Constructive Trust Remedy

When a nonprofit health care institution converts to for-profit status, the law requires that the charitable assets – equal to the full fair market value of the nonprofit institution – be transferred to another charitable organization with similar nonprofit purposes. In most cases, the assets are used to endow a new charitable foundation. However, if no charitable set-aside occurs, a court may impose a constructive trust remedy to ensure that charitable assets are transferred to their rightful owner, the public.

What follows is a summary of the remedy explaining how it might apply to a health care conversion. The constructive trust remedy is a common law doctrine, meaning that it is based on court decisions and it can vary from state to state. Thus, you must research the laws of your state carefully and seek professional legal advice to fully understand how the remedy applies.

What is the constructive trust remedy?

First, what is a trust? A trust is created when one party holds property for the benefit of another party (a "beneficiary"), generally for a specified purpose. A constructive trust is a temporary trust created by a court when a beneficiary has been deprived of property that rightfully belongs to him or her.

The constructive trust remedy prevents a person (including a corporation) from benefiting unfairly at the expense of another person or corporation. The remedy forces the person to return the property, The constructive trust remedy is based on principles of restoring fairness or "righting a wrong," and it is used by the courts when other legal principles are not adequate to correct the problem. In legal terms, this is known as an "equitable remedy."

When a person wrongfully possesses another's property, it is called unjust enrichment. Unjust enrichment is the underlying factor present in all constructive trust claims, whether or not there was wrongful conduct. Unjust enrichment without wrongful conduct is the simplest scenario because no evidence of actual wrongdoing is required to bring the claim. Instead, a court could impose a constructive trust based on the existence of unfairness alone.

In other cases, unjust enrichment is coupled with some type of wrongful conduct. Some types of wrongful conduct include fraud or breach of fiduciary duty. For example, fiduciaries of nonprofit corporations (directors, officers and executives) may not benefit financially from the operation of the nonprofit (referred to in legal terms as "private inurement"). However, in some conversions, board members of the nonprofit corporation have received huge bonuses, compensation, stock options or other forms of illegal private inurement when they converted a nonprofit corporation to for-profit status. In those situations, a court could impose the remedy to recover assets that were wrongfully pocketed by private individuals in violation of their fiduciary duty to the nonprofit.

When can a court impose the remedy?

A court can impose the constructive trust remedy after a nonprofit corporation converts to for-profit status. For example, suppose a nonprofit seeks and receives regulatory approval of a conversion transaction, but does not preserve its charitable assets for the benefit of the public through a set-aside or transfer to another charitable organization. Subsequently, regulators realize that the nonprofit has failed to fulfill its charitable obligations and the regulator files a claim seeking to recover those lost charitable assets. A court could impose the constructive trust remedy to return those assets to their rightful owner – the public.

Blue Cross and Blue Shield of Kentucky's ("BCBSKY") conversion to for-profit status illustrates this concept. Prior to 1987, BCBSKY was incorporated as a nonprofit hearth services corporation. In 1987, BCBSI became a mutual insurance company with nonprofit purposes. In 1993, BCBSKY merged with Anthem Insurance Companies, Inc., a for-profit mutual insurance company. BCBSKY and Anthem consummated the merger without any charitable set-aside to the public. Subsequently, the Department of Insurance requested that the Attorney General conduct an investigation into the merger, even though the Department had already approved the deal. In response, Anthem filed a lawsuit against the Attorney General and the Department, alleging that the merger investigation exceeded the regulators' scope of authority. Consumer groups urged regulators to broaden the investigation in order to consider, among other things, whether the charitable assets of the former nonprofit health services corporation were preserved to benefit Kentucky residents. The Attorney General filed a lawsuit against Anthem seeking to recover millions of dollars in charitable assets that Anthem absorbed when it merged with BCBSKY. Among the claims, the Attorney General asked the court to impose a constructive trust on Anthem and ordered the company to return the assets to the people of Kentucky. The lawsuit finally settled and Anthem agreed to place $45 million into a newly created 501(c)(3) foundation that funds the unmet health care needs of Kentuckians.

Another illustration of the constructive trust remedy as applied to health care conversions is the conversion of Blue Cross and Blue Shield of Georgia ("BCBSGA") to for-profit status. BCBSGA was originally incorporated as a nonprofit corporation. Until 1995, Georgia law provided that the full fair market value of a nonprofit’s charitable assets is held in trust for the benefit of the public. Upon conversion, Georgia law supported the distribution of the full fair market value of a nonprofit's charitable assets to other nonprofit charitable organizations serving similar purposes as the converting corporation. However, in 1995, the Georgia General Assembly changed Georgia's nonprofit law and allowed private investors to buy BCBSGA without a charitable set-aside. In the fall of 1997, eight Georgia consumer groups filed a lawsuit against BCBSGA, its holding company Cerulean Companies, Inc., and the Department of Insurance. The consumer groups sought a judgment requiring that the fair market value of the company be returned to the public based on the constructive trust doctrine. Ultimately, this litigation was settled by the parties, resulting in the establishment of a new foundation in Georgia with an endowment of $124 million.

Challenges to the imposition of the constructive trust remedy:

Several defenses may prevent a constructive trust claim, including the running of the statute of limitations, laches, and equitable estoppel.

• Statute of Limitations — These are laws that require a person to file a lawsuit within a certain amount of time.
• Latches — Means that a party cannot use the constructive trust remedy if they have waited so long to raise a claim that it would be unfair to permit recovery.
• Equitable Estoppel — Prevents a claim of unjust enrichment if the person seeking the remedy has concealed facts, made false representations, or engaged in other similar misconduct in an attempt to distort the facts.

The nature of these defenses varies by state, and the application of the constructive trust remedy to health care conversions may be new in your state. Thus, please consult your state's laws on these topics to determine the applicability to the health care conversion you are monitoring.