Preserving the Charitable Trust: Nonprofit Hospital Conversion in Texas

July, 1998

Preserving the Charitable Trust:
Nonprofit Hospital Conversion in Texas

This article was written by the Consumers Union Southwest Regional Office.

Executive Summary

Nonprofit to for-profit hospital and health plan conversions represent the transfer of hundreds of millions of charitable dollars out of the public domain and into the hands of big corporations and their investors. Consumers Union Southwest Regional Office (CUSWRO) studied five hospital transactions valued at about $444 million: the sale of one public hospital and three nonprofit hospitals to for-profit corporations, and one joint venture between a nonprofit hospital and a for-profit corporation.

We reviewed tax returns, annual reports, and news reports, and attempted to gather actual transaction documents. We interviewed nonprofit hospital administrators, foundation board members, and members of the public interested in the transactions. From these sources we developed a snapshot of nonprofit hospital conversions in Texas, the information publicly available, and the disposition of the assets.

Findings

Nonprofit hospitals do not release to the public (and therefore would not release to CUSWRO) actual documents related to the transaction, such as the sale agreement, management agreements, valuation estimates, or compensation arrangements. Without access to transaction documents, we were unable to evaluate whether for-profit corporations paid an appropriate price for the nonprofit assets they purchased or control (see all case studies except for Northwest Texas Hospital). The state's Nonprofit Corporations Act requires "all records, books, and annual reports of the financial activity of the (nonprofit) corporation" to be public. A nonprofit's conversion to for-profit status is probably the single most important financial action a board can take, and transaction documents should be available to the public.
Currently, nonprofit hospitals notify neither the Attorney General nor the public about a pending transaction, and negotiations with a for-profit buyer are held in secret (see case studies Providence Memorial Hospital and St. David's Health Care System).
While some foundations created from the disposition of the sale proceeds continue to support health projects in the community, as required by law, not all communities benefit in this way. One foundation uses its funds to support a number of non health-related causes, while another large nonprofit absorbed the proceeds into its statewide system and removed them from the community (see case studies for Angelo Community Hospital and Gilmer Medical Center).
Foundation boards and management are not necessarily independent of the parties that negotiated the sale and conflicts of interest may exist. Most foundation boards are composed of the same individuals who made the decision to sell the hospital in the first place and some senior executives transfer from administering the hospital to administering the foundation, although these are distinctly different types of jobs (see case studies, Providence Memorial Hospital, Angelo Community Hospital).
Joint ventures pose a unique set of problems because the nonprofit hospital changes to for-profit ownership but the nonprofit corporation is not dissolved. Instead it becomes a grant making foundation with a single asset (its share of the now for-profit hospital system) upon which all its fortunes rest. In cases where the partnership is not clearly controlled by the charitable organization, which can therefore assure that it uses the assets in furtherance of a charitable mission, the new venture may violate IRS rules and threaten the 501(c)(3) status of the nonprofit (see case study, St. David's Health Care System).
Transactions involving public hospitals do not come under the scrutiny of the Attorney General. They also require guidelines to ensure that the tax dollars used to fund these services continue to be used for the purposes for which they were collected, that is, for health care.

Recommendations

Require parties to a nonprofit conversion transaction to notify the Attorney General (AG) prior to closing the deal, and file adequate documentation for the AG to effectively review the transaction.
Require public notice of proposed transactions.
Require documents filed with the AG to be public.
Require the AG to review and approve or disapprove all transactions involving a material amount of assets or a change in control. Approval should be based on the price to be paid, public participation, the structure of the transaction and the preservation and future use of the assets.
Preserve the fair market value of the nonprofit's assets in all transactions for continued charitable use in the community.
Determine the fair market value of the charitable assets through an independent expert review of any evaluation conducted by the parties, or an independent evaluation conducted by the AG's own expert.
Set aside the assets for the community's health needs, and determine the new mission for these charitable dollars in an open and public process.
Ensure independent oversight of the charitable assets under a board unconnected to the entities involved in the original transaction.

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