Surviving the AG Conversion Process: Tips for Nonprofit Hospitals

by Davis Wright Tremaine LLP
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Any manager of a nonprofit health facility involved in a sale, merger or other affiliation knows that undergoing such complicated transactions can become a major distraction from the day-to-day task of running the facility. A particularly unfamiliar and time-consuming part of the transaction is gaining approval by the California Attorney General’s Office (“AG”). Prepared buyers and sellers who know what to expect from the process will be better equipped for success and avoid a potential roadblock to closing.

As brief background, California Corporations Code §§5914-5925 gives the AG the authority to approve, deny or condition any sale or change of control of a nonprofit general acute care hospital, or other “health facility” (as the term is defined in California Health & Safety Code § 1250) with a fair market value in excess of $3 million. Corresponding regulations in Title 11 California Code of Regulations § 999.5 list all information the seller must include in the notice of the transaction submitted to the AG for approval (“Notice”). (While the legislature currently is considering amendments to §§ 5914-5925, we do not expect any changes to impact the suggestions presented in this advisory.)

The AG’s directive when reviewing a Notice is to protect the interest of all public beneficiaries of a charitable organization. This requires, among other things, examination of any factors indicating self-dealing, improper use or diversion of charitable funds, and protection of the public interest. For this reason, preparation of the Notice is a significant undertaking that must include extensive data on factors ranging from the health facility’s fair market value and charity care spending to the search for a buyer and compliance with law.

This list of general tips, although by no means exhaustive, can serve as a helpful starting point for any health facility considering the need to navigate the AG notice and approval process:

1. Set realistic time expectations. Upon receipt of the Notice, the AG has 60 days to respond to the applicant, but may extend this period to 105 days. As part of the Notice, you must submit the final transaction agreement signed by all parties (“Definitive Agreement”), so this document must be completed first.

Tips:

  • Always budget at least 105 days after submission of a Notice before receipt of the AG’s decision, as this additional time period may be required. If time is tight, you can plan to file the Notice the day the Definitive Agreement is signed.
  • Notify the AG in advance of the date you plan to file. Often they can let you know how busy they are and the timing to expect.
  • Offer to jump-start the required health impact report prepared by the AG’s consultant. This is only an option if you are willing to pay the consultant’s fees regardless of whether the parties reach a Definitive Agreement (these fees can approach $100,000 for the final report).

2. Dedicate sufficient resources to preparing the Notice. The Notice generally contains a large volume of materials that will fill at least several large three-ring binders, and must also be provided in a digital format, such as PDFs copied on a CD. The Notice will not be deemed received until substantially all required information is submitted.

Tips:

  • The health facility should select staff members to work closely with counsel to collect all necessary internal information, including board of director minutes, proposals from potential buyers, financial statements and asset valuation data for the health facility, current and historical charity care data, community benefit program data, and certain health facility contracts and employee data.
  • Allow time for counsel (generally one to two weeks) to analyze and redact sensitive information, including strategic planning, confidential intellectual property, patient information, attorney-client privileged communications, and other competitively sensitive data. Anything not redacted will become public information as the AG will provide copies of the Notice to anyone requesting one. The AG needs to approve confidential treatment and does not always agree.

3. Don’t be ensnared by Health & Safety Code sections 1260 and 1260.1. These complicated prohibitions caution the board of directors of the health facility to exclude directors and management from the negotiating team if they will receive compensation of any kind from the buyer in the future.

Tips:

  • As a practical matter, this generally translates to excluding certain board members and management from the negotiating team from the very beginning. The board of directors should not delay in consulting their attorney on this matter.
  • The Chief Executive Officer and certain physician-board members (e.g. chief of staff; holder of hospital-based physician contract) are most often excluded from negotiations.
  • Clearly define the role of management as providing information only. Management is not to provide advice to the board of directors.

4. Focus on a clear “sales” process. Fairness is the key to any bidding process. The AG will want to ensure that all interested buyers have been treated alike and received equal access to information. This ensures the parties to a transaction did not manipulate the market value and that maximum value was obtained from the competing offers.

Tips:

  • Use standard/template process letters to communicate with all potential buyers. This format enables fair comparison of each buyer’s offer terms.
  • An initial letter will solicit proposals from select parties, describing the evaluation process and terms to include in the proposal by a certain due date.
  • An optional second letter would contain more specific information for finalists in the bidding process and generally request a mark-up of a form of letter of intent or definitive agreement.

5. Know what to expect for AG conditions. The AG’s web site posts its most recent decisions granting conditional consent to nonprofit hospital transactions. Although the AG develops additional unique conditions to address its specific concerns arising from a transaction, past decisions show the conditions most buyers can expect the AG to enforce for five to 10 years after the transaction:

  • Maintain the facility as a general acute care hospital and continue certain specialty services deemed essential (e.g., emergency medical services, oncology, women’s health).
  • Provide a minimum amount of charity care and community benefit services.
  • Participate in Medicare and Medi-Cal.
  • Comply with any capital investment commitments in the Definitive Agreement.
  • Submit yearly compliance reports to the AG.

6. Communicate with the AG’s office. The AG not only enforces the laws applicable to charitable organizations, but also makes itself available as a helpful and solution-oriented resource to assist charitable organizations with fulfillment of their legal obligations. Health facilities should utilize the AG’s office as a valuable resource to facilitate information exchange and understanding. In an ideal transaction where both buyer and seller commit to open communication with the AG, the parties are much more likely to reach a solution all parties can agree on and close without delay.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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