Regulatory Oversight 2: Guide to Communities Considering Hospital Conversion in the Carolinas

Fiduciary Responsibilities of Not-for-Profit Hospital Boards
Almost all members of corporation boards, including those of not-for-profit firms, hold fiduciary duties. As outlined in the organization's articles of incorporation, the fiduciary duties of its not-for-profit board members are defined by the duties of loyalty and care. The duty of loyalty, designed to "ensure that only pure motivations drive business decisions," demands that the interests of the organization come before individual interests of board members. This obligation is aimed at curtailing activities such as illicit profit-making or competitive situations resulting from inside knowledge.2 The companion duty of care is used to hold board members to a standard of prudence in their decision-making. Decisions affecting the corporation must be made by its members with the care that would be taken by a similar person under similar circumstances and following the most reasonable assumption of the corporation's best interest.2 With respect to conversions, trustees and management have a fiduciary duty to ensure assets are used for purposes stated in the hospital's articles of incorporation and to ensure that conversion is in the hospital's best interest.

The Attorneys General in some states recently have been active in their use of these fiduciary duties to regulate hospital conversions. Specifically, an Attorney General may assess compliance with the duty of care by analyzing the process used to arrive at a conversion decision. Thus, an Attorney General might judge the fitness of a conversion based upon whether or not the decision was made with adequate information and/or appropriate use of a third party expert.2

While an Attorney General may challenge the legality of a conversion based upon adherence to the duty of care, to some extent the business judgment rule protects the decision-making of directors. Stated more clearly, the business judgment of directors in a decision generally will not be challenged or overturned by courts or shareholders, and directors will not be held liable for the consequences of a judgment.4 However, the business judgment rule may not apply if it is determined that the decision-making process was undertaken in bad faith or involved a conflict of interest. In the absence of this, it is assumed that the directors have complied with the duty of care, a presumption that must be disproved in a challenge to a decision based upon the violation of this fiduciary duty. Consequently, this strategy has not proven to be widely successful in reversing conversion transactions.2

While state Attorneys General may have the authority to review conversions on the basis of board members' adherence to fiduciary duties, practical use of this mechanism is somewhat limited. Because not-for-profit hospitals are not public institutions, decisions made by their boards are not subject to sunshine laws requiring public access to meetings and related documents; hence Attorneys General in the Carolinas may be only in a position to review transactions after they have taken place.2 In some cases, this enables the transactions undertaken by these boards to be completed quickly, with little opportunity for public input. However, relying on the authority to review hospital conversions if notified, the state Attorney General may increase the public's knowledge of the transaction terms by calling for a public hearing.

* While to date, public hearings never have been ordered by the Office of the Attorney General in South Carolina in connection with a hospital conversion, this clearly is an option should the need arise for greater public accountability.

The Role of State Attorneys General
Apart from nonprofit corporation statutes, the adoption of state-specific legislation in some states has further defined the role of individual state Attorneys General in the regulation of not-for-profit hospital conversions. Through mechanisms of notification and clearly defined areas for review and approval of these transactions, such statutes guide the process to assure that conversions protect charitable assets and reflect the best interest of the general public.

* As of December 1997, 24 states and the District of Columbia had enacted laws to regulate not-for-profit hospital conversion. Such legislation may apply not only to hospitals, but may also regulate conversions of health maintenance organizations (HMO's), insurers, or other charitable, tax-exempt organizations.

However, even in states without such legislation, the Attorney General generally serves as the protector of charitable assets, a role grounded in state statute, common law, or both. The ability of the Attorney General to act on behalf of the general public as a caretaker of charitable assets is termed parens patriae authority.4 This authority is further enhanced by state charitable trust laws allowing the Attorney General to review hospital conversion transactions to determine the appropriate use of assets based on the charitable intent of the donor.2

It has been observed that "the single most important determinant of the outcome of a conversion is the regulator—in particular, his or her philosophy, politics, political independence, aggressiveness, commitment, and willingness to take risks."9 Attorneys General in North Carolina and South Carolina hold both common law and statutory authority to undertake such a review. In other states, the basis on which individual Attorneys General may review hospital conversions varies widely, ranging from the enforcement of trustee compliance with fiduciary duties to a review of the health impact of hospital conversion upon the affected community.

In the Cape Fear Memorial Hospital case, several of the principal negotiators for the hospital suggested their conversion received more scrutiny than similar past arrangements. Not only was the asset purchase agreement reviewed by the Attorney General to determine whether it represented fair market value, but the ultimate sale of the assets was delayed until approval of the arrangement was obtained. Attorney General Easley approved the formation of the Cape Fear Memorial Hospital Foundation after his review of the intended use of the hospital's resulting charitable assets. This review further included stipulations by the Attorney General that the board of the newly created foundation not have a majority of its members taken from the old 501(c)(3) hospital board. Thus, the Cape Fear Memorial Hospital conversion represented an expansion of the role of the Attorney General in the review of not-for-profit hospital conversions. The North Carolina Attorney General's Office presently is reorganizing its handling of hospital conversions and is seeking to hire a lawyer to focus on these issues, suggesting an even greater future role in the review and approval of conversion arrangements.

