A version of this article was published in The Daily Record on July 23, 2007.
A recent ruling by an intermediate Tennessee appellate court provides a stark reminder that boards of directors of non-profit institutions have a duty to investigate themselves, and, when warranted, to remove an unfit director. The failure to do so resulted in a trial court ordering the removal of most of the board of directors of Memphis Health, a non-profit community health center, and that order was upheld on appeal.
A. Controversial Chairman
At the center of the Memphis Health controversy was its Chairman of the Board, Gregory Grant. Grant, through a corporation named Magnolia Transportation, was engaged in the business of providing medical transport services that were reimbursed by various payors, including state agencies funded by the federal government.
In a separate case brought under the federal False Claims Act, the federal government accused Grant of filing thousands of false claims for reimbursement. In addition to failing to maintain insurance for his vehicles as required for payment, Grant was accused of billing and collecting for patient transports not actually made. The federal government prevailed in the case, and won a civil judgment against Grant, including actual damages, treble damages and civil fines, totaling almost $6,000,000.
The federal case against Grant occurred during a period of internal strife at Memphis Health. Grant and several other board members were accused by the center's CEO of interfering with the center's day-to-day operations, signing unauthorized contracts, and improper handling of funds and records.
B. Derivative Action
The CEO believed that Grant and his supporters on the board were about to terminate the CEO's employment, and the CEO went to court for protection. The CEO brought a derivative action (a suit by a director on behalf of the corporation) to force the board to adhere to its bylaws (by investigating and, if warranted, removing Grant from the board), to refrain from violating federal law, and to refrain from wrongfully terminating the CEO's employment. The CEO was eventually joined in the suit by two sympathetic members of the board.
Grant and his supporters challenged the CEO's standing to bring the suit on the basis that the CEO was not really a "director," but the trial court ruled that, under the bylaws, the CEO was a non-voting, ex officio member of the board, and was, therefore, to be considered a "director" with standing to bring the suit. (Stockholders of corporations are also permitted to bring derivative actions, but there were no stockholders in this case.)
C. Duty to Investigate and to Act
The Tennessee trial court issued an order requiring, among other things, that the board adhere to its bylaws. The bylaw provision at issue stated that a director may be removed if the director "does not discharge his/her duties, is convicted of a felony or exhibits conduct unbecoming a Board member."
Nevertheless, over several board meetings following the judgment against Grant, including one meeting held after entry of the trial court's order to adhere to the bylaws, the Memphis Health board did not address in any way the judgment against Grant, or Grant's fitness to continue as a board member. Instead, the board voted to suspend the CEO.
In response, the trial court took the unusual step of permanently removing Grant and his supporters from the board, and overturned the CEO's suspension.
The primary reason offered by Grant's supporters for not taking action to investigate Grant's fitness to continue on the board, was that Grant had filed an appeal of the judgment against him in the federal False Claims Act case. Both the trial and appellate courts rejected this argument. In essence, both courts ruled that the board should have acted immediately upon entry of the judgment against Grant, and that the board failed to discharge its fiduciary duties by not investigating and removing Grant from the board at that time.
Although director misconduct is seldom as egregious as in this case, boards of directors of hospitals and other non-profit institutions should be reminded by the Memphis Health case that their fiduciary duties include oversight of themselves, and the duty to investigate and, if warranted, to remove, board members who are not fit for continuation in office.