Proposed Acquisition of Rex Healthcare by the University of North Carolina Health Care System

Re: Advisory Opinion; Proposed Acquisition of Rex Healthcare, Inc. by the University of North Carolina Health Care System

Dear Representative Blue:

You have requested our opinion concerning a number of legal issues related to the proposed acquisition of Rex Healthcare, Inc. (“Rex”) by the University of North Carolina Health Care System (“System”). The proposal involves a three-party transaction between Rex, the System, and the John Rex Endowment (“Endowment”). In responding to your request we have reviewed information provided by the System, including a draft Acquisition Agreement dated January 25, 2000, and a draft Endowment Agreement dated January 25, 2000. We have also reviewed disclosures provided by the System to this office as required by G.S. § 55A-12-02. It is our understanding that final details of the proposed transaction have not been finalized and are subject to continuing negotiations between the parties.

The System was established by Chapter 212, Section 11.8 of the 1998 Session Laws, as an affiliated enterprise of the University of North Carolina. The System is comprised of the University of North Carolina Hospitals at Chapel Hill and the clinical patient care programs established or maintained by the School of Medicine of the University of North Carolina at Chapel Hill. The statutory purpose of the System is “. . . to provide patient care, facilitate the education of physicians and other health care providers, conduct research collaboratively with the health sciences schools of the University of North Carolina at Chapel Hill, and render other services designed to promote the health and well-being of citizens of North Carolina”. G.S. § 116-37(a)(1). The System is further authorized to establish, subject to certain limitations, its own policies, rules, regulations and procedures for purchasing requirements, real property transactions, and design, construction and renovation activities. G.S. § 116-37(h),(i) and (j). The System is governed by a board of directors composed of ex officio public official members, and private members nominated by the board, appointed by the President of the University and ratified by the Board of Governors.

Rex has existed as a Chapter 55A nonprofit corporation governed by a board of trustees since its legislatively approved reorganization in 1985. Prior to 1985, Rex operated for over 100 years under the organizational structure dictated by the will of John Rex. The Endowment was incorporated in August, 1999, also as a nonprofit corporation under Chapter 55A. Its board of directors consists of the current Rex board. Both corporations are operated exclusively for charitable, scientific and educational purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code. It is our understanding that the System does not contemplate any change in the nonprofit status of these two corporations subsequent to the proposed transaction.

The information provided to us indicates that the proposed transaction will involve two principal steps. First, the Articles of Organization and Bylaws of Rex will be amended to make the Endowment the sole corporate member of Rex. At closing, the Endowment will transfer this control to the System by installing the System as the sole corporate member of Rex. The System will also acquire the power to appoint, directly or indirectly, all members of the Rex board and the boards of its affiliates. In addition, twenty-five percent (25%) of the members of the Endowment’s board will be persons appointed directly by the System. Other powers which the System will acquire include the authority of the System’s Chief Executive Officer to replace the Chief Executive Officers of Rex and its affiliates. This transaction will vest the System with complete corporate control over Rex, and the corporate affiliates of Rex, as well as substantial influence on the Endowment board.

As consideration for acquisition of this control, the System will transfer to the Endowment One Hundred Million Dollars ($100,000,000) at closing. The Endowment will thereafter, over a ten-year period, transfer to Rex Twenty-Five Million Dollars ($25,000,000) for capital projects approved by the System. The investment income from the remaining Seventy-Five Million Dollars ($75,000,000) will be used by the Endowment to support indigent care and community health programs. In addition, the System will transfer directly to Rex, over a ten-year period, Sixty-Three Million Dollars ($63,000,000) to fund strategic initiatives approved by the System.

It is our interpretation of the proposed transaction that the System will not directly acquire the physical facilities, real property or other tangible assets of Rex and its affiliates. The System will instead acquire corporate control over Rex and its affiliates through the contractual transfer of power required under the terms of the Acquisition Agreement and Endowment Agreement. As the sole corporate member of Rex, the System will possess the legal authority to control the appointment of board members and maintain direct or indirect control over most management functions and responsibilities of Rex and its affiliates.

We have been advised by the System that the principal purpose of the proposed transaction is to enhance the quality of health care available to residents of the greater triangle area by preserving the financial viability of Rex while providing greater stability, a broader service area and enhanced strength to the System. The specific goals necessary to achieve this purpose include the maintenance of Rex’s identity, preeminence and visibility in its service area; utilization of the respective clinical components of Rex and the System to their best advantage; and enhancement of the ability of Rex and the System to deliver high quality, cost-effective care to patients. The System believes that the proposed transaction will additionally result in operational efficiencies that will produce cost-savings without adversely affecting patient care.