The South Carolina Attorney General's Office currently reviews proposed conversion agreements based on charitable trust law. Such reviews typically focus on 1) due diligence of trustees; b) any evidence of self-dealing, and c) whether the proposed use of charitable assets is consistent with the original intent. Parties requesting review and approval may be asked to finance the costs of the independent valuation for use in this review, as the Office currently does not have funds appropriated for this purpose.

In late 1997, the National Association of Attorneys General (NAAG) adopted a resolution to focus state attention upon the protection of charitable assets in conversion transactions. In doing so, the NAAG formalized its position that charitable trusts "are not private business entities, an that the public, therefore, has a greater interest in how those trusts are treated because of its investment in them and its reliance on their services." To this end, the NAAG has established that the central role of its individual state Attorneys General is "to protect the public's interest in these institutions by enforcing charitable trust laws." In March 1998, the NAAG issued a draft of model legislation for use as a framework by individual states confronting these issues. Section VIII outlines many of the considerations in the review process currently used by individual state Attorneys General and recommended by NAAG.14

REGULATING PUBLIC HOSPITAL CONVERSIONS
A large focus of the conversion debate has been the movement of not-for-profit hospitals to for-profit sector; yet, at the same time, large hospital systems are expressing considerable interest in investing in the potential of the nation's county hospitals. A recent study determined that public hospitals were more likely than nonprofit or for-profit hospitals to convert, with study data counting public hospitals as almost 32% of all hospital conversions resulting in a change in ownership status between 1990 and 1993.

In response to this activity, some states have enacted legislation to regulate the conversion of public hospitals, such as North Carolina's 1983 enactment of the Municipal Hospital Act. Various provisions seek to ensure an equitable transaction, including those mandating disclosure of terms and notification of public hearings, the adequate consideration of bids, post-conversion provision of patient care and mechanisms for compliance monitoring. In contrast, South Carolina currently has no similar law regulating hospital conversions (although bills proposing regulation of the sale or transfer of these hospitals have been proposed in the 1997 session of the General Assembly). However, even in the absence of a specific statute to govern the sale or other conversion of public hospitals, these transactions may be covered, to some extent, through components of other laws such as each state's Freedom of Information Act (FOIA).

Notification of the General Public
The potential for public awareness and oversight in the conversion of public hospital facilities is guaranteed both through the broad application of individual state "sunshine laws" (FOIA requirements for open meetings and access to public records), and specific state laws governing the sale or other conversion of public hospitals.

State Freedom of Information Acts
Individuals interested in following or becoming involved in the conversion decisions made by the governing boards of public hospitals may do so, in part, by attending meetings of the regulatory body (e.g. county council) making these decisions. State laws (including North and South Carolina law) dictate that all official meetings of public bodies be open for public attendance. North Carolina law further specifies that the governing board of a public hospital is considered a "public body" under this law, as well as the governing board of any nonprofit corporation to which a public hospital has been sold or conveyed in accordance with the state's Municipal Hospital Act.

Open meeting laws may specify that certain meetings may be closed to the public for designated reason, generally to protect confidential communication by legal counsel (attorney-client privilege), or discussion of confidential information in connection with contractual arrangements such as a bid or other business proposal. When meetings are closed, its minutes will only be a matter of public record if they do not jeopardize the purpose of the closed session. However, while a meeting may be closed to the public, formal action such as taking a final vote may not be taken in closed session, thereby increasing public knowledge and the accountability of public officials.

Public participation in such meetings is protected further by statutes in both North Carolina and South Carolina mandating that the public receives advance notice of the regular meetings of public bodies. Included in the statutes are provisions for notification of the news media and the posting of written notice in the office or meeting place of the public body.

Similarly, as entities supported by taxes paid by the general public, and therefore the "property of the people," most government records and information are available to the public, subject to certain limitations. Under this authority the public may have access to copies of proposals and other documents related to the sale of public property (e.g. a hospital facility). Certain matters may be specifically declared public information, such as, according to the South Carolina statute, "Information in or taken from any account…or contract dealing with the receipt or expenditure of public or other funds by public bodies."

In addition, the minutes of all proceedings of public bodies are matters of public record in North Carolina and South Carolina, (with the exception of those meetings specifically designated as closed to the public). As with public meetings, public documents may be withheld from public disclosure if they are considered confidential communication between legal counsel and a public board or agency. Requests for copies of public records will receive, as soon as reasonably possible, a response regarding whether the request has been granted. Despite their accessibility, the time frame in which these documents may be available to the public has been the source of frustration for those seeking the details of such agreements.