Use of Proceeds 2: Guide to Communities Considering Hospital Conversion in the Carolinas

What Type of Foundation Should be Created?
The majority of foundations established by not-for-profit conversions are classified as private foundations. A (501)(c)(3) private foundation is one whose primary function is to make grants, rather than to operate its own programs.2 Funded primarily from one donor, the private foundation generally does not raise funds from the public. Annual charitable expenditures of the private foundation must equal five percent of the market value of their assets annually, and its net investment income is subject to a 1 to 2 percent excise tax.7

According to a 1997 status report, public charities are the second largest group of foundations. Public foundations are required to meet a public support test (raising a substantial portion of their resources from general public fund-raising or from the government), but they are not bound by annual giving requirements.2 Generally, conversion proceeds generate the endowment of a foundation, which would, in turn, generate annual public support, a feat few foundations borne of conversions are likely to be able to achieve.7 Other types of conversions include supporting organizations, which receive grant-making, investment and administrative assistance from a relationship with an existing public charity, and social welfare organizations which, classified under section 501(c)(4), are allowed to engage in otherwise disallowed lobbying activity.1

Allowable Use of Charitable Assets: Cy Pres Doctrine
In addition to trust law, the assets of a charitable, not-for-profit hospital are maintained in many states based upon the common law doctrine of cy pres. Derived from the French words for "as near as possible," cy pres is the doctrine stipulating that, when a charity becomes impossible or impractical to fulfil, the assets of that charity will be used to fulfill another effort whose charitable purpose is as close to that of the original as possible.

In principle, the cy pres doctrine may apply in the case of hospital conversion when the apparent necessity of conversion indicates that the mission of a not-for-profit hospital is no longer possible to fulfill. Thus, cy pres would require that the charitable assets of the hospital be used to continue to serve a mission as close as possible to their original charitable purpose, often through use in a foundation whose focus is also health care. Such use of the charitable assets is clearly very similar to the original intent of the funds long-used in support of the not-for-profit hospital. As a practical matter, cy pres is rarely used to mean the same thing and also is rarely strictly enforced.

What is the Role of Cy Pres in North and South Carolina?
North Carolina adopted the cy pres doctrine in 1967, allowing courts to broadly direct charitable funds for other charitable uses. In South Carolina, however, the courts have consistently rejected cy pres, favoring, instead the doctrine of equitable deviation, a stricter interpretation leaving intact as much of the original charitable intent as possible. Adhered to strictly, this doctrine would imply that a hospital conversion foundation could not elect to undertake a non-health purpose without court approval. However, because equitable deviation has not been tested in the courts for hospital conversion, it is not clear what implications this would have for foundation mission.

* In our case studies, several conversion foundations have emphasized areas other than health for grant-making, including education, the arts, and economic development. Although these are clear instances where the foundation elected to adopt a broad mission rather than a strict health focus, in no case did the board of the foundation or hospital seek court approval through a cy pres proceeding for their change in mission, seeking, instead, other means for this transition.

Can the Mission of a Foundation Focus on Issues Other Than Health?
In the initial stages of conversion foundation development, it clearly is important to define an appropriate mission for the use of the charitable assets, to be set forth in the foundation's articles of incorporation. In the context of a not-for-profit conversion, the change in nature of the charitable assets is approved by the state Attorney General, who is notified according to provisions in the state's Nonprofit Corporation Act. At this stage, the use determined for the charitable assets may be broad (broader than use for the strict purpose of hospital care), a level to be determined by the Attorney General.

However, if, at a later date a foundation wants to broaden its mission, it must seek court approval to alter the use of charitable funds, based on the application of cy pres or equitable deviation. Approval for such a change may be based upon analysis of the original intent of the charitable assets; the practicality of continued adherence to this purpose, and the proposed alternative use of charitable assets. The Attorney General of a state is automatically a party to such a proceeding.6

