AHA, attorney offer advice on hospital mergers
It seems like you can’t go longer than a day or two without hearing about another hospital merger. Risk managers in these situations often face the task of searching for exposure and liability buried in complex legal and financial agreements. The American Hospital Association (AHA) and a Pittsburgh attorney experienced in the sale of nonprofit assets offer some advice to help you get through a merger without overlooking important points.
The AHA recently issued guidelines applicable to both nonprofit and for-profit hospital mergers, with the idea of keeping the hospitals strongly accountable to community needs. Here are some of its suggestions:
• Evaluate proposals using community health improvement needs, as well as your organization’s values and mission.
• Study how the merger would affect the protection and use of community assets and the financial viability of your organization.
• When considering options, favor changes that reflect the shared missions and strategies of the organizations being merged.
• Obtain a valuation by an uninvolved party of the charitable assets that are being restructured.
• Make sure that any community payment or foundation that comes out of the transaction continues to serve an appropriate health need in the community.
• Educate your community about the merger and how it will affect residents.
Liability arises with sales of nonprofits
Further advice comes from John R. Owen III, an attorney with Eckert, Seamans, Cherin & Mellott in Pittsburgh. Owen tells Healthcare Risk Management that nonprofit hospitals are being sold to for-profit health care groups more than ever before. The sale of a nonprofit is a more complicated affair than the sale of a for-profit institution because the common law of trusts and the nonprofit laws of most states require that the proceeds of the sale of nonprofit assets must continue to serve the community.
Failure to ensure the community is served can mean your institution will hear from the state attorney general. If a charitable hospital is sold, for instance, the proceeds of the sale can be used to establish a charitable foundation that will continue to serve the community. Determining whether the proceeds truly serve the community’s interest is the responsibility of the attorney general, so it is helpful to know what attorneys general look for in making that decision.
The Internal Revenue Service also can get in on the act by reviewing whether individuals within nonprofit organizations are misusing the tax-exempt status of a nonprofit organization for personal gain within the larger context of the hospital merger.
State attorneys general and the IRS can derail a proposed sale if their scrutiny of the nonprofit assets suggests that the merger would cause a loss to the community or violate tax laws. For this reason, risk managers should be closely involved in the merger process, Owen says.
Here are the three general requirements that the attorneys general and IRS will look for when a nonprofit health care facility is sold:
• The purchaser must pay full and fair value for the charitable assets.
• The proceeds of such a sale must be applied to proper charitable purposes.
• Private individuals must not receive improper private benefit from the agreement. Golden parachutes, severance payments, and generous salaries with nonprofit foundations will be considered suspect.
To keep everything above board, Owen says you should notify your state attorney general and the other party’s state attorney general well in advance of the sale of your nonprofit’s assets. When doing so, he suggests you address all of these questions that the attorney general will be most interested in:
• Is the sale price of the charitable assets fair?
Parties to the sale of charitable assets should obtain an independent, professional appraisal of the assets and provide a full explanation of the appraisal method. The attorney general will be more impressed if the charitable institution can find more than one bidder for the assets.
• How will the proceeds of the sale be used?
The attorney general will want to know specifically how the sale proceeds will continue to serve the community’s charitable needs. Simply saying that they will do so is not enough. Some plan for the use of the assets will be necessary.
• Are there any special restrictions on the charitable assets?
If the charity or a fund within the charity was created to serve a certain purpose, proceeds from the sale of those assets should be used to continue fulfilling the donor’s wishes. In some cases, the original wishes of the donor cannot be fulfilled, possibly because the targeted problem no longer exists. In those cases, you should devise an approximation of the original intent and have the attorney general approve the use of the assets for that purpose.
Anticipate IRS questions
The IRS will take a similar look at the agreement, with its own special concerns in mind. Owen advises making sure the agreement provides suitable answers to these questions:
• Did the charity receive an appraisal of the assets by independent, nationally recognized professionals?
The IRS publishes valuation standards for all appraisals. In general, the IRS expects the price of a nonprofit asset to be in excess of four to six times the asset’s earnings before interest, taxes, depreciation, and amortization.
• Did the nonprofit organization look for other bidders?
• Will the for-profit purchaser provide charity health care?
• Have there been arms-length negotiations?
The IRS will want to see that negotiations for the sale were conducted in such a way to ensure that the amount paid for the charity’s assets is fair value and will not result in private benefit to the buyer or any private shareholder or individual.
• Will some charity continue to promote health care in the community previously served by the nonprofit hospital?
• Will any "insiders" at the tax-exempt hospital receive excess compensation or other benefits from a foundation created with proceeds from the sale of the hospital?
Such benefits will be a red flag for IRS investigators, suggesting that the foundation was orchestrated to appear to satisfy the requirement for charitable use of the proceeds but actually is intended to reward the insiders.
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