State Regulation of Non-Profit Hospital Conversions

By Ronald L. Scott
rscott@central.uh.edu

A report issued by the U. S. General Accounting Office found that increased competition as well as the growth of managed care is driving hospitals and other health care organizations to convert from nonprofit to for-profit status. See Not-for-Profit Hospitals: Conversion Issues Prompt Increased State Oversight, GAO, HEHS-98-24, available at http://www.gao.gov/AIndexFY98/abstracts/he98024.htm (Report).

Such conversions apply to a number of health care entities, including hospitals, insurers, and managed care organizations. Public policy concerns raised in conjunction with such conversions focus on two issues. First, concerns have been raised about the potential loss of community benefits resulting from such conversions. Concerns have also been voiced about charitable groups’ use of conversion proceeds. In both cases, public disclosure of proposed conversions and community input in conversion transactions are related issues.

Nationally, 192 of the more than 5,000 nonprofit hospitals converted to for-profit status between 1990 and 1996. Nonprofit hospitals have traditionally provided such charitable community services as uncompensated care for uninsured and underinsured patients, in return receiving financial benefits including exemption from federal, state and local taxes. Although proceeds from hospital conversions are usually directed to other charitable entities, concerns have been raised about the potential loss of community benefits as well as use of conversion proceeds for nonhealth-related activities.

Significantly, the Report found that such transactions were "not routinely subject to public disclosure," and therefore, "[a] growing number of states are recognizing the public interest at stake and becoming more involved in overseeing the conversion process and reviewing terms of the conversion transactions." Most hospitals did report that they included provisions for continued charity care in the sales agreements, but the for-profit hospital or joint venture boards of directors that resulted from the conversions are mainly responsible for ensuring compliance with the agreements.

The increasing concerns raised about nonprofit conversions prompted legislation in 24 states and the District of Columbia at the time of the Report. Most legislation contains provisions requiring advance notice, state review and approval, and public disclosure and hearing. Legislation regulating nonprofit conversions continues in 1998, with 34 states introducing legislation, and 17 measures becoming law as of October 1998.

Attorneys general generally have a duty to protect non-profits’ charitable assets, including funds initially donated to a nonprofit health care organization, together with any increase in value of such funds and other sources of income of the entity. Charities raise funds through public appeals and other activities, and the attorney general is responsible for representing the public’s expectation that funds raised contribute to the entity’s charitable services. Until recently, charity law was mostly derived from the common law rather than statute. An attorney general can ensure that boards of directors of nonprofit organizations follow the law by filing a lawsuit alleging breach of fiduciary duty by the directors, e.g., if a conversion violates common-law, charitable trust principles or is arguably not in the public interest because the charitable trust assets are undervalued. Legislation should help remove such transactions from the courts by outlining the procedures for converting nonprofit entities.

10/30/98