Foreclosures—Religious Corporations Law Section 12(9)—Mortgage Deemed Invalid—Lacked Proper Corporate Resolution and Prior Approval of the Attorney General or a Court—Record Unclear as to Whether the Mortgage Was In The Best Interests of the Congregation and Furthered Its Corporate Purposes

A plaintiff moved for, inter alia, a summary judgment dismissing a defendant church's (church's) answer, and for an order pursuant to Religious Corporations Law (RCL) §12(9), confirming a previously executed mortgage. The plaintiff also moved for an order confirming a referee's report reforming the mortgage “nunc pro tunc from its execution, to include the full legal description” and granting a judgment of foreclosure and sale. The church cross moved for an order declaring that the subject note and mortgage were unenforceable, null and void, denying approval of the mortgage as it is not “in the best interests of defendant” and dismissing the complaint with prejudice.

The plaintiff had commenced a foreclosure action on a mortgage which encumbered the church's property. By a deed dated July 3, 1996, the property had been conveyed from an individual to the “Grace Christian Church, a California corporation….” There is no recorded deed further conveying the property to anyone else.

On Nov. 13, 2007, a mortgage on the property was given by “GRACE CHRISTIAN CHURCH, A New York Religious Corporation,…in favor of the plaintiff” to secure a $350,000 note. At the time, the property had been encumbered by a mortgage in favor of “American Church Mortgage Company (ACMC).” Pursuant to the terms of the note, the church had to make monthly payments of interest from Dec. 13, 2007 through the maturity date of Nov. 13, 2008, unless the maturity date was extended for one year. To obtain the one-year extension, the church had to give prior notice to the plaintiff, and pay an extension fee in the amount of $7,000. The note required that the church deposit with the plaintiff $56,000 from the loan proceeds, for payment of interest for the first year.

The plaintiff alleged that on April 30, 2010, the church defaulted on the note by failing to pay the entire balance due. The church alleged that the mortgage had been executed without the consent of the Attorney General (AG) as required by the RCL and that the loan was usurious.

The plaintiff had moved for inter alia, summary judgment, an order of reference and an order authorizing the mortgage nunc pro tunc pursuant to RCL §12(9). The motion had been granted on Sept. 6, 2017 and, a referee had been appointed to compute. The church thereafter moved to vacate the referee's order and reinstate the answer. The plaintiff moved for an order confirming the referee's report and for a judgment of foreclosure. The court had granted the church's motion, vacated the prior order and judgment and restored the prior summary judgment motion to the court's calendar.

The church then cross moved to dismiss the complaint, arguing that the mortgage was invalid since the defendant was not the “true title owner of the property, that the mortgage is invalid as the transaction never received approval from (the church's) congregation as required by RCL §200, that the mortgage is invalid as it was not approved by (the church's) board of directors, that the mortgage should not be retroactively approved as it was not in the best interest of (the church's) congregation and that the instant action is precluded as plaintiff failed to comply with the condition precedent of serving a notice of default.”

RCL §12(1) “provides that in order to sell or mortgage any of its real property, a religious corporation must apply for, and obtain, leave of court pursuant to Not-For-Profit Corporation Law (NFPCL) §511…. 'The purpose of such requirement is to protect the members of the religious corporation, the real parties in interest, from loss through unwise bargains and from perversion of the use of the property'….” Where court approval is not obtained for the transfer of real property from a religious corporation, the conveyance is invalid….”

The church was “a religious corporation subject to the requirements of RCL §12(1),” which had mortgaged it property without leave of court or approval from the (AG). However, pursuant to RCL §12(9), “the court may authorize a mortgage 'if it shall appear, to the satisfaction of the court, that the consideration and the terms of the transaction are fair and reasonable to the corporation and that the purposes of the corporation or the interests of the members will be promoted' (NFPCL §511(d)).”

The church's pastor and president of its board of directors (board) had testified in a deposition and had submitted an affidavit on a prior motion. The pastor had stated that (church) “was experiencing financial difficulties due to decreased contributions from parishioners and that (the church) needed a short term loan in order to assist in paying the existing ACMC mortgage on the property and to make repairs.” The pastor had also explained that the subject loan proceeds were used to make payments on the ACMC mortgage and to pay other expenses such as “energy, bills, salaries and upgrades.”

The pastor had further explained that in or around May 2007, he had been advised by a mortgage broker (broker) to obtain a “short-term 'bridge loan' to pay expenses while he pursued permanent refinancing of the existing ACMC mortgage.” The loan proceeds were to be utilized for retaining a “proposal writer/development specialist,” “daycare furnishing & setup,” “commercial kitchen equipment,” “fitness club set up & equipment,” “media/web promotion & advertising,” “set up offices for rental,” “administrative assistant” and “administrative overhead.” The pastor and two other members of the board had “executed a corporate resolution authorizing (the church) to borrow $300 million.”

The pastor alleged that he was surprised at the closing to see loan documents for a $350 million loan, since only $300 million had been authorized by the corporate resolution and that notwithstanding the $350 million figure, the church would receive only $253,794 in cash proceeds and that a 16 percent interest rate would be charged. The pastor asserted that the corporate resolution. had been “altered at the closing to increase the amount to $350 million” and although he initialed the change and signed the resolution at the closing, “the alteration was not initialed, signed or approved by the other two board members.”

