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March 6, 2015

Court Holds Officers and Directors of Non-Profit Healthcare Facility Personally Liable to Creditors for Breach of Fiduciary Duty

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On January 26, 2015, the U.S. Court of Appeals for the Third Circuit held that officers and directors of the Lemington Home for the Aged, a non-profit healthcare facility in Pittsburgh, Pennsylvania, were individually and personally liable to creditors for breaching their fiduciary duties owed to the home through mismanagement and exacerbation of the home’s debt during insolvency. The court ruled that the officers, specifically the home’s administrator and CFO, and board of directors were jointly and severally liable to creditors in the amount of $2.25 million. The court also ruled that the home’s administrator and CFO were liable for $1 million and $750,000, respectively, in punitive damages.

In determining that the administrator, CFO, and board of directors were liable to creditors for compensatory damages, the court found that they had breached their respective duties of care owed to the nursing home. The administrator of the home was unqualified and had severely mismanaged the home, and continued to accept a full-time salary even after beginning to work part-time in violation of Pennsylvania law. The CFO did not keep adequate financial records, failed to bill Medicare for up to $500,000, and lied to the board of directors about supplying financial information to a consultant hired by the home. In addition, the court stated that despite having actual knowledge of mismanagement and multiple deficiency citations, the board of directors failed to remove the administrator or CFO from their positions. The court held that these failures constituted breaches of the fiduciary duty owed to the nursing home and that the officers and directors could be held personally liable. The court also found that the officers and directors owed a fiduciary duty to creditors since the home was descending into insolvency, and they not only did nothing to stop it or curtail it, but through their action and inaction exacerbated the harm caused to the home’s creditors. This fiduciary duty owed to creditors was breached through undue delay and mismanagement of the bankruptcy process.

The Third Circuit upheld punitive damage awards against the nursing home’s administrator and CFO based on their breaches of the duty of loyalty owed to the home through self-dealing. Apart from continuing to accept full-time compensation for part-time work, the administrator diverted grant funds that were provided by a community foundation for the purpose of finding a replacement administrator with the appropriate qualifications. The CFO was found to have engaged in self-dealing as well. In an attempt to sell the home after it had closed due to mismanagement, he tried to broker a deal that would make him president and CEO of the nursing home after the sale. The Third Circuit reversed the punitive damages award against the board of directors, however, because the court determined that their failure to remove the administrator and CFO, though incompetent, was not malicious or self-interested.

This case is significant because it exemplifies the trend of holding officers and directors of non-profit entities personally liable for breach of their fiduciary duty to the corporation. Officers and directors of non-profit entities are increasingly held to the same standards of care and loyalty as officers and directors of for-profit entities. Officers and directors of non-profit entities are expected to have knowledge of the organization’s operations and finances, as well as the industry in which the entity is engaged. And in some jurisdictions, officers and directors of non-profit entities can even owe a fiduciary duty to creditors when the entity is insolvent or approaching insolvency. New board members need to be fully informed of their duties and exposure for failure to fulfill those duties, and existing board members should be reminded of the same.

About the Author

Robert Blaisdell

Robert Blaisdell is a Boston attorney providing general business and corporate legal services to healthcare clients. You can find him on LinkedIn.

Andrew Maglione is a clerk at Donoghue Barrett & Singal. He contributed to this alert.

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