Your first inquiry is whether the System can lawfully expend public funds for the acquisition of corporate control over Rex without specific authorization by the General Assembly. As previously noted, the System was established by the General Assembly as an “affiliated enterprise” of the University of North Carolina in order to “. . . provide patient care, facilitate the education of physicians and other health care providers, conduct research collaboratively with the health sciences schools of the University of North Carolina at Chapel Hill, and render other services designed to promote the health and well-being of the citizens of North Carolina.” In furtherance of these goals the legislature has provided the System with management flexibility in a number of areas, including personnel, purchasing, construction, real property acquisition and finances. On a broader scale, G.S. § 116-37(b)(4) specifically states:

In meeting the patient-care, educational, research, and public-service

goals of the University of North Carolina Health Care System, the board of

directors is authorized to exercise such authority and responsibility and

adopt such policies, rules and regulations as it deems necessary and

appropriate, not inconsistent with the provisions of this section or the

policies of the Board of Governors.

The legislation thus reflects a legislative intent to authorize the System to manage its operations, including decisions concerning capital investments, with such degree of autonomy as it deems necessary to carry out its statutory responsibilities, without further authorization by the General Assembly.

The North Carolina Constitution also sanctions the appropriation of public money to a private corporation for the accomplishment of a public purpose. North Carolina Constitution, Article V, § 2(7). Under Article V, § 2(7) direct disbursement of public funds to private entities is a constitutionally permissible means of accomplishing a public purpose provided there is statutory authorization to make such appropriation. Hughey v. Cloninger, 297 N.C. 86 (1979). Consistent with that revision, public funds have been appropriated by the General Assembly to the North Carolina Biotechnology Center, The Microelectronics Center of North Carolina, and the Rural Economic Development Center, Inc. The North Carolina Ports Railway Commission, pursuant to authority granted under G. S. § 143B-469.1, acquired one hundred percent (100%) of the stock, and thereby corporate control, over two private railroad companies between 1990 and 1995. More recently, the 1997 General Assembly authorized the investment of Sixty-One Million Dollars ($61,000,000) in order to acquire the outstanding private shares, and thereby total control, of the North Carolina Railroad Company. In view of these precedents, it is our opinion that the General Assembly, through the enactment of Chapter 212, Section 11.8 of the 1998 Session Laws, authorized the System to acquire control of Rex through the proposed transaction.

Your second series of questions concerns the legal status of the Endowment, Rex and the employees of each corporation upon closing of the proposed transaction. You have specifically inquired as to whether public funds will be used to capitalize the corporations and secure future financial obligations, while the structure of the transaction circumvents the public accountability required of state agencies and institutions. As previously noted, Rex and the Endowment are each nonprofit corporations organized under Chapter 55A of the General Statutes. We do not believe that the System’s acquisition of corporate control over Rex and its affiliates or the power to appoint members of the Endowment board modifies their legal status or transforms them into public entities. The System proposes to acquire corporate control by becoming the sole corporate member of Rex, and by acquiring the power to appoint members of Rex’s board of directors. These board members do not, however, possess characteristics of the state, but are required to exercise their fiduciary responsibilities to the corporations in the same manner as other directors of private corporations. As stated by the North Carolina Supreme Court in Marshall v. Railroad Co.:

Where the state is a stockholder in a railroad company, it is bound by the

provisions of the charter in the same manner as an individual stockholder.

It has no advantage as a stockholder on account of its sovereignty; for by

becoming such it lays down its character as a sovereign, and it places

itself on a footing of equality with the individual stockholders.

92 N.C. at 322. In Southern Railway Co. v. North Carolina Railroad Co., 81 F. 595

(W.D.N.C. 1897), a federal district court reached a similar conclusion in addressing the issue of whether the North Carolina Railroad was protected from suit by sovereign immunity in view of the state’s ownership of three-fourths of the company’s stock. The court concluded that the state’s sovereignty did not extend to a corporation which it controlled, stating:

So far as respects the transactions of the corporation, its contracts, or its

torts, the state exercises no power, enjoys no privilege, with regard to

them, not derived from the charter, or differing in any way with the power

or privilege enjoyed by any other stockholder.

81 F. at 599. Based upon these principles, it is clear that the System’s acquisition of corporate control over a nonprofit corporation does not alter the legal status of the corporation or vest within it attributes of the State of North Carolina. Furthermore, any operating losses or other liabilities of Rex, its affiliates, or the Endowment will accrue to the corporations and not to the public.

