Nonprofit health corporations are unique. While they are created to meet the health needs of a particular community, they are also organized to fulfill broad public purposes. Thus, nonprofits and their boards have obligations to the public and must be responsive and accountable to the people they serve. To reward nonprofit corporations for their public commitment, society provides special treatment and recognition to them, such as government subsidies or the ability to accept tax-deductible donations. In order to understand the special obligations of nonprofit corporations, especially as they go through the conversion process, it is helpful to discuss the distinctions between nonprofit and for-profit corporations, the special obligations of nonprofit board members to the community, and the legal doctrines involved in preserving the public’s assets.
The important distinctions between nonprofit and for-profit health corporations illustrate the special obligations nonprofits owe to their communities. These distinctions fall into the five following categories: mission and purpose, ownership, use of assets, dissolution and tax status.
Mission and Purpose
The purpose of an organization establishes why it was formed and/or its mission. A nonprofit health corporation commits to uphold a charitable, educational, benevolent, or social welfare purpose and its activities must advance that public purpose. A for-profit focuses on the financial bottom line and works to maximize stockholder or private investor profits.
Where to Find Evidence of a Nonprofit Corporation’s Charitable Purpose
Articles of incorporation, by-laws, enabling statutes, or other incorporating documents.
Advertising, marketing materials, annual reports, fundraising materials, and statements to regulators.
Magazine and newspaper articles about the nonprofit.
History of the nonprofit corporation, including involvement in health promotion, health coverage of otherwise uninsurable populations, special discounts or rate reimbursements, and other community efforts.
Filings made with regulatory agencies responsible for oversight of nonprofit corporations, including I.R.S. Form 990 (a form containing financial data which nonprofits with annual revenues greater than $25,000 are required to file annually with the I.R.S.) and reports that insurance companies must file annually with state regulators. Click here for more about I.R.S Form 990.
Ownership determines who can benefit from the corporation and identifies to whom the board or executives are responsible. Essentially, the public is the owner of a nonprofit corporation. The board of directors and executives who run a nonprofit do not own it; rather they are trustees who manage the nonprofit and its assets to ensure that the charitable or public purpose is fulfilled.
In contrast, for-profits are owned and operated by private individuals – often shareholders. In the health setting, the interests of the private investors – to maximize profit – can be diametrically opposed to the interests of health consumers – to get the best care possible, regardless of cost.
Special Obligations of Nonprofit Board Members to the Community
The unique public purposes and ownership of nonprofit corporations also mean that nonprofit board members have special legal obligations to the communities that they serve. But lawmakers and the public have not always held accountable nonprofit board members. For example, a nonprofit health corporation and its board may not solicit public input when making decisions about the health needs of its community, thereby resulting in a failure to provide the best services possible. In order to ensure that nonprofit corporations and their boards fulfill their special obligations, they must fulfill their community benefit responsibilities to the public. The overarching purpose of these obligations is to ensure the nonprofit corporation’s openness, responsiveness, and public accountability.
Fiduciary Obligations to the Community
Every board member of a nonprofit is obligated to ensure that the corporation is managed well and operates consistently with its nonprofit purposes. This obligation is commonly referred to as the board members’ “fiduciary duty.” Black’s Law Dictionary defines “fiduciary duty” as a duty to act for someone else’s benefit while putting one’s personal interests aside. This is the highest standard of duty imposed by law. Nonprofit board members considering conversion must make decisions based upon their fiduciary duties and not their potential private interests. In most cases, the state Attorney General is charged with ensuring that nonprofit board members meet their fiduciary obligations.
There are a number of different fiduciary duties that board members owe the corporation. Two of the more common fiduciary duties that are violated during a health conversion from nonprofit to for-profit status are the duty of care and the duty of loyalty.
Duty of Care
The duty of care requires board members to exercise good judgment and reasonable care in conducting the business of the corporation. For example, in 1996, the California Attorney General found the board members of a nonprofit hospital system in San Diego had undervalued the charitable assets of the hospital by $100 – $200 million when deciding to sell the system to the for-profit company, Columbia/HCA. The Attorney General wrote the hospital system a letter (PDF) concluding “that the [Board’s] acceptance of the Columbia proposal represents a serious breach of trust” and threatened to hold each individual member of the board who voted for the proposal personally liable for the $100 – $200 million undervaluation.
Duty of Loyalty
The duty of loyalty prohibits a board member from profiting at the expense of the nonprofit corporation. For example, in 1996, the president and some board members of Blue Cross and Blue Shield Mutual of Ohio stood to gain millions from a proposed sale of the nonprofit corporation to for-profit Columbia/HCA through payments and noncompetition and consulting agreements. The Attorney General filed suit against the nonprofit, the president, and individual board members, asserting, among other things, that these individuals had breached their fiduciary duty of loyalty. Less than a year later, the parties resolved the litigation and many of the board members and executives agreed to return their personal profit to the nonprofit organization.
Use of Assets
A nonprofit is more restricted in its use of assets or money generated by the corporation than a for-profit corporation. Money made by a nonprofit must remain in the nonprofit sector and be used to further the charitable purpose of the organization. Assets, and money generated from the assets, cannot be used to benefit private individuals. When an insider, such as a board member or executive, personally benefits from the assets of a nonprofit it is called “private inurement” and is illegal.
Money made by a for-profit corporation, on the other hand, can be distributed to stockholders or private owners as dividends, can be invested back in the for-profit venture, or can be paid out in executive compensation. The prohibition against private inurement does not apply to a for-profit corporation.
Significant restrictions govern how nonprofit corporations may distribute their assets upon dissolution. When a nonprofit corporation can no longer continue its purpose and/or mission, its assets must be distributed according to the corporation’s dissolution clause, usually found in the nonprofit’s incorporation papers and/or under the state nonprofit code. Most state laws require nonprofits to transfer all of their assets upon dissolution to another nonprofit corporation that has a purpose similar to the dissolving nonprofit.
A for-profit can distribute its assets to private individuals and is under no obligation to continue to use the assets consistent with the original corporation’s purpose.
The Internal Revenue Service categorizes nonprofits and for-profits differently. While for-profits must pay taxes and cannot accept tax deductible donations, many nonprofits are fully tax-exempt, paying no federal income taxes and no state or local income, sales or property taxes. Most can accept tax-deductible donations and all must use their assets for the nonprofit purposes identified in their incorporation papers. Nonprofits are commonly organized under sections 501(c)(3) or 501(c)(4) of the federal tax code. Although Blue Cross and Blue Shield plans pay federal taxes, they get reduced rates under section 501(m) of the federal tax code. In addition, nonprofits are often limited in their ability to lobby. For-profits are not restricted in their lobbying activity and are not required to organize or use their assets for any prescribed purpose.
Blue Cross: 501(m)
In the early 1980s, many commercial insurers began to challenge the fully tax-exempt status of the Blue Cross and Blue Shield plans. They brought their challenge to the IRS and to Congress. The national BCBS Association, a nonprofit organization that holds the BCBS trademark, went to great lengths to distinguish BCBS plans from commercial insurers by stressing their dedication to charitable, community-based health care services. As of January 1, 1987, the federal government removed the full tax-exempt status of BCBS plans and instead created a special tax class for BCBS organizations, Internal Revenue Code (“I.R.C.”) 5833. The new I.R.C. category subjected BCBS plans to federal taxation but recognized the unique role BCBS plans play. Under I.R.C. 5833 the BCBS plans, unlike commercial for-profit insurers, are entitled to special tax benefits.