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Health Care Law Alert: Duties of Directors Under Connecticut Nonprofit Hospital Conversion Statute

March 8, 2012

In today’s economically challenging times, many nonprofit hospitals have begun to consider partnering with for-profit entities in order to provide the best possible healthcare in their communities. To date, only one such transaction has been completed in Connecticut, but joint ventures between nonprofit hospitals and for-profit entities may very well be the wave of the future.

Under the Connecticut Nonprofit Hospital Conversion Statute (the "Conversion Statute") set forth at C.G.S. § 19a-486 et seq., the Attorney General (the "AG") and the Public Health Commissioner (the "Commissioner") must review and approve a nonprofit hospital’s agreement to sell or otherwise transfer a material amount of its assets or operations to a for-profit entity. The Conversion Statute outlines the process that must be followed by the hospital and the particular diligence and care that must be taken; the Connecticut Revised Nonstock Corporation Act (the "Corporation Act") outlines the standard that must be followed by directors of the hospital.

The Conversion Statute requires that the application include documentation that the nonprofit hospital exercised due diligence in deciding to transfer its assets or operations, in selecting the purchaser, in obtaining a fairness opinion by an independent expert and in negotiating the terms and conditions of the proposed transfer. To satisfy this due diligence requirement, the board of directors must act in accordance with the duty of care and the duty of loyalty, as provided in the Corporation Act.

The duty of care requires that directors exercise ordinary and reasonable care in the performance of their duties, exhibiting honesty and good faith. This "reasonable care" includes a responsibility to conduct a reasonable inquiry, as would be done by an ordinarily prudent director under similar circumstances. This inquiry may ordinarily include reliance on a committee of the board on which the director does not serve, or on information, opinions, reports or statements, including financial statements and other financial data, if prepared or presented by: 1) one or more officers or employees of the hospital whom the director believes in good faith to be reliable and competent in the matters presented; or 2) legal counsel, public accountants, or other persons as to matters which the director believes in good faith to be within the person's professional or expert competency.

The duty of loyalty requires that directors act with undivided allegiance to the hospital's mission. For example, in performing his duties, a director may not consider the financial or other interests of himself, his family members, his employer, entities of which he or his family serves as a director or partner, or entities over which he or his family has control, unless the entity is also controlled by the hospital. If the director does have a conflict of interest, he may vote on the proposal so long as he can fulfill the duty of loyalty, but it is critical that this conflict be fully disclosed to the board of directors.

In exercising due diligence in accordance with the duty of care and duty of loyalty, there are many factors and risks for a director to consider. These factors and risks are not necessarily of equal importance and directors may differ on the weight that they place on each factor. Some examples of relevant questions to be considered include:

  • What is the offered purchase price?
  • What is the proposed governance structure?
  • What is the "best fit" for the community?
  • Is the purchaser a secular or faith-based institution?
  • Is the purchaser a nonprofit or for-profit entity?
  • What are the characteristics of the purchaser in terms of reputation, quality of management, financial strength and ability to provide quality care?
  • Is the purchaser committed to continuing existing services and providing health care to the uninsured and underinsured?
  • Does the purchaser have the ability to close the transaction and operate the hospital?
  • Is the transaction likely to be approved by the State and, if necessary, religious institutions?
  • Is the transaction likely to be supported by physicians, the community, unions and politicians?
  • Would the transaction result in the loss of "better" opportunities?

While the purchase price is but one factor to be considered, it must be at least the fair market value of the hospital’s assets. Regardless of other considerations, the AG will deny an application if the nonprofit hospital will not receive fair market value for its assets. A fairness opinion must be obtained by the hospital to confirm the fair market value of the hospital’s assets. The board of directors must also ensure that they satisfy their duties of loyalty and care in selecting an independent expert to provide the fairness opinion.

When selecting an expert to provide a fairness opinion, there are several factors that can be considered by a director in exercising his due diligence in accordance with the duties of care and loyalty. Some factors that are often considered include the expert’s:

  • Experience in preparing fairness opinions;
  • Experience with non-profit hospital asset transfers;
  • Potential conflicts with the hospital or other interested entities;
  • Diligence needs;
  • Proposed timeframe;
  • Logistical and coordination issues; and
  • Required compensation.

Again, these factors are not necessarily of equal importance, but they are a reasonable starting point in weighing issues that could be relevant. As part of the process, the AG will obtain its own fairness opinion.

In addition to guiding hospitals through the intricacies of the Conversion Act, counsel can assist directors in this process in several ways. First, counsel can educate directors as to their duties throughout the conversion process. Second, counsel can review the hospital’s directors and officers liability insurance policies to ensure that coverage is adequate. Finally, counsel can review the hospital’s certificate of incorporation and bylaws to ensure that they include adequate indemnification provisions. If they do not already do so, these documents should ideally be amended to provide the maximum amount of legally permissible indemnification for directors who make a good faith effort to comply with the duty of care and the duty of loyalty.