Avoiding Legal Traps in Health Care Growth with Non-Profits

Published: McLane.com
March 1, 2008

An aging population, improving technologies, advances in treatment and increasing health care spending all mean one thing: health care providers are challenged to keep pace in providing state-of-the-art facilities. Year after year, new projects and renovations are almost a constant priority for health care organizations in New England. Providers are formed, merged, and reshaped almost as frequently.

Most providers either are non-profit organizations or they work extensively with non-profits. Providers are necessarily well-versed in the federal and state regulations of the medical and financial side of their businesses, which affect their lives every day. Intuitively, providers will know that when facilities are being built or renovated, they will need to deal at least with the host municipality for basic requirements such as site plan approval, building permits and the like. Similarly, providers will know that when new entities are being formed or merged, they will need to deal at least with their state of domicile for basic requirements such as filing of entity documents.

But the need to pay close attention to state regulation of the non-profit “mission” is hardly intuitive, and can trip up even the most obviously worthy projects. Each state has laws that, in essence, provide that non-profits must use their money and resources for the purposes they have held out to the public, and particularly to their donors, as being the entity’s reason for obtaining and maintaining its non-profit status. In the situation where a non-profit grew out of a gift made by one or a few donors “once upon a time”, the state is charged with enforcing the expressed will of those founder(s). If a non-profit has received support from donors for years, the state is charged with making sure the non-profit carries out the mission for which those donors sent their checks. In any case, the organization is answerable to the state as a “charitable trust”.

Charitable trust doctrine becomes a trap when the needs of the community change – which is, of course, a constant in health care. Even a fairly recently formed organization may find its board determining that the organization, in order to maximize its effectiveness, must change directions a little – or a lot. That is appropriate, of course, and probably required, but the last thing a non-profit entity wants to learn (or that a for-profit entity partnering with or entering into a deal with a non-profit wants to learn) is that the state is challenging the charitable trust validity of the actions of the non-profit. The trick is to recognize when an action (which may be as simple as providing a note or a guaranty to finance a project) might be seen by the state as constituting a change to the charitable trust.

This question should be addressed before the deal hits the point of awkward return. For example, when a lawyer is requested to provide an opinion letter in support of financing or a change of legal form involving a non-profit, the lawyer will need to look hard at whether the deal arguably involves any change in charitable trust. If it does, the opining lawyer must be prepared to demonstrate that the change does not impede the performance of the charitable trust obligations of the non-profit. As state charitable trust offices prefer to ask questions before a problem arises, by far the best plan is to have the non-profit’s lawyer contact the state as early as possible to explain the background of the charitable trust, the proposed change, and why the change is consistent with the charitable trust purpose of the non-profit.

The state can approve the change only if it really is consistent with the ongoing charitable trust. If the state likes the proposed change but is not sure it has immediate authority to approve the change, the state will typically ask the non-profit to obtain approval of the change from a court. In New Hampshire, for example, that is typically pursued with the probate court for the home county of the non-profit. This need not be an unduly time-consuming or expensive procedure. The New Hampshire Director of Charitable Trusts frequently files in support of such petitions, which are often granted in a matter of a couple of weeks without a hearing. But even if a hearing is required, that is far preferable to having the issue raised after a transaction has already been committed to.

The alternative may be a worst-case scenario. There are many cases where deals have foundered on charitable trust objections well after the point of great discomfort. Famously, the New Hampshire Charitable Trust director undid the merger of Manchester’s two hospitals in 1998 – well after the merger had been accomplished in 1994. The hospitals clearly thought the merger was necessary to obtain economies of scale and to eliminate costly duplication – in short, to modernize an outdated situation. The Attorney General, however, found that “each hospital was established with a specific charitable mission…bound by a social contract to their local community and to the particular communities they have been created to serve,” and undid the merger.

Uncoupling a merger is a particularly stark extreme. More typically charitable trust questions arise if, for example, resources are being used (directly or as collateral) to support growth that is arguably not the way things have always been done, or, for another example, to support an affiliated program. Dealing with charitable trust questions may be uncomfortable, but it easily beats finding out about them later. A lawyer versed in charitable trust law can be helpful in times of change.