July, 1998
This article was written by the Consumers Union Southwest Regional Office.
Nonprofit hospitals do not have shareholders in the traditional business sense. In fact, under the Texas Nonprofit Corporation Act, a nonprofit cannot distribute any part of its income to its members, directors, or officers. 14 If it dissolves a nonprofit must distribute its assets to another charitable entity that will continue its mission, thus assuring that the public, and never private individuals, will benefit from those assets forever.
In Texas these public benefits are particularly important. As a general matter, Texas does not provide a rich array of government benefits, and expects significant assistance from nonprofits to provide a safety net for the needy. Texas courts have clearly outlined this responsibility.
"[C]haritable gifts and trusts are favorites of the courts…they tend to relieve the government of a part of its responsibility to a portion of its citizens and thus reduce the general tax burden on the public. They are therefore to be encouraged rather than discouraged."15
In order to encourage nonprofits to fulfill this role, the legislature grants them significant incentives and individuals donate money directly. After the Second World War, nonprofit hospitals benefited from grants and low interest loans through the federal Hill-Burton program. Since then, "the tax exempt status of nonprofit hospitals allows donors to give them tax-deductible gifts, allows nonprofit hospitals to sell tax-free bonds, exempts nonprofit hospitals from federal taxation, and increases the probability that they will be exempted from state and local taxation."16
Nonprofit hospitals exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code (IRC) are also exempt from Texas sales, franchise, and ad valorem tax.17 Nonprofit hospitals receive these generous tax benefits specifically because they provide indigent care and other community benefits.
Individuals also encourage nonprofit hospitals to provide indigent care and other community services through their generous direct donations. In 1997, a number of donors to the nonprofit Baylor Health Care System objected to a proposal by Baylor University to sell its affiliated hospitals for approximately $1 billion, and threatened to withhold substantial gifts to the university. 18
"I'm sure the donors feel betrayed," said Mrs. Ruth Collins Sharp Altshuler, who would not have made a recent donation to Baylor Health Care System if she had known Baylor University planned to sell the hospitals.19 In the end, the Baylor Health Care System remained in charitable hands.
Two common law principles, the charitable trust and cy pres doctrines, dictate that nonprofit assets remain in the public domain.
The charitable trust doctrine in Texas applies to all charitable or "public benefit" organizations; Texas nonprofit hospitals are charitable, public benefit entities. 20 Under this precept, the assets of a charitable entity are impressed in perpetuity with a public trust and must continue to serve its charitable purpose in the event of a change in status.
A nonprofit organization's statement of purpose, articulated in its Articles of Incorporation, creates a dedication of the organization's assets for those purposes, and "its charitable identity is thus permanently and irrevocably established."21
Texas case law recognizes that charitable corporations are organized for the benefit of the public, and "[T]herefore, the public has a beneficial interest in all the property of a public benefit, nonprofit corporation. Such a corporation has legal title to the property, but may use it only in furtherance of its charitable purposes."22
The Texas Nonprofit Corporation Act states that "No dividend shall be paid and no part of the income of a corporation shall be distributed to its members, directors, or officers."23 Typically, a nonprofit will specifically prohibit private gain from its assets in its articles of incorporation or bylaws. For example, St. David's Articles of Incorporation state, "No part of the net earnings of the Hospital shall inure to the benefit of or be distributable to its members, trustees, officers, or other private persons…"24
The common law cy pres principle is also used to govern the assets of charitable organizations in Texas. "Cy Pres is equitable power authorizing a court to effectuate the general charitable purpose of a testator when his particular intention cannot be carried out, or becomes impractical or illegal, whereupon the court may direct the trust funds or property be expended or utilized in a chari table manner as near (cy pres) to the donor's intent as possible."25
In other words, when the charitable purpose of an organization becomes impossible or impracticable to fulfill, the assets must be used for charitable purposes substantially similar to those found in the articles of incorporation.
For example, a nonprofit hospital's charitable purpose typically includes service without regard to a person's ability to pay (indigent care). If the nonprofit sells the hospital, it no longer has the facilities to provide indigent care directly. It could continue to support indigent care, or broaden its mission.
Where it is not practical to use the assets for actual hospital services, the cy pres doctrine would allow these assets to be dedicated to substantially similar purposes, such as serving a broader realm of health care needs in the affected community.
