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Wall Street comes to Main Street: What Michigan nonprofit, charitable hospitals need to know about affiliations with for-profit systems

January 15, 2014

In the recent past, several Michigan nonprofit, charitable hospitals have affiliated with for-profit hospital systems. This trend will likely continue in light of the changing health care industry. In addition to the already challenging issues requiring resolution when hospitals affiliate, the conversion of a nonprofit, charitable hospital to a for-profit entity, whether as a result of an acquisition, merger or other process, adds another layer of complexity. The following summarizes certain key issues related to the conversion process.

Attorney General oversight

Michigan law gives the Michigan Attorney General comprehensive and wide-ranging authority to protect charitable assets in Michigan, and the current and former Michigan Attorneys General have demonstrated a willingness to use their broad authority to review and oversee transactions involving the conversion of nonprofit, charitable hospitals to for-profit enterprises. Accordingly, parties engaging in such transactions must seek Attorney General approval as a condition precedent to closing. Additionally, early involvement and cooperation with the Attorney General is recommended. The Attorney General has indicated that it is prudent for organizations to request review before executing a definitive agreement and before publically announcing a transaction.

While the scope of the Attorney General’s review is not fixed by statute, the Attorney General has generally focused on the following principal inquiries in reviewing past transactions: 

  1. Whether the board of the converting hospital has appropriately fulfilled its fiduciary duties in approving the transaction; and
  2. Whether the transaction properly serves the public interest by protecting the charitable assets and promoting the charitable mission of the converting hospital.

In reviewing a conversion transaction, the Attorney General will likely request various items, including the terms of the definitive agreement, the process followed by the converting hospital’s board that led to the transaction, the valuation of the converting hospital’s assets, and information regarding the viability of the buyer. Depending on the complexity of the transaction, the Attorney General may also request that the buyer or seller pay for an expert to assist the Attorney General in evaluating the transaction.

In the event the Attorney General determines that the proposed transaction does not contain commitments adequate to safeguard the public interest, the Attorney General may require, as a condition to its approval of the transaction, that the parties’ definitive agreement contain additional terms, such as commitments to protect charitable gifts, assurances of resources necessary to police the buyer’s performance, and acknowledgement of the Attorney General’s authority to enforce buyer commitments.

Learned Profession Doctrine

Michigan common and statutory law generally requires that business entities engaging in the practice of medicine be organized as professional corporations or professional limited liability companies. This legal requirement, commonly referred to as the “Learned Profession Doctrine,” can create an obstacle with regard to for-profit affiliations. For example, individuals who are not professionally licensed are not permitted to hold ownership interests in a health care entity organized as a Michigan professional service corporation or a Michigan professional limited liability company. Rather, all shareholders/members must (i) be licensed to render a professional service under the Michigan Public Health Code, and (ii) be licensed or authorized to perform the same professional services as those provided by the corporation/company (subject to some exceptions).

A 1993 Michigan Attorney General's opinion creates an exception to the Learned Profession Doctrine for nonprofit hospitals and other corporations incorporated under the Nonprofit Corporation Act to provide medical care services through employed physicians. This exception, however, does not extend to for-profit business entities. As a result, an affiliation with a for-profit entity may require significant corporate restructuring to the extent the target nonprofit hospital (i) provides medical services through employed physicians, and (ii) the for-profit buyer has shareholders or members that are not licensed to practice medicine. In these scenarios, the resulting for-profit hospital could not provide medical services through employed physicians and would need to pursue an alternative delivery model.

Action Steps

Ultimately, nonprofit conversion transactions involve additional and complicated risks. The Michigan Attorney General has demonstrated a strong interest in overseeing and regulating such transactions. Nonprofit, charitable hospitals considering a conversion should be mindful of the requirements unique to converting nonprofit entities and evaluate potential risks early, including how the terms of the proposed transaction will impact the community served by the hospital. For assistance in these efforts, or if you have any questions regarding nonprofit conversion transactions, please contact any of our Health Care attorneys.