Federal Appellate Court Ruling Sounds The Liability Alarm For Officers And Directors Of Struggling Health Care Providers – Both Non-Profit And For-Profit

Last month, the United States Court of Appeals for the Third Circuit issued an important, 28-page opinion that confirmed a jury verdict, holding former officers and directors of a not-for-profit health care provider in bankruptcy, jointly and severally liable to the facility's creditors – in the amount of $2.25 million – for breach of fiduciary duty in failing to properly oversee and manage the non-profit entity. Official Comm. of Unsecured Creditors ex rel. Lemington Home for Aged v. Baldwin (In re Lemington Home for Aged), No. 13-2707, 2015 WL 305505, at *1 (3d Cir. Jan. 26, 2015). In the same decision, the Court upheld punitive damages of $1 million and $750,000 against two of the officers – the nursing home's Administrator and Chief Financial Officer ("CFO") – but reversed a punitive damages award against the directors.

While focused on Pennsylvania state law, regardless of jurisdiction, the Third Circuit's opinion provides a cautionary tale for the corporate officers as well as board members of not-for-profit health care organizations – for the most part, volunteers – that they may be held to the same standards of accountability as those of for-profit, public corporations. Additionally, in jurisdictions where the concept of "deepening insolvency" is recognized or gaining currency, officers and board members must be particularly vigilant to prevent actions that could exacerbate a struggling provider's financial condition. Under the "deepening insolvency" theory as stated in the decision, a director's duties extend to creditors whenever the provider is technically insolvent.1

This memo discusses key aspects of the Court's decision and takeaways for directors and officers of health care providers to mitigate the risk of personal liability, particularly in the event of a corporation's insolvency.

Facts Adduced at Trial

The Home for Aged and Infirm Colored Women was established in 1883 and operated as a nursing home in Pittsburgh, Pennsylvania from that time, being renamed as the Lemington Home for the Aged in 1900. In 1997, at the request of the Home's board of directors, Hershberg Salter Associates developed a comprehensive long-range plan to remediate the Home's image problems within the community as a health care provider, made more acute by a history of Pennsylvania Department of Health deficiency citations at a rate almost three times greater than the average nursing home operating in the state. Id. at *14. The long-range plan recommended, among other things, that the Home replace the Administrator, and hire a "quality human resources staff," and outside specialists. In re Lemington Home for Aged, 659 F.3d 282, 287 (3d Cir. 2011), as amended (Oct. 20, 2011), subsequent mandamus proceeding sub nom. In re Baldwin, 700 F.3d 122 (3d Cir. 2012). Another study, in 2001, funded by a community foundation, also recommended that the Board replace the Administrator with a "qualified, seasoned nursing home administrator" and "review, revamp and re-staff each department". Id. at 287. The community foundation provided a grant of more than $175,000 to hire a new Administrator. The Board did not act to replace the Administrator, and the Administrator instead used the grant monies for...