Fiduciary Duties Of Officers And Directors Of Financially Distressed Nonprofit Hospitals

Changes in the health care marketplace and uncertainties regarding the implementation and future of the Affordable Care Act (ACA) have placed tremendous strain on not-for profit hospitals and health systems. The pressures affect both sides of the ledger, as nonprofits struggle to maintain revenues, to contain costs, and to stay above water.

Officers and directors of these financially distressed nonprofits face a difficult role. As officers and directors, they generally owe fiduciary duties to their nonprofit organization and its charitable mission. However, if the nonprofit is or may be insolvent, uncertainty arises as to whether and to what extent those fiduciary duties may be altered. In the past, those questions were answered with references to terms such as "zone of insolvency" and "shifting duties"—advice that provided little guidance about how to make decisions for their struggling corporations.

Over the past several years, the law in this area has developed, moving away from the "zones" and "shifts" of yore and towards a framework that better defines officers' and directors' duties and defers to their reasonable business judgment, even when their corporations are insolvent.

Nonprofits and their Current Challenges

Stories of financially distressed not-for-profit hospitals are increasingly common. In California, the Daughters of Charity Health System, which operates six hospitals in the Bay Area and Los Angeles County, and Doctors Medical Center, a community-owned safety-net hospital in San Pablo, are engaged in ongoing, well-publicized efforts to sustain their operations through going-concern sales or increased community support. In Georgia, Hutcheson Medical Center, a nonprofit hospital in Oglethorpe, filed for chapter 11 bankruptcy late last year to stave off foreclosure attempts by one of its creditors. Hutcheson continues to operate while it pursues its exit from chapter 11. Other nonprofit hospitals have suffered worse fates. Among those hospitals that have closed their doors this past year are Crittenden Regional Hospital in West Memphis, AR, North Adams Regional Hospital in North Adams, MA, and Nicholas County Hospital in Carlisle, KY.

Health care executives and industry experts alike see no immediate relief in sight. A recent survey of hospital CEOs identified "financial challenges" as their top concern for 2015.1 Each of the three largest ratings agencies—Fitch, Moody's, and S&P—issued negative forecasts for the not-for-profit health care industry for 2015. Matters soon could get worse, especially if interest rates increase or if the Supreme Court's ruling in the King v. Burwell2 case currently pending before the Court adversely impacts the federal insurance exchanges created by the ACA.

The Sources of Distress

Among the factors contributing to nonprofits' problems are:

Declining patient volumes

The general decline in demand for hospital services has depressed hospital revenues. Reduced patient volumes are attributable to numerous factors, including increased competition from alternative models of care such as urgent care centers, stand-alone emergency departments, outpatient surgery centers, and home care and long term acute care providers. The Medicare program's emphasis on reducing patient readmissions, its "two-midnight rule," and its value based compensation reforms all encourage care outside of the hospital environment, exerting additional downward pressures on hospital revenues. Higher deductible insurance plans are causing individuals to evaluate the costs of their health care options more closely than ever before. Many nonprofits, especially rural hospitals, cannot afford the specialty services their community seeks, driving that demand and those revenues elsewhere.

Increased operating costs

The ACA's electronic health record (EHR) meaningful-use criteria have required many nonprofits to invest in expensive information systems upgrades, and the shift from cost-based reimbursement to a value-based compensation model is imposing new tracking and reporting obligations on providers. To remain competitive, nonprofits must invest in upgrades to their aging equipment and facilities and in recruiting and retaining physicians, especially those in key specialties. For some nonprofits, above-market collective bargaining agreements and unfunded pension obligations may further strain their coffers.

The move from cost-based to value-based government compensation

Many nonprofits serve high percentages of Medicare and Medicaid patients and, thus, rely on government payments for the disproportionate bulk of their revenues. In the past, hospitals were paid for services provided to these patients through traditional fee-for-service reimbursements. The ACA, however, has shifted the basic payment structure away from fee-for-service reimbursement to a value-based payment model that bases compensation increasingly on the quality of care a hospital provides and the outcomes its patients realize, and not on the services provided. Under programs such as Medicare's Value-Based Purchasing (VBP) and CMS' Hospital Readmissions Reduction Program (HRRP), payments to hospitals that fail to reach specified benchmarks tied to quality of care and patient outcomes are at risk. Nonprofit hospitals stand to be disproportionately affected by these changes, with at least one study showing that safety-net hospitals—the majority of which are nonprofits—are more likely than other hospitals to be penalized under the VBP program and the HRRP. 3

Meanwhile, federal programs that provided additional support to many nonprofits, such as Medicaid's Disproportionate Share Hospital (DSH) program and Medicare's critical access...