By Roger Strode, partner and health care business lawyer with Foley & Lardner LLP
As hospitals and health systems continue to partner with one another, we are often asked to guide directors and trustees with respect to their duties when considering a combination. This concept can be a bit of a “rabbit hole” where advice can get muddy and confused, and this can be especially true when an organization is financially distressed or in a jurisdiction with a particularly intense degree of regulation. The need for this advice has become more acute as these partnerships have become larger and more sophisticated in an effort to create structures that are designed to be transformative to the communities served as well as to the participants to the combinations. Below, we outline three basic concepts that should apply to any combination, no matter the structure, context, or jurisdiction.
What Duties Does a Director or Trustee Have in Connection with a Proposed Transaction?
As a general rule, directors of nonprofit corporations have two main duties: the duty of loyalty and the duty of care.
Duty of Loyalty: As a general proposition, the duty of loyalty requires a director to do the following in conjunction with a proposed transaction:
- Avoid and disclose conflicts of interest
- Act in the organization’s best interest
- Maintain confidentiality
Duty of Care: In addition to the duty of loyalty, directors and trustees owe a duty of care, which focuses on the process by which the decisions with respect to a proposed transaction are made. That process should mirror the significance of those decisions. In this regard, the duty of care includes a duty to be adequately informed before making decisions related to a proposed transaction.
How Must a Director or Trustee Perform His or Her Duties of Loyalty and Care?
Under concepts of common law, and under many state laws, a director must perform his or her duties of loyalty and care in connection with the consideration of the proposed transaction:
- In good faith
- With the care an ordinarily prudent person in a like situation would exercise under similar circumstances
- In a manner the director reasonably believes to be in the best interests of the organization
When performing his or her duties, a director or trustee is often entitled to rely on information, opinion, reports, or statements, including financial statements and other financial data, if prepared or presented by:
Officers or other employees of the organization that the director or trustee reasonably believes are reliable and competent in the matters, such as, for example, the organization’s CEO, CFO, CSO, General Counsel or the like
Legal counsel, public accountants or other persons as to matters the director or trustee reasonably believes are within that person’s professional or expert competence, such as outside counsel auditors or, for example, a nationally recognized investment banking or financial advisory firm
A committee of or appointed by the board, of which the director or trustee is not a member, if the director reasonably believes the committee merits confidence.
Under most laws, if a director or trustee complies with the above requirements with respect to any matter, that person will not be liable for any action taken (or for a failure to take action). This is often referred to as the “business judgment rule.” The rule means that a court will start its evaluation (or a claim of breach of fiduciary duty) by presuming that a director’s or trustee’s actions followed those requirements—to prevent those persons from becoming liable when they make a good faith decision that turns out poorly for the organization. In a legal challenge, the burden is on the challenger to establish facts that rebut that presumption by “clear and convincing evidence.”
How to Comply with the Above Duties as a Practical Matter
Duty of Loyalty and Conflicts: With respect to any aspect of a proposed transaction in which any board member has an interest or potential interest, ensure that independent consultants and/or committees comprised of disinterested directors take the lead in evaluating such aspects. As noted above, if any conflict or potential conflict is identified, appropriate steps should be taken to ensure that the board is able to make decisions based on objective criteria.
Duty of Care and The Questions to Ask, Consider, and Answer:
When evaluating a proposed transaction the questions below provide an outline of the sort of inquiry a board member may want to consider.
- What are the factors requiring or motivating the organization to consider a particular proposed transaction?
- What is the current economic environment and how is that motivating the consideration of a particular proposed transaction?
- Is the proposed transaction consistent with the purpose/mission of the organization?
- What are the alternatives to the proposed transaction?
- What are the pros and cons of the proposed transaction?
- What monetary and nonmonetary terms are being offered and how should they be considered? Are their capital infusions promised? Will the acquiring organization promise to retain core services for a period of time? Will the acquiring organization promise to construct new facilities? Is the acquiring organization promising board seats?
- Will the proposed transaction create or have the likelihood of creating an adverse effect on the access to or availability or cost of health care services in the relevant market? Will it increase, or does it have the likelihood of increasing that access?
- To what extent is the proposed transaction expected to impact community benefit activities and is that impact consistent with community benefit purposes? What resources of the newly capitalized organization will be committed to community benefit purposes following the proposed transaction? To what extent will the combined entity use community benefit assets for community benefit purposes following the proposed transaction?
- Will any director, officer, agent, or employee of the organization receive any community benefit asset or benefit directly or indirectly from the proposed transaction, except for the receipt of compensation for professional services relating to the proposed transaction or normal compensation for services rendered? This inquiry also relates to the duty of loyalty (discussed above).
- What level of diligence has the organization’s executive team and board undertaken in the selection of the proposed affiliation partner and in connection with the negotiation of terms and conditions of the proposed transaction?
- What experts and other resources are available to assist the board in analyzing the relevant issues pertaining to the proposed transaction and has the board availed itself of that expertise and those resources?
- When and how will beneficiary groups and other parties be informed of a proposed transaction? Should the board’s evaluation process include a mechanism for obtaining input from any such groups? Has it?
- What is the fair market value of your organization’s assets and activities? Will or should the organization obtain a valuation prepared by an independent valuation specialist? In most not-for-profit to not-for-profit arrangements, it generally is not necessary to obtain a fair market value opinion. Such opinions tend to be necessary only (i) if statutorily mandated and/or (ii) in transactions where a not-for-profit entity is going to sell substantially all of its assets to a for-profit entity.
- What governmental authorities must receive notice or give their approval for a change of control transaction?
As transaction volume remains strong, and as deals among provider entities become larger and more sophisticated, it’s important that directors and trustees of health care organizations understand their duties when considering these combinations. The foregoing basic concepts outline critical duties and ways to approach them regardless of the nature or structure of a particular transaction.