It is equally clear that the employees of Rex, its affiliates, and the Endowment will not become “state employees.” The State of North Carolina’s system of personnel administration for employees of State government is codified under Chapter 126 of the General Statutes. G.S. § 126-5 defines and categorizes employees of state agencies, institutions and boards who are vested with legal employment rights by virtue of their status as state employees. Chapter 135 of the General Statutes defines the term state “employee” for purposes of entitlement to benefits under the Retirement System and Comprehensive Major Medical Plan. Neither these state statutory programs, nor any other statutory provision of which we are aware, includes within a definition of the term “state employee” individuals who are not directly employed by a state or local governmental entity.

In regard to the issue of accountability, Rex, its affiliates, and the Endowment, as private corporations, will not be directly subject to the same statutory oversight requirements imposed upon the System and other public entities. The corporations will, however, be indirectly subject to a substantial degree of public accountability through the statutory requirements imposed upon the System, which remains subject to the provisions of the Executive Budget Act, including all aspects of budget preparation, budget execution, and expenditure reporting. G.S. § 116-37(e). An annual report by the System to the Joint Legislative Commission on Governmental Operations is required.

G.S. § 116-37(g). Policies, rules, and regulations adopted by the System’s board of directors concerning personnel, purchasing, real property and construction require review by appropriate state agencies. G.S. § 116-37(d), (h), (i) and (j). All actions of the System must be consistent with the policies of the Board of Governors. G.S. § 11637(b)(a). In addition, the System’s power to appoint and remove directors will provide a substantial measure of public oversight and control of the activities of Rex, its affiliates, and the Endowment, as will the management control provided by the transaction documents.

You have also inquired as to whether the corporate entities will enjoy any of the immunities of the State of North Carolina. Again, we believe that Rex, its affiliates, and the Endowment will retain the characteristics of private, nonprofit corporations. Acquisition of corporate control by the System will not provide these corporations with any of the immunities possessed by state agencies or institutions. Nor will employees of the corporations be protected by the Tort Claims Act, G.S. § 143-291, et seq, or the Defense of State Employees Act, G.S. § 143-300.2, et seq.

In response to your next question, we do not view the proposed transaction as raising legal issues similar to those surrounding the proposed conversion of Blue Cross/Blue Shield from a nonprofit to a for-profit corporation. The Blue Cross conversion raises issues related to the appropriate post-conversion treatment of accumulated monetary reserves arguably the product of the benefits accrued by Blue Cross as a Chapter 55A nonprofit corporation. We are aware of no evidence suggesting that either the Endowment or Rex will be converted into a for-profit corporation subsequent to the proposed transaction. Should such a conversion be proposed in the future, this office will review the transaction as required by G.S. § 55A12-02.

In regard to antitrust issues, this Office has advised the System that the proposed transaction is governed by the doctrine of state action immunity and that we do not plan to contest, under state or federal antitrust law, the acquisition of Rex by the System. As nonprofit corporations, however, Rex and the Endowment will be subject to the same federal and state antitrust considerations in future transactions as other corporations.

Finally, you have inquired as to “. . . the status of a foundation created by the transfer of public revenues”. You ask whether the General Assembly retains ongoing administrative and oversight responsibility of such a foundation. Assuming your question refers to the Endowment, we believe the answer is no. It appears that your questions is premised upon an assumption that the Endowment is a publicly created and publicly funded entity. It is clear, however, that the Endowment was incorporated as a private, nonprofit corporation under Chapter 55A, to be operated exclusively for charitable, scientific and educational purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code. The initial incorporator of the Endowment was James

W. Albright, a private citizen. The initial board of directors of the Endowment consists of the directors of Rex, which is also a private, nonprofit corporation.

As we understand the proposed transaction, the Endowment will, through a contractual agreement, receive public funds from the System as primary consideration for the System’s acquisition of control over Rex. Those funds will become assets of the Endowment, to be used in accordance with the purposes for which the corporation was created. Public funds transferred to a private corporation within the context of a valid business transaction do not retain their status as public funds. It is therefore our opinion that the General Assembly will not retain ongoing administrative oversight of the Endowment.

I trust this advisory opinion is responsive to your inquiry. The opinions we have offered are, of course, based upon the most recent information provided by the System. Should the continuing negotiations between the parties result in material modifications to the terms of the proposed transaction, a subsequent review of certain legal issues may be required.

Signed by:

Grayson G. Kelley Senior Deputy Attorney General