Nonprofit mergers, fiduciary questions

State charitable trusts chief issues guidance on obligations of sole-member organizations

Acquisitions and affiliations occur in the not-for-profit sector as well as among for-profit business. Mergers, asset purchases and other arrangements are common, especially involving health care entities, many of which are tax-exempt charities qualified under IRS Section 501 (c)(3). Many are multimillion-dollar transactions and also involve funds donated for particular purposes. Increasingly, such transactions take place over state lines, involving entities from one state potentially controlling charitable assets in another.

One of many recent examples is the acquisition of Wentworth-Douglass Hospital in Dover by the holding company of Massachusetts General Hospital in Boston.

In many affiliations, the easiest way from a legal organizational perspective, is for the acquiring entity to become the “sole member” of the acquired. Most not-for-profit corporations have “members” instead of shareholders, whether it be hundreds, in instances like YMCAs, few who also are the board of directors, a so-called “self-perpetuating” board, or only one, as in the case of a parent-subsidiary structure.

Sole-member structures sometimes are established by existing not-for-profits to segregate new functions in subsidiary corporations that the existing ones establish, or to protect against liability issues. In other cases, acquiring corporations accomplish their goals by amending the articles of agreement of the acquired entity to constitute the acquirer as the “sole member,” and specify what powers the sole member has — electing or removing directors, establishing budgets, approving transactions of a certain size or nature, etc.

The Charitable Trusts Unit of the Attorney General’s Office has jurisdiction over charitable and educational not-for-profits in this state, as well as over funds donated for designated purposes. In the case of mergers and the sale of assets, it routinely reviews the transactions and has to consent prior to their being completed. Recently, that office has had to deal with acquisitions of the “sole member change” variety, and to consider the conditions of such transactions. In doing so, it has had to consider what obligations the acquiring entity has to the acquired, in more complex ways than in the past.

On Feb. 13, Director of Charitable Trusts Thomas J. Donovan released a letter with his office’s findings on this subject. In the letter to Attorney General Joseph Foster, Donovan was careful to distinguish between the kinds of “sole member” structures, noting that those established by existing entities to segregate or support programs were not his focus.

Concerning those transactions involving a real acquisition, however, Donovan’s conclusion was that “the corporate member owes its member organization a limited fiduciary duty.” Donovan noted that in the case of one charity becoming the sole member of another, it might vote in its (the parent’s) best interest, rather than the subsidiary’s best interest, which poses a potential legal problem. In concrete terms, a hospital might vote to close a department in another hospital of which it is the sole member in order to increase the profits of the parent, thus depriving the subsidiary of a profitable line of business.

Donovan wrote, “After reviewing New Hampshire statutes, case law from other states, and scholarly opinion, our conclusion is that New Hampshire courts would hold that a charitable organization acts as a fiduciary to the extent it employs governance and operational control over another charitable organization. Accordingly … the Attorney General should similarly require that corporate members act as a fiduciary when they exercise their control.”

Donovan listed some practical examples:

• Putting the interests of the subsidiary ahead of the controlling board’s or member’s.

• Paying attention to financial details.

• Considering whose interest is influencing decisions—parent or subsidiary’s.

• Including definitions and fiduciary standards in documents creating the sole member relationship.

• Recognizing that the sole member owes the same obligations to the entity of which it is sole member as directors do to charities of which they are directors.

• Seeking legal advice when a conflict arises between the interests of the sole member and its subsidiary.

For those considering consolidation of charitable entities, sometimes very large ones which may be among the largest employers in communities they serve, being aware of the recent advice issued by Donovan, and seeking his advice prior to entering into a transaction which may become a quagmire, is both advisable, and a real, practical way to avoid the legal complexities which led to his writing the letter in the first place. 

Brad Cook, who heads Sheehan Phinney’s Estate Planning and Probate, Government Relations and Not-for-Profit, Charitable and Religious Institutions Practice Groups, can be reached at 603-627-8110 or bcook@sheehan.com.