Checkpoints on the Conversion Highway: Some Trouble Spots in the Conversion of Nonprofit Health Care Organizations to For-Profit Status

James J. Fishman* I. INTRODUCTION For the past few years, the United States has witnessed the largest redeployment of charitable assets in the Anglo-American world since Henry VII closed the monasteries in 1536-1540 as formerly nonprofit health care providers are switching to for-profit status. Conversions refer to a growing array of transactions that have in common the transformation of the core enterprise from a charitable undertaking to a for-profit venture. Billions of dollars in charitable assets have been redeployed from eleemosynary to profitseeking purposes, leading to a fundamental change in the structure of the American health care system. The conversion of charitable health providers has created some of the nation's largest private foundations.1 This essay does not address the truly important policy issues: whether for-profit healthcare should be allowed or encouraged;2 how the quality of care compares to nonprofits or what criteria should be used to evaluate the quality of care;3 or what the impact of these conversions is on the communities they serve.4 It discusses less significant issues: those of process-how can we shape and control this tidal wave of change so that the public will be served and charitable assets preserved to the maximum extent possible? The focus is upon the valuation of these charitable assets; the appropriate process of conversion; how to protect the public; who should represent the public interest; and what, if any, should be the legal response. A. Section 501 (c)(3) Organizations: "Traditional Nonprofits" There is a vast array of organizations in the United States that share the designation "nonprofit." Section 501 of the Internal Revenue Code provides twenty-seven different organizational categories which exempt an organization from federal income taxation.5 These categories of tax exempt organizations include corporations, title holding companies, civic leagues, local associations of employees, business leagues, social clubs, and organizations operated for religious, charitable, educational and similar purposes. Over half of the 1.2 million charities registered with the Internal Revenue Service are covered by section 501(c)(3) which consists of traditional charities.6 The tax code states that these traditional charities must be organized and operated exclusively for religious, charitable, scientific, literary or educational purposes.7 No part of their net earnings can inure to the benefit of any private shareholder or individual, and no substantial part of their activities can include carrying on propaganda or otherwise attempting to influence legislation.8 These traditional charities may not participate or intervene in political campaigns.9 Recognition as a 501(c)(3) charity is very valuable to organizations, because contributions to such charities are deductible by the donor from their personal or corporate income.10 B. The Promotion of Health as a Tax Exempt Purpose From the time of the Elizabethan Statute of Uses,ll the promotion of health has been considered a charitable purpose, and in the United States, hospitals and other health care providers have always been tax exempt.12 Non-profit hospitals seemed so much the symbol of charitable purpose that many states specifically granted them exemption from taxation.13 In the eighteenth century, the nonprofit hospital was often little more than an almshouse where the homeless came to die.14 During the nineteenth century, nonprofit hospitals were known as "voluntary" institutions-organized by religious societies, heavily funded by donations, and staffed by doctors who worked without compensation, and nurses who worked for room and board as part of their lifetime commitment to a religious order devoted to caring for the poor.15 Through medical advances, changes in the payment system which made the "voluntary" nature of the hospital a myth, and the emergence of for-profit competition, hospitals retained their tax exempt status. …