The Sacramento County (Calif.) Superior Court has ordered the owners of Health Net to place in an escrow account $3.3 million that they were planning to pay themselves under terms of a pending merger with QualMed.
The California Department of Corporations, whose approval is needed to complete the deal, opposes the payments to Roger F. Greaves, chairman, president and chief executive officer of the HMO, and four other executives. The funds were to remain in escrow pending the results of a hearing on the payments or a court-approved settlement before Feb. 16.
The state sued Woodland Hills, Calif.-based Health Net on Jan. 20, arguing that the severance arrangement was illegal because it would "constitute a gift of assets which Health Net is required to hold in trust to complete its charitable settlement." Federal tax codes bar the earnings of tax-exempt organizations from being used to benefit, or inure, private individuals.
R. Randall Huff, Health Net's attorney, said the state has no legal authority to block the severance payments. He also said the payments were fair when viewed in light of the changes that will occur in the executives' duties and responsibilities.
The inurement question has dogged Health Net ever since management planned to convert the organization into a for-profit company in 1991. At one point, Rep. Fortney "Pete" Stark (D-Calif.) asked the Internal Revenue Service for help in drafting legislation that would impose a multimillion-dollar federal excise tax to "prevent violations of the public trust" (Oct. 14, 1991, p. 6).
While a bill was never drafted, a successor charity, the California Wellness Foundation, was created on Feb. 7, 1992, as part of the conversion. Health Net management agreed to pay the foundation $225 million in notes as well as 80% of the stock of the new for-profit company. But, most of that $225 million has yet to be paid, the state says.
Mr. Huff said the foundation continues to own the stock, which has appreciated since the conversion.
Meanwhile, as part of the merger, top executives of Pueblo, Colo.-based QualMed also will receive severance payments totaling $2.1 million.