July, 1998
This article was written by the Consumers Union Southwest Regional Office.
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In the absence of a binding obligation in the partnership's governing documents for the partnership to serve charitable purposes...the partnership will be able to deny care to segments of the community, such as the indigent. Because the non-profit will share control of the partnership with the for-profit, the nonprofit will not be able to initiate programs within the partnership to serve...the community without the agreement of at least one governing board member appointed by the for-profit. --IRS Guidance |
In April 1996, The St. David's Healthcare System ("the System") finalized a joint venture agreement with Columbia/HCA, the largest for-profit hospital corporation in America. Joint ventures pose a unique set of problems for the community because the charitable nonprofit hospital corporation usually retains its tax-exempt status, but links itself to the ongoing operations of the for-profit absence partner. The original nonprofit becomes a grant giving foundation with a single asset--its share of the for-profit partnership--upon which its revenues depend but over which it exerts little control.
St. David's was founded in 1924 as a charitable corporation "for the purpose of administering to the sick, the infirm, the helpless, the maimed and the afflicted of all creeds, colors, and nationalities, receiving and properly caring for all such as may be brought to, or present themselves at, such Hospital."1 The main component of the network, St. David's Hospital, has served Austin for nearly 74 years. St. David's fulfilled its charitable mission by providing health care services regardless of race, creed, sex color, religion, national origin, handicap, age or economic means.2
However, in 1994, the System's Board of Trustees began questioning the feasibility of fulfilling its mission under its existing ownership structure. Assessing its future, the Board "concluded that the System has inherent weaknesses as an independent provider with limited geographic coverage, limited access to capital, vulnerability to managed care power buyers, and vulnerability to emerging primary care networks."3 As a result, the Board decided to examine possible alliances with other health care systems in the area, including one with Columbia/HCA. The Board then authorized its Executive Committee to enter into further discussions with Columbia/HCA.4
On October 18, 1995, the System executed a letter of intent outlining a joint venture between the two entities.5 Prior to signing with Columbia/HCA, System officials claimed that they considered other options, including a deal with Scott & White Hospital and Clinic, a nonprofit institution in Temple, Texas.6 In addition, the System explored a proposal to consolidate with Seton Medical Center to run Brackenridge Hospital, the only public hospital in Austin.7 However, potential anti-trust considerations scuttled the deal and Seton entered into a long-term lease with the City of Austin to manage and operate Brackenridge.8
On April 30, 1996 the System formalized a partnership agreement with Columbia/HCA to combine St. David's and Columbia/ HCA's existing facilities in the Austin area into a single health care system named the Columbia/ HCA/St. David's Healthcare System, L.P. ( "the Partnership"). The nonprofit board amended the System's bylaws to withdraw the corporation from the direct operation of the hospital, but retain its nonprofit status.9
The System engaged Cain Brothers and Co., a Wall Street health care investment firm routinely used by Columbia/HCA, to conduct a financial examination of its assets.10 According to its IRS Disclosure Statement, the System contributed all its assets&emdash; six facilities, including St. David's Hospital, St. David's Rehabilitation Center and St. David's Medicenters, valued at $116,324,000&emdash;to the new joint venture.11 Columbia/HCA contributed its five area facilities and a 50 percent share of the Austin Diagnostic Medical Center to the Partnership, and took over managerial control of all the facilities. St. David's may sell its ownership to Columbia/HCA five years from the date of the transaction.12 Columbia/HCA also agreed to pay off the system's tax exempt bond debt, estimated at $32.5 million.13 The System effectively converted its facilities to for-profit ownership but retained its tax-exempt status as the nonprofit owner of a 50-percent share in the Partnership.
The profits of the joint venture will accrue to the partners, the System and Columbia/HCA, on a 50-50 basis. Columbia/HCA pays taxes on its share of the profits. The System 50- percent share of the profits, which are tax-exempt, are reinvested in the Partnership or passed on to its subsidary, St. David's Foundation, for distribution as grants. Columbia/HCA also reinvests a portion of its profits in the partnership.14 Currently the Partnership has reinvested $38 million for capital improvements to facilities in Round Rock and South Austin, both formerly owned by Columbia/HCA and now jointly owned by the partnership.15
The Partnership is governed by a board on which the System holds six seats and Columbia/ HCA holds six seats. According to a System official, each side votes as a block (effectively one vote each).16 Further, the board agreed to contract out management of the Partnership to a wholly owned for-profit subsidiary of Columbia/ HCA's, so the System no longer directly manages its charitable assets. The System selected the first CEO, Jack Campbell, formerly the head of the St. David's Hospital.17
POLICY ISSUES
The agreement between the System and Columbia/HCA illustrates several problems consistent with the other cases reviewed by CUSWRO: no Attorney General notification, inadequate community involvement, and no access to information. However, in this case, no charitable foundation was created from the assets and the charitable nonprofit no longer clearly controls their use by the partnership.
