Mid-Atlantic Health Law TOPICS

Public to private hospital conversions have grabbed headlines in recent months. Not surprisingly, these sales of not-for-profit hospitals to for-profit hospital chains have also generated governmental responses, including new legislation and regulation.

The conversions are fueled by many factors. Some not-for-profit hospitals believe that they cannot compete in the new health care arena. These charitable hospitals believe that the giant for-profit chains will be better able to close or to consolidate services, compete for contracts and serve their communities.

Other not-for-profits believe that they need to convert their bloated debt to equity. By going
public, a formerly not-for-profit hospital can raise money from the public to pay off debt, or raise
capital from the public for expensive information systems or other new technology.

Perhaps some hospital administrators are seeking for-profit conversion to earn equity in their hospitals. An administrator of a for-profit hospital can obtain options to buy the stock of the for-profit company that runs the hospital, while an administrator of a not-for-profit cannot.

Whatever the motivation, the conversions are occurring, triggering significant legal issues, and
causing significant legal responses.

A. Legal Issues Raised

Both state and federal law require the proceeds from the sale of not-for-profit, tax-exempt assets to be used for charitable purposes. Moreover; the public often believes that charitable assets belong to the community rather than the hospital. Accordingly, the community, the Internal Revenue Service, and the state attorneys general are all stakeholders in hospital conversions.

Furthermore, while for-profit hospital directors maintain the traditional fiduciary obligation to
negotiate the best deals they can for their hospitals, some believe that these directors should also get the best deal they can for the public.  This latter obligation often involves assuring that community needs, such as indigent care, are met.

Concerns also are raised about permissible uses for the proceeds resulting from the sale of not-for-
profit assets, and whether such proceeds will be used to serve a public purpose, such as the community's health care needs, rather than simply to enrich private individuals or organizations.

For all of these reasons, when a not-for-profit "strays from its charitable purposes, the state often
feels compelled to step in to preserve charitable assets.

B. Legal Responses

Responses to for-profit conversion activity are coming from the various state attorneys general and
legislatures. The common goal is the protection of the public's interests by assuring the proper
continued use of the charitable entity's assets.

In March, the National Association of Attorneys General recommended state legislation to improve
notice to the public and to state attorneys general of proposed conversions. This group unanimously endorsed written disclosures, public involvement, attorney general review, protection against excessive compensation to trustees, and safeguarding the value of charitable assets.

In addition, this year alone, approximately 20 states considered legislative proposals related to
not-for-profit conversions.  Most of these proposals require that the terms of the transaction are fully disclosed to the public, that the proceeds of any sale stay in the community, and that the not-for-profit realizes fair value for the sale.

More specifically, on January 1, 1997, California strengthened its authority over conversion, or sale,
of not-for-profit providers to for-profit entities. A key element of the California response is the
requirement for public hearings for all for-profit hospital conversions. In addition, the California
Attorney General must affirmatively consent to a conversion or merger of a not-for-profit hospital
with a for-profit entity.

Georgia, Arizona, and Virginia laws regulating conversions of non-profit hospitals also took effect
this year. These states require attorney general "review" of not-for-profit to not-for-profit
transfers, as well as not-for-profit to for-profit transfers. However these attorneys general must
initiate an action to stop a transfer; unlike the situation in California where a conversion cannot
proceed without attorney general approval.

On the federal level, Congressman Stark of California has requested that the General Accounting Office collect and disseminate data on how not-for-profit foundations are fulfilling their charitable
missions after they have sold their hospitals to for-profit companies. Congressman Stark also has
considered introducing legislation requiring Office of Inspector General notice and approval of such
conversions.

Although additional federal scrutiny of not-for-profit conversions would not be totally unexpected,
the health care industry can assuredly expect additional and more aggressive responses from state
legislatures and state attorneys general.

For more information, please contact:  Barry F. Rosen