A bankruptcy court in Ohio has allowed two hospital foundations to withdraw from the bankruptcy proceedings involving 18 separate entities within the Forum Health system, despite creditors’ claims that the foundations’ unrestricted assets should be made available to pay the claims of creditors of the other entities.  The Court has held that even though the foundations have the right to give to the other entities, the other entities have no right to take from the foundations.  (In Re Forum Health, Bkrptcy Ct., N.D. OH, No. 09-40795, 3/17/11.)

Eighteen entities of the Forum Health system, including Trumbull Memorial Hospital Foundation (“TMHF”) and Western Reserve Health Foundation (“WRHF”), filed for bankruptcy about two years ago.  The two foundations filed because they were jointly liable with others on some outstanding bonds.  When the bonds were paid off from proceeds of a sale of other entities’ assets, the foundations filed to dismiss their bankruptcy cases.  The Official Committee of Unsecured Creditors objected, primarily on the grounds that the foundations’ unrestricted assets should be used to increase the recovery of the creditors of other debtors.

The foundations were structured similarly.  Western Reserve Care System (“WRCS”) was the sole corporate member of WRHF.  Trumbull Memorial Hospital was the sole corporate member of TMHF.  Each had its own board of directors, raised money from donors for its own charitable purposes, made grants for charitable purposes, utilized a Grants Review Committee to review applications and make recommendations, without approving every grant request from the affiliated hospital, and maintained separate accounts for its funds.  TMHF also made some grants to organizations other than Trumbull Hospital.  Although the foundations were included on consolidated financial statements, they nevertheless maintained distinct legal existence.

The Court said that each foundation had established grounds for dismissal of its bankruptcy filing, since the bond obligations that had caused them to file had been satisfied.  It rejected the creditors’ claim that their assets should nevertheless be utilized to pay the debts of the other entities.

“There is no dispute that the Foundations have the power to ‘give’ or grant unrestricted funds to Trumbull Hospital and WRCS in furtherance of the charitable purposes of Trumbull Hospital and WRCS,” the Court said.  “However, there is no evidence that the converse is true.  When pressed by the Court, [the attorney for the creditors] acknowledged, albeit reluctantly, that Trumbull Hospital and WRCS had no ability to ‘take’ the Foundations’ funds for their own use, despite the Foundations’ ability to ‘give’ Trumbull Hospital and WRCS grants from their unrestricted funds.  Since Trumbull Hospital and WRCS had no ability to take the unrestricted funds to pay their creditors, the Committee has no greater rights and cannot require the Foundations’ unrestricted assets to be distributed to creditors of the other Debtors as part of its proposed plan.”

The Court pointed out that neither foundation made grants without its Grants Review Committee reviewing and approving each grant request.  “Neither of the foundations rubber stamped requests for funds,” the Court said.  They “were cognizant of their fiduciary duties and responsibilities concerning the donor-generated funds that they held.”

The creditors also argued that the other debtors had a fiduciary duty to assert claims for contribution from the foundations but the Court said there was no basis in the record to support such an argument.

Finally, the creditors argued that the foundations were prohibited from using their funds for any purpose other than paying the debts of their respective hospitals. Their attorney argued that it would be “unreasonable to believe” that donors did not expect their funds to be used for the hospitals.  But “this argument is too broadly stated,” the Court said.  The donors believed that their gifts would be used for “the charitable purposes” of the hospitals; the foundation funds were not the same as the general funds of the hospitals.

“There is no evidence that Trumbull Hospital and WRCS, as the sole members of the Foundations, could compel the Foundations to use their unrestricted funds to pay the creditors of Trumbull Hospital and WRCS, let alone the creditors of any other Debtors.  Indeed, there is no basis to find that Trumbull Hospital or WRCS could compel either of the Foundations to give them any money.  Accordingly, even if, upon proper grant requests, TMHF and WFHF could ‘give’ unrestricted funds to Trumbull Hospital and WRCS, there is absolutely no basis to find that the creditors of either Trumbull Hospital or WRCS had the ability to ‘take’ these unrestricted funds in payment.”

The foundations were seeking to use their assets to pay their own creditors, the Court said.  “A creditor with a claim against one debtor has no right to distribution from the estate of any other debtor.”

YOU NEED TO KNOW

This case is an important one in confirming the value of separate foundations to hold the reserve assets of charitable entities, especially those within a system of multiple organizations. It is also clear on the value of maintaining separate existence and procedures to prevent the creditors from “piercing the corporate veil” and effectively making the assets of the foundation the assets of the debtor.

When the court says, as it does at the end of its opinion, that the sole member of the foundations could not compel grants to other organizations, it is correct as a matter of law.  As a practical matter, of course, if the board of the foundation does not grant the request, the sole member can change the board to install people who will take a different view.  But the whole purpose of the separate foundation is to protect the assets from claims of creditors.  (See Ready Reference Page: “Charities Weigh Restructuring to Protect Assets”)  If done correctly, they give the system a lot more flexibility in protecting its reserves.