There is no evidence that the partners to the agreement, the System and Columbia/ HCA, notified the Texas Attorney General prior to finalizing the joint venture agreement. In this particular transaction the Attorney General's office learned of the joint venture, and initiated a review of the transaction.18
The AG asked Price Waterhouse to conduct an independent valuation of the System assets to ensure that the transaction secured a fair market value for the charitable assets.19 Although the AG took no further action, it declined to release to the public details of this analysis because it was obtained through the confidential CID process (see main text).
Secondly, the System did not notify or involve the community during negotiations. There is no evidence that the nonprofit provided public hearings or any other forum for the public to voice its concerns regarding the terms of the joint venture, the fate of the charitable assets, or the availablilty of other options.
Further, the System did not provide the public access to information about the joint venture with Columbia/HCA. A draft Partnership proposal released by the System officials indicated that the details of the final contract would be released to the public.20 However, the System never followed up on this promise and declined to provide for this report any documents pertaining to the valuation of the System's assets or the joint venture agreement. System officials claim that this information is proprietary and would not corroborate the exact financial terms of the agreement.21
The Partnership also raises larger questions about the wisdom of joint venture agreements. The terms of the transaction require the System to contribute all of its assets to the partnership. At the same time, the System does not appear to control the partnership board and therefore may not be able to directly assure that the assets will be used in furtherance of the charitable mission. And, the management contract gives Columbia day to day control as well as additional revenues for managing St. David's facilities. According to Michigan Assistant Attorney General Fred Hoffecker, these kinds of arrangements, now illegal in Michigan, are a sweet deal for the for-profit partner. With the management services contract in place, "Columbia gets a nice slice of the gross before you ever get to the net, and then they get half the net."22
A 1998 IRS ruling requires that the non-profit retain clear control over the assets through a voting majority on the board, a clear charitable mission in the partnership articles and management control over day to day activities.
"In the absence of a binding obligation in [the partnership's] governing documents for [the partnership] to serve charitable purposes or otherwise provide its services to the community as a whole, [the partnership] will be able to deny care to segments of the community, such as the indigent. Because [the nonprofit] will share control of [the partnership] with [the for-profit], [the nonprofit] will not be able to initiate programs within [the partnership] to serve new health needs within the community without the agreement of at least one governing board member appointed by [the for-profit]. As a business enterprise, [the for-profit] will not necessarily give priority to the health needs of the community over the consequences to [the partnership's] profits. The primary source of information for board members appointed by [the nonprofit] will be the chief executives…and the management company, which is a subsidiary of [the for-profit]."23
According to this ruling, the St. David's/ Columbia partnership, which does not give the nonprofit a clear voting majority on the partnership board or management control over the use of the charitable assets, may violate the requirements for the System to remain a 501(c)(3) organization. Neal Kocurek, the President and CEO of St. David's Health Care System, told CUSWRO that the IRS is auditing the partnership and the System for compliance with the guidelines, and he acknowledged that the Partnership may need to be restructured in order to comply.24
Essentially, this joint venture bypasses setting aside the charitable assets of the nonprofit St. David's Hospital System into a foundation and allows Columbia/HCA to earn significant profits using formerly charitable health care facilities.
As owner of a 50 percent share of a joint venture, the charitable nonprofit St. David's System had to amend its purpose to become a grant making organization. But, the System already owned a separate Foundation.
The St. David's Foundation was formed as a nonprofit charitable organization in 1981 to raise funds from the community for hospital equipment and programs. When the System entered into a joint venture agreement with Columbia/HCA in 1996 and converted its facilities to for-profit ownership, the System and the Foundation both retained their nonprofit status and the Foundation altered its role.25 Now, the System passes through a portion of its income from the joint venture to the Foundation, which distributes funds to charitable health-related programs and activities in the community.26
The Foundation continues to promote a Foundation is to improve the health of the people of Central Texas through leadership, collaboration and education." The Foundation seeks to enhance access to primary and preventive care and provide support for medical education and research. In 1997 the foundation awarded over $2 million to the People's Community Clinic, an Austin indigent care provider, the Central Texas Medical Foundation, Hospice Austin, the Blood and Tissue Center of Central Texas, and others.27
