits, so taking the time to learn the fundamentals is a worthwhile investment.  

Why might a nonprofit consider bankruptcy?

The primary benefit of bankruptcy, particularly in Chapter 11, is that it allows the entity’s mission to continue in some manner.  

A chapter 11, or reorganization, bankruptcy can provide an organization room to breathe while continuing to operate and conduct its activities. If the organization’s financial pressures are too great to be managed through a reorganization, a chapter 7 can allow the organization to liquidate and dissolve in an orderly fashion.  

Some real-world examples of nonprofits which have undergone bankruptcy filings include diverse organizations ranging from retirement  communities and housing nonprofits to museums and theaters to Boy Scouts of America and  certain  Church  dioceses.  

Strategic Decision Making

Learning about bankruptcy is useful both for leaders of financially sound nonprofits and nonprofits in financial distress.  

For healthy organizations, a proper understanding of bankruptcy can empower leaders to make strategic decisions and develop strong relationships with creditors so that a bankruptcy does not become necessary. For organizations which are facing severe financial distress, understanding the types of bankruptcy filings and the benefits of each can help the organization respond to their financial crisis in a way which best protects the organization’s mission and the people they serve.  

To learn more about the circumstances in which a nonprofit may wish to consider filing for bankruptcy, and about what a nonprofit can do to avoid bankruptcy, check out Napa Legal Institute's recent whitepaper on bankruptcy and nonprofit organizations for an overview of this complex and always-evolving area of law.  

_______________

Professor Brian Link is assistant professor of teaching of business law at Pepperdine University’s Seaver College. Professor Link is an experienced legal professional and consultant who has worked in litigation, transactions, and appeals. Prior to joining the faculty at Pepperdine University, Professor Link worked for seven years in private practice in California, focusing on bankruptcy and restructuring. Professor Link’s research interests include business law, contracts, bankruptcy, constitutional law, space law and future technologies, and legal pedagogy. Any views expressed in this article are his own.