If California is a trendsetter, wheeling and dealing not-for-profit hospitals in other states should take notice.
Although California's year-old hospital sales disclosure law doesn't cover deals between not-for-profits, the California attorney general's office is dusting off provisions of various state corporation and government agency codes to subject such transactions to greater legal scrutiny.
One provision gives the attorney general the right to review a transaction between two not-for-profits if most of the assets of one are transferred to the other. Another lets the attorney general conduct audits of charitable organizations in the state.
The first providers to be touched by the effort are 362-bed Bay Harbor Hospital, a private not-for-profit hospital in Los Angeles, and Torrance, Calif.-based Little Company of Mary Health Services, a private not-for-profit system that owns two hospitals south of Los Angeles.
Last fall, Bay Harbor proposed merging into Little Company of Mary. Under one provision of the state corporations code, the attorney general signed off on the deal in November without comment. The two parties subsequently completed their due diligence process and said in February that the transaction would be final on March 1.
But just days before the close, a division of the state attorney general's office called the Registry of Charitable Trust said it was launching what's known as a "correspondence audit" of Bay Harbor's finances. A provision of the state government code permitted the agency to conduct the audit.
Bay Harbor Chief Executive Officer Jack Weiblen said the state had questions about $7 million in tax writeoffs by a Bay Harbor for-profit subsidiary called Harbor Ancillary Services. The losses stemmed from two businesses operated by the subsidiary: a medical office building near the hospital and an outpatient clinic in San Pedro, Calif.
Bay Harbor entered the businesses in the mid-1980s but by 1991 had pulled the plug on both. Bay Harbor closed the clinic, which served cruise ship passengers and merchant marines sailing into Los Angeles Harbor, and it transferred ownership of the office building to itself from the subsidiary.
Although Bay Harbor and Little Company of Mary were legally free to complete their deal because of the previous clearance from the state, they voluntarily delayed the close until the state's audit was completed.
The state did so on April 28, ruling Bay Harbor accurately reported the losses from the two businesses and no rules governing the use of charitable money were violated. The merger was set to close on May 31.
Delaying the merger "was the prudent thing to do," said Jim Lester, Little Company of Mary's CEO.
Both Lester and Weiblen said they were surprised by the audit, but they said it was a coincidence that it was ordered just before the merger was set to close.
"They survey how tax-exempt boards are carrying their fiduciary responsibilities. Their screening process kicked out our writeoffs, and that triggered it," Weiblen said.
But industry observers aren't so sure. They believe the attorney general is using obscure state codes to review not-for-profit hospital deals that aren't covered by the state's new hospital sales disclosure law.
The law, which took effect Jan. 1, gives the attorney general the right to review and approve the sale of a not-for-profit's healthcare assets to a for-profit corporation. The state also can hold public hearings on such a proposed transaction.
The corporations code doesn't allow for public hearings, so the Bay Harbor-Little Company of Mary merger wasn't subjected to a hearing last fall.
Wanda Jones, president of the New Century Healthcare Institute, a San Francisco-based consulting firm, wasn't surprised about the last-minute audit of the hospitals. "They're (the state attorney general's office) looking at any trick they can do to find out (if these deals) are legitimate or not," she said.
Said attorney Andrew Demetriou with Jones, Day, Reavis & Pogue, "It's not completely clear yet, but I think it's fair to say (the attorney general) is increasingly making noises on the topic, now that they have the backing of the Legislature."
Attorney Paul DeMuro with Latham & Watkins said what's happening in California and Arizona, which recently passed the nation's first state hospital sales disclosure law that applies equally to for-profits and not-for-profits, may become the trend.
"The investor-owned community has their transactions scrutinized, and many of the larger nonprofit players act like investor-owned facilities anyway, so there is some pressure to take a look at those deals as well," he said.
The California attorney general's office denies eyeing deals between not-for-profits more closely.
"We're doing the same thing we're always doing," said Jim Schwartz, the San Francisco-based deputy attorney general who coordinates many of the inquiries regarding hospital conversions and charitable obligations.
In a separate transaction unveiled last week, Little Company of Mary signed a letter of intent to affiliate with Orange, Calif.-based St. Joseph Health System, which operates 10 hospitals in California and Texas. The deal needs federal antitrust clearance, and the systems expect a charitable review by the state attorney general. They haven't set a closing date.