A hospital's board plays an integral role in transaction preparations because it is responsible for fiduciary duties. While the fiduciary duties imposed will vary by state, there are a few concepts that will apply universally. The fiduciary duties are important because they enforce a diligent process prior to and during a transaction. Overlooking this may cause negative implications for a transaction's timeline, process and outcome.
In a webinar hosted by McGuireWoods, Barton Walker, JD, healthcare attorney for McGuireWoods, stressed the importance of fiduciary duties in preparing for a merger or affiliation. To avoid problems, a hospital board should be properly educated on its duties for conducting a diligent process. According to Mr. Walker, a board should be knowledgeable in the following four areas to run a successful transaction.
To fulfill duty of care, the following questions should be asked. What has the transaction process been from start to finish? Was the evaluation process conducted in a thoughtful and diligent manner? Has there been a full investigation of the relevant details? The above questions should all have answers of "yes." Beyond addressing these questions, a board should address the following concepts.
1. Evaluation of alternatives. It is important for a hospital's board to evaluate all the alternatives for a transaction. This includes considering no transaction at all. Regardless of the direction the hospital's board decides upon, each type requires a diligent investigation, said Mr. Walker. The following three alternatives are most often considered.
2. Evaluation of competing offers. The next step for a board of trustees is to evaluate the competing offers for a merger or affiliation, and just like every other task, the board must conduct a thorough, diligent and fair process. Every offer should be given full consideration. "Once the board has gone through the footwork and the background research detailing the hospital's ideal transaction, it can request the help of an investment banker or consultant to evaluate partner offers," said Mr. Walker. "The board shouldn't ignore an offer because it comes late in the game. Every offer needs to be given an opportunity. Any preference given to one offer over the other could hurt the transaction during review by the state attorney general or the Federal Trade Commission," he said.
3. Fair market value. Later on in a hospital's transaction process, it is the hospital board's responsibility to make sure the transaction is fair market value. If the board of trustees is looking to sell the hospital, then the sale price or any capital exchange must be fair market value. If the board is looking to conduct an affiliation or management agreement, it is critical that any tax-exempt assets being used in the management relationship are paid at fair market value as well, said Mr. Walker.
A conflict of interest — whether a director or board member stands to benefit personally — with the transaction is the most common threat to the substance of a transaction. In order for a board to determine that there are no conflicts of interest, Mr. Walker recommends the following questions: Is the director acting in the hospital or the organization's best interests? Is every board member acting in favor of charity and community benefit rather than self-interest?
According to Mr. Walker, a conflict of interest may not be cut and dry such as a director who is a shareholder of a potential buyer or partner. Sometimes there are less obvious ways for board members to benefit from a transaction, so it is important for the board to be educated on this element in their fiduciary duty.
"The importance of eliminating conflicts of interest is heightened in the context of a sale or merger. Although many boards will have a conflict of interest policy, educating the board on the process during the pre-transaction phase will guarantee the board does not inadvertently miss any conflicts of interest, which could throw a wrench in the process," said Mr. Walker.
• The board's strategic needs and objectives including management updates from the past 12 months.
• The extent to which the board and its advisors conducted a competitive process.
• The comprehensiveness and rigor of the market-clearing process (e.g., how many partners were contacted and what ownership forms were considered).
• The fairness and openness of the transaction as viewed by regulators and other stakeholders (e.g., competitors, lenders and payors).
• The responses that were requested of these partners (e.g., what financial and non-financial issues were addressed and how the responses were documented in instruction letters and proposals).
• The extent to which a detailed comprehensive analysis of the proposals was reviewed with the board.
An ability to demonstrate that fair market value was set through the market clearing process.
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In a webinar hosted by McGuireWoods, Barton Walker, JD, healthcare attorney for McGuireWoods, stressed the importance of fiduciary duties in preparing for a merger or affiliation. To avoid problems, a hospital board should be properly educated on its duties for conducting a diligent process. According to Mr. Walker, a board should be knowledgeable in the following four areas to run a successful transaction.
1. Duty of care
One of the fiduciary duties for a hospital board is duty of care. According to Mr. Walker, duty of care focuses on the process of the transaction and is necessary for a sound and smooth process. In almost every state, a hospital's board is required to conduct a full investigation of all relevant details, meaning it conducts a diligent investigation into transaction and partner options prior to and during a transaction. "This implies that the board ought to ask questions," said Mr. Walker.To fulfill duty of care, the following questions should be asked. What has the transaction process been from start to finish? Was the evaluation process conducted in a thoughtful and diligent manner? Has there been a full investigation of the relevant details? The above questions should all have answers of "yes." Beyond addressing these questions, a board should address the following concepts.
