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Eden Township Healthcare District v. Sutter Health et al

December 21, 2011


Trial Court Alameda County Superior Court Trial Judge Honorable Marshall Ivan Whitley (Alameda County Super. Ct. No. RG09-481573)

The opinion of the court was delivered by: Dondero, J.


As part of an agreement with the Eden Township Healthcare District (the District) to upgrade Eden Hospital (Eden), Sutter Health (Sutter) committed to spending $300 million to construct a replacement hospital for Eden. Sutter also planned to exercise an option it had acquired under the agreement to purchase San Leandro Hospital (SLH) and convert it from an acute care emergency service facility to an acute rehabilitation center. The District refused to convey SLH. An arbitrator ruled in favor of Sutter. The District then filed a lawsuit contending the underlying agreement is void due to a conflict of interest that allegedly arose because of the roles two individuals played in negotiating the agreement.

Cross-complainant the District appeals from the trial court's order granting summary judgment to cross-defendants Sutter and Eden Medical Center (EMC) (collectively referred to as respondents), and denying the District's motion for summary adjudication. The District claims the trial court erred in concluding certain agreements made by the parties are not void under the conflict of interest law as stated in Government Code section 1090 et seq. (section 1090).*fn1 We affirm because an analysis of the facts and, specifically, the alleged financial interest involving George Bischalaney and Dr. Francisco Rico discussed in this opinion do not demonstrate a conflict of interest as defined in section 1090.


I. Parties and Actors

The District is a public agency established in 1948 pursuant to the California Local Health Care District Law (Health & Saf. Code, § 32000 et seq.). The mission of the District is to "fulfill the function of protecting the public health and welfare by furnishing hospital services [and] provide for the public health and welfare . . . ." (Talley v. Northern San Diego Hosp. Dist. (1953) 41 Cal.2d 33, 40 [257 P.2d 22], overruled on other grounds in Muskopf v. Corning Hospital Dist. (1961) 55 Cal.2d 211, 213 [11 Cal.Rptr. 89, 359 P.2d 457].) The District's operations are overseen by a board comprised of five publicly elected members. The board appoints key executives to run the day-to-day operations of the District. Prior to 1998, the District owned and operated multiple hospitals in Alameda County, including Eden in Castro Valley.

Sutter is a California nonprofit public benefit corporation. Sutter does not own any hospitals. The 24 hospitals with which Sutter is affiliated are owned by other nonprofit public benefit corporations. Sutter is a "member" of each of these nonprofit public benefit corporations, including EMC.

EMC is a California nonprofit corporation that was formed to operate Eden for the District. EMC also operates SLH, which is a general acute care hospital with an emergency services department. EMC currently leases SLH from the District. EMC is owned not by shareholders, but by its two members. The District is the "Community Member" of EMC, and Sutter is its "General Member." During the time period relevant to this lawsuit, EMC had 11 voting directors, 5 of whom were the members of the District's board.

Bischalaney is the president and chief executive officer (CEO) of EMC, a position he has held since 1998.*fn2 He also served as the District's CEO from January 1998 through June 2008. During the time period relevant to this lawsuit, he earned an annual salary in excess of $200,000 from EMC. He did not receive any salary in connection with his District position.

Between 2002 and 2008, Rico was a member of the District's board of directors. Rico holds an ownership interest in Alameda Anesthesia Associates Medical Group (AAAMG). Since 1986, AAAMG has been the sole provider of anesthesia services at Eden. Since 2004, AAAMG has also been the sole provider of such services at SLH. According to the president and CEO of AAAMG, a closure of SLH would represent a "significant and material threat" to AAAMG's business plan and model.

II. History of Agreements

In 1997, Sutter purchased Eden from the District for $30 million, plus an assumption of approximately $40 million of District debt. Sutter also invested approximately $65 million in improvements to the hospital campus, including the purchase of adjoining property to expand. Pursuant to a 1997 Memorandum of Understanding between the District and Sutter (the 1997 MOU), Eden's assets were transferred to EMC, then known as "NewCo." Under a contemporaneous management services agreement (the 1997 MSA), EMC agreed to provide administrative services to the District.