If, in reviewing the case, the court finds that the original intent of the charitable assets cannot be maintained in their current form, the court may permit other more broad uses for the assets. This may be the case in the conversion of a hospital whose charitable assets are guided by a mission statement that reflects the narrower scope of health of the era in which it was written.5 However, the court may only have cy pres authority if it is determined that the original intent of the assets was the general public benefit, and that no provision in the original bequest specifies the return of assets to the donor or his successors in the event of the failure of that trust.13 Thus, the court may, among other possibilities, revert funds to the original donor or dictate a new use for the charitable assets, such as transferring the assets to another hospital providing similar services. Consequently, the permissible focus of the resulting foundation will depend upon the court's interpretation of past intent of the assets.5

* Each of the six foundations formed in the hospital case studies specified health care as at least part of its mission. Community health was most often the focus, to be targeted through prevention and wellness programs. The Sisters of Charity Foundation (the result of the Providence Hospital conversion) is committed to addressing the needs of the poor and underserved by understanding the root causes of poverty and nurturing the growth of healthy communities, among other things. Thus, health is one of many possible areas of foundation giving (see Table 11).

What Has Been the Charitable Focus of Most Foundations?
Although there is much controversy as to how close to health the mission of the foundation must be,7 as a practical matter, most charitable conversion foundations have broad discretion in the use of their grant-making funds. Nevertheless, according to a recent survey, the majority of foundations created as a result of not-for-profit hospital conversions spent all or a portion of their assets for health-related projects, including health promotion and disease prevention. In this way, the foundation may reach beyond hospital care to address the health needs of a population that may not necessarily seek services through the hospital. However, across the nation, foundations have focused on a wide range of areas, including community services, scholarships and loans for medical education, arts and cultural development, job training and domestic violence prevention programs.2 While not directly funding health care, a focus on social issues of importance to the community may have a great impact on a broader public health level.

This matter is clearly an issue of public concern, prompting several to recommend (see Section VIII) that decisionmakers take into account whether the health needs of the community will be addressed by a proposed agreement and resulting use of assets. However, until further clarified through law, this decision will have to be made on a community-by-community basis.

Table 11

Is There Potential Conflict of Interest Between the Foundation's Mission and the Work of the New Hospital?
The degree to which the work of the new foundation is distinct from the care provided by the acquiring hospital has been a source of great controversy for conversion foundations finding their footing.7 In developing a mission, there is clear potential for its grant activity to benefit the for-profit hospital. For example, a foundation whose mission would be to fund health care for uninsured people, would clearly help to alleviate the burden of uninsured care normally carried by the hospital. While some recommend limitations on the foundation's direct or indirect benefit or an acquiring entity (particularly for a for-profit corporation), individual state laws determine the legality of such a relationship. Currently, legislation in neither North Carolina nor South Carolina addresses this issue.

* In the case studies, most of those interviewed explicitly stated that the purpose of the foundations was not to provide indigent care after conversion. Instead, most had developed a proactive approach to health through focus on prevention and wellness.

Should the Foundation's Mission Statement Rely on Community Input?
A mission statement, when properly written, is a mechanism of oversight that allows the board of the hospital to specify implicitly the way in which this money will be used. While a strong mission statement should allow a foundation to guide the flow of funds, it should not be so narrow as to unnecessarily limit related projects.

To ensure the effectiveness of a foundation, some suggest that the mission statement be developed during the conversion process, to heighten general public awareness and obtain input. By including the proposed articles of incorporation of the foundation as a topic for discussion in a public hearing7, the public's input and ideas may help guide the foundation's efforts to coincide with community needs and anticipated changes in the availability of services. How Can the Community Have Input Regarding the Foundation Mission?
Allowing the public an opportunity for input into this process is particularly fitting for the development of a conversion foundation, given the long-term community investment into the charitable hospital whose assets now have a new purpose. 7 Stimulating communication among differing constituencies may be the best assurance that a foundation will focus of the issues the community believes are important. In determining this focus, decision-makers may gain local perspective by consulting among others, officials of state and local public health agencies, government and schools.7

* The case study foundations exhibited a broad range of community involvement as they determined their missions. Byerly Hospital helped to fund a community needs assessment in addition to working closely with the city in a joint on-going community planning process.

However, it is difficult to determine from this limited evidence whether widespread community involvement plays an important role in determining a conversion foundation's mission. Whether or not this is true, broad community input may help community members feel less concerned about the sale of their not-for-profit hospital and increase the potential for public support of the transaction.