The pastor characterized the subject mortgage transaction as a “sham” and a “bait and switch.” He alleged that he had been “deluded and pressured” by the broker into “taking on an ill-advised short term high interest balloon loan, relying on (the broker's) representation that the mortgage would be satisfied through refinancing.” The pastor also alleged that the “attorney hired by plaintiff to represent (the church) at the closing never consulted (the pastor) or anyone else concerning what corporate or judicial approvals were necessary to authorize the mortgage and otherwise did not serve (church's) best interest in the transaction.”

An appellate court decision enunciated a “two-prong test in determining whether a conveyance should be ratified under RCL §12(9):”

First, the court must determine that the terms…of the transaction were not unwise. In assessing the prudence of the bargain,… the court should look to the conditions prevailing at the time it was struck… the second prong of the test requires the court to determine that the sale would benefit the corporation or that the best interests of its members would be promoted thereby… the court may consider whether corporate purposes would have been served or the best interests of the membership promoted at the time the contract was made, but it should be guided primarily by whether those ends would be realized in light of conditions prevailing at the time the issue is presented to the court….

The court noted that an “infusion of cash” was apparently necessary to pay expenses relating to the property and certain other expenses. Since there was a one-year interest reserve, the loan did not require any immediate payment of monthly interest. The church also had the opportunity to extend the loan for one year for a $7,000 fee, giving the church additional time to seek refinancing before the indebtedness would become due.

The court stated that the “probability that refinancing would have been readily available in one or two years following closing cannot be determined from the record. If a sensible refinancing option was not realistic, the subject mortgage loan was doomed to failure as (the church) faced the obligation to make a substantial balloon payment on the maturity date in addition to its continued liability under the existing ACMC mortgage.” The court was also concerned about the alteration of the corporate resolution, which had apparently not been authorized by the two other trustees, nor was there evidence that the loan was approved by the congregation.

RCL §200 provides, in part, that “the trustee of an incorporated church to which this article is applicable, shall have no power…, or without the consent of a corporate meeting to incur debts beyond what is necessary for the care of the property of the corporation”. Decisional precedent held that the “phrase 'incur debts' includes entering into a mortgage which encumbers the property of a religious corporation and that… the trustees of a congregational church have not power to mortgage its property without the consent of its members….”

The court further held that “nunc pro tunc approval of a $350,000 mortgage, with a 16 percent rate of interest and default interest rate of 24 percent, upon which it was previously determined that the amount of indebtedness due and owing as of Nov. 30, 2017, exceeded ($1,000,000), would not be in (the church's) best interest as it would likely result in the loss of its house of worship in foreclosure.” The court cited judicial precedent which held that a transaction would not further the purpose of a religious corporation, where the transaction would leave a religious corporation without a house of worship.

Accordingly, the court refused to grant nunc pro tunc approval to the subject mortgage and declared the subject mortgage invalid under RCL §12(1). Thus, the court denied the plaintiff's motion to approve the mortgage, without prejudice “to seek any remedy available at law.” The court noted that a “creditor may sue upon a debt irrespective of the security” and that “an action may be brought upon a bond secured by a mortgage without reference to the mortgage.” The court granted the church's cross motion for summary judgment.

Comment: Generally, in New York, religious institutions cannot enter into mortgage or sale transactions without the approval of the AG or a court. Real estate transactions with religious corporations have involved inter alia, litigation involving internal disputes among members of the congregation as to a proposed transaction as well as disputes with sellers, lenders and developers. Occasionally, the AG or a court has refused to approve a transaction when the transaction was viewed to be contrary to the interests of the congregation.

Many religious institutions, throughout this country, are struggling with declining congregations and revenues, and rapidly escalating costs to maintain very old properties that suffer from structural and/or mold, roof, window, plumbing, electrical, HVAC (heating, ventilation and air conditioning) problems. When buildings drain a congregation's financial resources, the congregation has less funds to support and further their religious mission. There is less money to feed the poor, help the homeless, children and elderly.

Some congregations that were located in poor, blighted neighborhoods became “land rich” because of “gentrification,” urban renewal, etc. Thus, many congregations have sought to sell, mortgage, lease, rezone their properties or enter into joint venture agreements to develop their real estate. This is why the AG and the courts have seen a significant increase in number of requests for approvals of transactions, pursuant to the RCL.

While it is important that the AG and the courts review these transactions to assure that they are in the best interests of the congregations, and to protect congregations from fraudulent or unwise transactions, it is also important that the AG and courts respect congregations' rights to determine how best to further their religious missions. Government may not impermissibly interfere with congregations' rights under the Free Exercise Clause of the First Amendment. These cases will be determined based on the specific facts of each case. For instance, was the congregation represented by experienced counsel, were real estate values supported by an independent appraisal and were the terms of a proposed transaction “market” terms.

John T. Walsh Enterprises LLC v. Grace Christian Church, Supreme Court, Kings Co., Case No. 10885/10, decided Feb. 28, 2019, Partnow, J.

Scott E. Mollen is a partner at Herrick, Feinstein.