United States: Hospital And Health System M&A Series: The Role Of The Nonprofit Hospital Board In Consolidation Transactions

The hospital consolidation market continues to gain steam.  The year 2013 saw a total of 87 consolidation transactions, following 105 in 2012.  This volume represents a significant increase over 58, the median number of transactions completed each year between 2001 and 2011.  Consolidation transactions offer the possibility of achieving economies of scale, better access to capital, geographic expansion, and improved quality and clinician expertise.  The vast majority of consolidation transactions involve a nonprofit health system.  In such cases, ultimately it is the nonprofit board's decision whether, and under what terms and conditions, a hospital pursues a consolidation transaction.

It is critical for a nonprofit board of directors to prepare in advance to evaluate a consolidation opportunity in a timely and informed manner, consistent with its fiduciary duty.  Doing so requires the board to, at a minimum, undertake the following preparation:

  • Be informed about the fiduciary obligations incumbent on the directors
  • Establish good governance processes in advance
  • Make provisions to address certain regulatory and business issues common to consolidation transactions 

The law expects the board to closely oversee the transaction process in order to preserve the value of the corporate assets and to protect the charitable mission.  Failure to provide sufficient oversight will weaken the credibility of the board's ultimate decision and imperil any board-endorsed deal's chances for regulatory approval.  Corporate conventions related to business combination decision-making policies offer good guidance for hospital boards.  Several decades of case law and well-developed M&A market experience can provide meaningful direction for the new wave of hospital directors confronted with evaluating similar change-of-control opportunities.

The Board's Fiduciary Obligations

The board of directors of a nonprofit health system or hospital has three core fiduciary duties: the duty of loyalty, the duty of care and the duty of obedience to the charitable mission of the organization.  These three core duties apply to the governing board as a whole and its various committees and subcommittees.  The fiduciary duties are not for the benefit of other board members, donors to the hospital, executives or physicians.  Instead, these fiduciary duties are owed to the organization itself and its charitable purposes.  Therefore, nonprofit directors are bound to serve the best interests of the organization itself, and not another constituency. 

Duty of Loyalty

The duty of loyalty requires corporate directors to exercise their powers in good faith in furtherance of the charitable mission and not in their own interests or the interests of another person or entity.  In the context of evaluating a potential consolidation transaction, the duty of loyalty imposes an obligation on directors that they not consider other interests in making the decision.  Furthermore, directors are obliged to keep confidential the presence and mechanics of a transaction process and the details thereof for the benefit of the organization.  For example, the impact of a consolidation on certain physician groups or staff should not be put before the goal of furthering the organization's charitable mission.

Duty of Care

The duty of care requires that corporate directors act in an informed, good faith manner when participating in board decisions and exercising their oversight of the organization.  The duty of care applies not only to oversight of day-to-day operations and compliance issues, but also to the evaluation and oversight of consolidation transactions.  Some states may hold a "seller's" board to an even higher standard of care.  To fulfill the duty of care, corporate directors are encouraged to allow sufficient time for consideration, to gather and review all relevant data (including primary source data), and to ask questions in order to gather all necessary information.  Furthermore, to meet this duty, boards often are advised to establish a basis of comparison across transaction options in order to be able to defend the fairness of the transaction's terms and conditions.

Duty of Obedience to the Charitable Mission

Lastly, the duty of obedience to the charitable mission (which is acknowledged in a majority of states) requires that a director further the charitable purposes of the corporation and act in conformity with all laws generally affecting the corporation.  To fulfill this duty, directors should have a strong understanding of the charitable purposes of the organization.  It is incumbent upon boards to constantly examine their mission and purpose, and to understand how a consolidation might further (or detract from) that mission.  In order to provide effective oversight, the board must understand the rationale prompting a specific proposal, and how that proposal supports the organization's objectives. 

In examining any consolidation transaction, the general counsel or outside counsel should brief the board on the standards of conduct the law will expect it to apply in connection with its evaluation of a consolidation proposal.  A consolidation transaction will require the board to apply a higher level of attentiveness and scrutiny to its review than it does to normal and customary board matters.  If the board elects to delegate day-to-day oversight of the consideration and negotiation of a transaction to a standing or special committee, the extent of that delegation, and the communication between the committee and the full board, should be thoroughly understood. 

Advance Establishment of Good Governance Structures

Establishing good governance structures and the authority of the board is critical to achieving a positive outcome in a consolidation transaction.  Furthermore, hospital and health system boards should take this action well in advance of the actual consideration of a consolidation opportunity. 

