Manhattan Eye, Ear and Throat Hospital v. Spitzer

Brief Fact Summary.

Manhattan Eye, Ear and Throat Hospital (MEETH) (Plaintiff) sought approval of its proposed sale of a not-for-profit medical complex pursuant to section 511 [New York Not-For-Profit Law].

Synopsis of Rule of Law.

To gain approval for selling a not-for-profit corporation, the corporation must show that the consideration and terms of the transaction are fair and reasonable and that the sale will promote the purposes of the corporation.

Facts.

In 1995, Manhattan Eye, Ear and Throat Hospital (MEETH) (Plaintiff), was world renowned as an acute care specialty hospital.  Their medical complex was located on East 64th Street, and they opened an outpatient center in Harlem.  Plaintiff’s articles of incorporation stated the corporation’s purposes as “to establish, provide, conduct, operate and maintain a hospital in the City, County and State of New York for the general treatment of persons suffering from acute short-term illnesses; performing general plastic surgery, treating persons suffering from diseases of the eye, ear, nose or throat; maintaining a school for post-graduate instruction in the treatment of such illnesses, performing such surgery, and the treatment of such diseases, and conducting associated and basic research.”  Because of budget restrictions, Plaintiff decided to sell the 64th Street complex in 1999 to Memorial Sloan Kettering Cancer Center (MSKCC) and Downtown Group/Colony Capital (Downtown).  The sale would require shutting down its programs at the 64th Street location.  Plaintiff also intended to transform the clinic in Harlem to a freestanding Diagnostic and Treatment center (D&T).  Also, there were plans to add more D&T centers in the South Bronx.  The 64th Street complex property was appraised between $46 and $50 million.  Plaintiff sold the property to MSKCC and Downtown for $41 million.  MSKCC planned to use the portion of the real estate it bought to expand its cancer treatment and research, while Downtown intended to use its portion to build an apartment complex.  There was also discussion by the board of directors to revise the purpose of the corporation to its “original” purpose—to serve the poor in areas of the City not receiving adequate services.  However, the articles of incorporation were never amended.  Plaintiff planned to time its petition for approval of the sale to follow the Department of Health’s (DOH) approval for creation of the D&T centers and after the hospital had been closed.  This timing however did not work out, and the petition was filed before DOH approval and the facilities were still partly operational at the time the court was evaluating the sale.

Issue.

To gain approval for selling a not-for-profit corporation, must the corporation show that the consideration and terms of the transaction are fair and reasonable and that the sale will promote the purposes of the corporation?

Held.

[Judge not stated in casebook excerpt.]  To gain approval for selling a not-for-profit corporation, the corporation must show that the consideration and terms of the transaction are fair and reasonable and that the sale will promote the purposes of the corporation.  The evaluation of the first prong of this test, determining if the consideration and terms of the transaction are fair and reasonable, requires more than merely looking at the market value of the real estate because the sale is linked with eliminating the medical services currently provided by Plaintiff.  Essentially, closing the acute care medical specialty facility will bring about a fundamental change to the corporation’s purposes as described in their articles of incorporation.  Plaintiff has major medical value that is not being preserved under the terms of the proposed transaction.  “Monetizing” the value of the physical assets does not capture the full value of its not-for-profit provision of world-renowned medical services.  As for the second prong of the analysis, whether or not the corporation’s purposes will be promoted, the evidence of Plaintiff’s plan to amend its articles of incorporation to line up the corporation’s new purposes with the function of its newly proposed D&T centers shows that the corporation was well aware that it was not meeting this requirement under the transaction’s terms.  While the definition of “hospital” includes the functions of what the D&T centers would provide in terms of general medical practice, the center’s deviation from specialty eye, ear, nose and throat surgery and research cannot be ignored or denied.  The transaction before the court can best be summarized as one where an organization sells major assets to solve financial troubles and then begins a completely new mission.  Plaintiff’s Board of Directors did not consider various alternatives that would have preserved the mission of the corporation.  The proposed transaction fails to meet the two-pronged test of § 511 and the court denies Plaintiff’s petition.

Discussion.

In the context of charitable organizations, procedurally there were no shareholders to represent the interests of the corporation’s interests.  In order to ensure protection of the interests of the beneficiaries of the not-for-profit hospital, the court appointed the Attorney General (Spitzer) to represent those interests.
  Many not-for-profit health insurance companies and HMOs have recently decided to convert to for-profit status.  Blue Cross organizations have led the way in this movement.  In the typical conversion, the assets are sold to a for-profit entity.  To comply with internal revenue laws, the money made from the sale of the not-for-profit assets is supposed to be distributed to charitable organizations that are eligible pursuant to § 501(c)(3) of the IRC.  When making this conversion, many not-for-profits intentionally undervalue their assets and purchase the assets for the newly formed for-profit corporation, which is conveniently under the management of the same Board of Directors.  The new corporation then has a sale of public stock at a substantial premium above the price paid by the investors.  This practice has resulted in lawsuits to retain the actual value of the not-for-profit corporation in the particular communities who had invested good will and tax relief with the expectation of receiving the charitable services in return.  A number of states also responded to this tactic by amending the law for their not-for-profit corporations to ensure the sales were not shams—such as the situation in the above case.