1. Evaluation of alternatives. It is important for a hospital's board to evaluate all the alternatives for a transaction. This includes considering no transaction at all. Regardless of the direction the hospital's board decides upon, each type requires a diligent investigation, said Mr. Walker. The following three alternatives are most often considered.
- Continue operations as is — The board should consider the option to remain independent regardless of whether the hospital is financially stable or financially distressed. "The board should always evaluate its potential to continue operations as is. Even if this option is discarded, the board must have discussed it to fulfill the requirements of a diligent investigation," said Mr. Walker.
- Merger or sale transaction — This transaction is a larger and more significant change for a hospital.
- Affiliation or management agreement — This type of transaction is the least rigorous of the three options.
2. Evaluation of competing offers. The next step for a board of trustees is to evaluate the competing offers for a merger or affiliation, and just like every other task, the board must conduct a thorough, diligent and fair process. Every offer should be given full consideration. "Once the board has gone through the footwork and the background research detailing the hospital's ideal transaction, it can request the help of an investment banker or consultant to evaluate partner offers," said Mr. Walker. "The board shouldn't ignore an offer because it comes late in the game. Every offer needs to be given an opportunity. Any preference given to one offer over the other could hurt the transaction during review by the state attorney general or the Federal Trade Commission," he said.
3. Fair market value. Later on in a hospital's transaction process, it is the hospital board's responsibility to make sure the transaction is fair market value. If the board of trustees is looking to sell the hospital, then the sale price or any capital exchange must be fair market value. If the board is looking to conduct an affiliation or management agreement, it is critical that any tax-exempt assets being used in the management relationship are paid at fair market value as well, said Mr. Walker.
2. Duty of loyalty
Duty of loyalty focuses on the substance of the transaction. The board of trustees is responsible for identifying and eliminating any issues or conflicts that jeopardize the purpose of the transaction. "A transaction needs to be for the benefit of the hospital and its community rather than for a board member's personal gain," said Mr. Walker.A conflict of interest — whether a director or board member stands to benefit personally — with the transaction is the most common threat to the substance of a transaction. In order for a board to determine that there are no conflicts of interest, Mr. Walker recommends the following questions: Is the director acting in the hospital or the organization's best interests? Is every board member acting in favor of charity and community benefit rather than self-interest?
According to Mr. Walker, a conflict of interest may not be cut and dry such as a director who is a shareholder of a potential buyer or partner. Sometimes there are less obvious ways for board members to benefit from a transaction, so it is important for the board to be educated on this element in their fiduciary duty.
"The importance of eliminating conflicts of interest is heightened in the context of a sale or merger. Although many boards will have a conflict of interest policy, educating the board on the process during the pre-transaction phase will guarantee the board does not inadvertently miss any conflicts of interest, which could throw a wrench in the process," said Mr. Walker.
3. Personal liability
Board members and board directors need to be educated on personal liability so they place the proper amount of emphasis on duty of loyalty. "While many hospitals will have a directors and officers insurance to cover the action of its boards and executives, some states may not allow DNO insurance to shield board members from mistakes in reviewing conflicts of interest. Board members and executives could suffer personal liability if they breach their fiduciary duties. For this reason, the pre-transaction phase is a good time to revisit the policies and understand the limits of the coverage," said Mr. Walker.4. A defensible board process
A hospital and its board can never predict the reaction of the community when they propose a transaction. In addition, the length and intensity of an attorney general or FTC review is unpredictable. In order to have a strong defense for the rationale behind the transaction, the board needs to document its strategic goals and objectives as well as the extent to which the board and any advisors conducted a competitive process. Mr. Walker recommends documenting the following:• The board's strategic needs and objectives including management updates from the past 12 months.
• The extent to which the board and its advisors conducted a competitive process.
• The comprehensiveness and rigor of the market-clearing process (e.g., how many partners were contacted and what ownership forms were considered).
• The fairness and openness of the transaction as viewed by regulators and other stakeholders (e.g., competitors, lenders and payors).
• The responses that were requested of these partners (e.g., what financial and non-financial issues were addressed and how the responses were documented in instruction letters and proposals).
• The extent to which a detailed comprehensive analysis of the proposals was reviewed with the board.
An ability to demonstrate that fair market value was set through the market clearing process.
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