State law uniformly agrees that the board is in charge and that no consolidation transaction of any consequence can proceed without board approval.  The expectation is that management and its advisors will do the basic "blocking and tackling," but that the transaction is the board's responsibility and the board must sign off on the final game plan.  This is to ensure the presence of checks and balances deemed necessary to protect charitable assets, given the potential and unavoidable conflict of interest when management team members negotiate with their potential new employer. 

A prepared board will assess potential approaches to managing the process of a consolidation transaction well in advance.  The board should consider establishing a "strategic review committee" or other committee that will be tasked with assessing combination opportunities (both inbound and outbound).  While the committee should not take over the full activity of the board, the committee can vet opportunities, gather data and information, and present findings in a coherent fashion to the full board.  Consolidation proposals and similar "big deals" require a transaction timetable that is sufficient to allow thorough evaluation.  This is an area where the board and the designated committee can exercise particular common sense oversight (e.g., "This is dragging; we need to pick it up," versus, "This timetable is too aggressive; we need to slow it down.")  The board must have an understanding of the proposed transaction timeline, the implementation of a competitive process, the risk exchange involved in the major decision-making points (e.g., a letter of intent and definitive agreement) and any external factors (e.g., regulatory or principal vendor approvals) that may influence the timetable.  Significant mistakes are made when boards do not realize the steps involved, the sequence of those steps or the intentional use of proven processes to maximize outcomes. 

Lastly, the board should develop its evaluation criteria in advance of the consideration of a potential consolidation.  Such evaluation criteria should include information relating to achievement of charitable goals, the reasonableness of financial terms, human resources issues, implications to the medical staff, and closing responsibilities and obligations.  The criteria also should reflect recognition of specific transaction-related legal risks (e.g., antitrust challenges).  An increasingly important consideration is the extent to which the board had the opportunity to consider the results of the due diligence investigation and the related risks (regulatory and operational) to the organization.  This is especially the case if unusual or unexpected risks are identified.  The presence of a written record reflecting application of such criteria will be very persuasive to regulators called upon to review the transaction and the board's related diligence.  For more information, see "The Board's 'M&A' Fiduciary Duty Checklist" and "The Board's Role in the M&A Process: Meeting Fiduciary Obligations," published by the Governance Institute.

Key Issues for Board Consideration

As the overseer and steward of the nonprofit hospital or health system's assets and charitable mission, the board should be aware of key issues that it will be asked to confront when considering a consolidation transaction.  At a minimum, these issues will include the following:

Know your state regulators and their power.  Consolidation transactions are frequently governed by various laws that are overseen by a State Attorney General office (charitable and antitrust sections).  There also may be Certificate of Need filing requirements.  A board should be aware in advance of the applicable regulators that would review and provide input on any consolidation transactions.  

  • Be prepared to defend the decision.  The board should be prepared to answer central questions that external critics likely will pose, including "how did the board arrive at a particular decision?" and "what steps did it take to ensure that the transaction value and terms are fair?"  The best defense against these questions is the rigor and thoroughness of a well-run board-led process.
  • Understand your corporate structure.  The differing corporate forms of hospitals and health systems and consolidation transactions are important to understand.  For example, in change-of-membership-based arrangements, it is important to articulate with clarity such important governance-related terms as the formation, mission and board composition of the parent organization; the specific reserved powers to be retained by the parent over the affiliate hospital providers; the process by which board members and chief executive officers are selected and removed; and any special voting arrangements, such as supermajority provisions.  In arrangements involving faith-based organizations, it is important to establish a process by which particular faith tenets and identities are preserved and protected.
  • Be prepared to handle federal antitrust matters.  Depending on the size and structure of the proposed consolidation transaction, the parties may be required to file a Hart-Scott-Rodino (HSR) application with the Federal Trade Commission (FTC) and the U.S. Department of Justice (DOJ).  The HSR application requires that the parties disclose materials that discuss the proposed transaction and the service area.  The general counsel and/or outside counsel should advise the board regarding the creation and content of written communications, which can create unintended issues and delays with the FTC and DOJ.  Regardless of whether an HSR application is required, the FTC and DOJ continue to challenge transactions in the health industry that they view as anticompetitive.  If the FTC believes the proposed consolidation transaction is potentially anticompetitive, it typically contacts payors for their input on the proposed transaction.  Hospital leadership may positively influence payor reaction by identifying the community benefit and pro-competitive effects of the transaction and communicating those benefits to payors and the community.  Demonstrating the transaction's value to the community is also part of the board's Duty of Obedience discussed above.

Conclusions

It is vitally important that management (including general counsel or outside counsel) make a special effort at the beginning of the transaction process to brief the board on the law's expectations and how the management team can support board compliance with those expectations.  This should be neither a difficult nor cumbersome task.  The failure to complete it, however, will jeopardize the likelihood of a successful transaction and the reputation of the board.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions