Adhering to Board Duties in an Affiliation Transaction

By Thomas M. Fahey, Partner, Nixon Peabody

The trustees of a non-profit community hospital have a similar profile: engaged community members, a few physicians, an administrator or two. The business conducted by the board in normal times is challenging.  The board is charged with understanding and governing  a wide range of issues ranging from finance to quality and compliance to ethics. They are not compensated for their efforts, but rather derive their payback in helping to assure that their community benefits from all that a thriving health care institution offers.

That is in normal times, which seem rather fleeting in the current environment. In addition to dealing with the challenges of keeping their institution moving in the right direction on a day-to-day and year-to-year basis, with increasing frequency these boards must now deal with questions of even greater significance: Can the hospital survive as a stand-alone provider, or is it time to hand over the control of the hospital to a larger health system that may be better suited to allow the hospital to compete and thrive in today's environment?

The decision to relinquish independence, and to whom, is the most important one that a board will ever be called upon to make. There is no rule book to follow that will lead the board to the right decision; there are no consultants who can provide a quick answer. Instead, this circumstance requires, more than ever, that the trustees follow the basic principles of governance in their search for answers. These principles require adherence to the time-tested duty of care, and the duty of loyalty, as the board works its way toward an answer that is in the best interest of its community for the future.

Duty of care

Directors considering affiliation options must exercise necessary care in reaching any decision.  Their actions will be judged by whether they were appropriately diligent in considering all options.  They need to attend meetings, prepare for those meetings, become educated about the pros and cons of continued independence, and learn about the strengths and weaknesses of the hospital’s potential partner.

It is fine (indeed it is prudent) to engage consultants to assist in the process and to defer appropriately to their industry expertise. But the board cannot let the consultant’s judgment be substituted for their own. The same goes for committees. Directors can delegate much of the granular work on affiliation matters to an affiliation subcommittee, but they cannot blindly rely upon the committee’s work and recommendations. The consultant’s or the committee’s work should help form the board’s view, but that view must be developed independently through the board’s own diligent efforts.

Read. Inquire. Show up. Pay attention. In short, do everything possible to position yourself to make a prudent, informed decision and you will have met your duty of care.

Duty of loyalty

Of equal importance is that directors adhere to their duty of loyalty as the corporation deliberates an affiliation. This duty requires, in short, that the interests of the corporation take precedence over all personal interests as the process unfolds. This duty is more nuanced than the duty of care and requires directors to be introspective and candid about the manner in which their personal interests can impact their ability to maintain an objective view of affiliation options. 

It would be typical for a number of board members to have some type of personal interest implicated by a decision to affiliate and the selection of particular partner. Typical examples include administrators who are voting members of the board, physicians who are professionally comfortable with the status quo, and community representatives who have business relationships with the hospital or a prospective partner.

There is nothing wrong with having a “conflict” of this sort. But a formal process must be followed to identify and disclose the relationship causing the conflict and to come to an appropriate conclusion whether the conflict is disabling (i.e., one that would prohibit the board member from voting) or is of the type that will allow the director to remain objective and able to make decisions in the best interests of the hospital and the community it serves.  The hospital’s conflict of interest policy should be reviewed to make certain it is up to date, and it should be followed to the letter.

The duty of loyalty has a second prong — confidentiality. Clearly directors cannot use confidential information about the affiliation for their personal benefit. Even short of that, and presenting a more realistic breach scenario, directors must maintain in strict confidence all information that they receive about the affiliation. This is not an easy task as there is always great curiosity about the hospital’s future, and rumors and misinformation are the norm. Directors will be approached by a range of people who want to know the latest information or to confirm a rumor. But sensitive information cannot be shared as it can jeopardize the ability of the hospital to complete a transaction, or to obtain the best possible terms as it does so.

Adhering to the duties

Satisfying the duties of care and loyalty accomplishes a number of objectives. It will provide directors with the satisfaction of knowing they have done their job the right way. It also provides the best assurance that the right decision will be reached for the hospital’s future. An informed, objective board will be positioned to reach the right outcome on this critical decision. 

A final benefit is that if directors adhere to the duties of care and loyalty, they will best protect themselves from liability in the event a party questions the decision reached by the board. No one can guarantee whether a decision to affiliate, and with whom, will prove to be the right one.  Indeed, in today’s challenging and evolving environment, it is likely that any board decision will lead to some second guessing.  By following the duties of care and loyalty, an individual director, and the board as a whole, will be able to move forward assured that their actions were taken with the best interests of the hospital in mind.