By the early 2000's, Eden, which was built in the 1950's, faced the prospect of closure because the facility did not meet current seismic code requirements. To address this problem, the District entered into an agreement in 2004 (the 2004 Agreement) by which EMC agreed to spend at least $262 million to construct a new hospital to replace Eden. Around this time, the District purchased San Leandro Hospital (SLH) from a third party and leased it to EMC, on the condition that EMC maintain general acute care services at SLH for three years. Sutter guaranteed EMC's obligations under the 2004 Agreement. The 2004 Agreement further provided that if the replacement hospital was not operational by December 2011, EMC would purchase SLH at a price equal to $35 million, minus straight-line depreciation.

In 2006, Sutter notified EMC's board, including the five District board members, that it would not build the contemplated replacement hospital. In November 2006, the District notified respondents that they were in breach of their contractual obligation to the District to construct the replacement hospital. The District claimed Sutter's notification amounted to an anticipatory breach and threatened to sue Sutter for $262 million if it did not provide "adequate written assurance" that it would construct the replacement hospital.

On November 24, 2006, Bischalaney informed the District that the notice of anticipatory breach to respondents created a conflict that required him to recuse himself from any decision making relating to the anticipated litigation between the District and respondents. In part, he noted the 1997 MSA "prohibits any [EMC] employee, such as myself, from participating in any District decision that could have a material financial effect upon [EMC] or [Sutter]."

Rather than litigate the dispute, the parties commenced negotiations on a new contractual arrangement. Bischalaney actively participated in the negotiations as a representative of EMC's negotiating team. He attended meetings between the parties and otherwise acted as a lead negotiator for EMC. The committee that formally represented the District in the negotiations consisted of outside counsel Craig Cannizzo,*fn3 Dr. Rajendra Ratnesar (a District board member), Rico, and outside consultants Steven Hollis and Cynthia Lee.

Cannizzo, Hollis, and Lee all subsequently attested that Bischalaney did not participate in the negotiations on behalf of the District. While Bischalaney, as one of the negotiators for EMC, did provide certain information, thoughts, and ideas to the District's negotiating team, he did not attempt to influence the District's board of directors to enter into the 2008 Agreements. For example, he was sometimes asked to provide history and background to new District board members.*fn4 He was often excused from executive sessions of the District's board when it discussed the negotiations. Cannizzo never indicated to Bischalaney that he thought Bischalaney was acting on behalf of the District in the negotiations.

The negotiations ultimately resulted in a series of related agreements, including a new Memorandum of Understanding and an Amended and Restated Lease and Hospital Operations Agreement (the 2008 Lease), which were signed by the parties in March 2008 (collectively, the 2008 Agreements). Under the 2008 Agreements, Sutter committed to spending $300 million to construct the replacement hospital, secured by a $260 million escrow deposit. Additionally, the provision in the 2004 Agreement that had called for the District to sell SLH to Sutter was converted into an option for Sutter to purchase. The 2008 Agreements also required the District board members to resign as directors of EMC six months after a notice of commencement of construction of the new hospital had been delivered. Rico negotiated, voted to approve, and signed the 2008 Agreements in his official capacity as a board member for the District.

Construction of the replacement hospital began on July 15, 2009.

On July 27, 2009, Sutter exercised its option to purchase SLH. Sutter announced that after it acquired title it planned to lease SLH to another party in order to convert the facility from an acute care emergency services hospital to an acute rehabilitation hospital. According to the District's brief on appeal, "a newly constituted District board determined that it was not in the best interests of the citizens served by the District to allow [SLH] to be transferred to Sutter and closed as a provider of emergency care services." The District refused to convey SLH to Sutter, asserting Sutter had breached an obligation to convert the fourth floor of SLH to acute rehabilitation. Sutter then commenced arbitration proceedings against the District.

On October 27, 2009, Sutter filed a complaint against the District for specific performance of a written agreement to convey real property and for damages. The complaint alleges the District refused to proceed with the sale of SLH, in repudiation and breach of the 2008 Lease and of the purchase and sale agreement that was formed upon Sutter's exercise of the option. Sutter indicated it had filed the action to preserve its rights while the dispute was being arbitrated. The complaint seeks specific performance of the purchase and sale agreement, delay damages for breach of contract, constructive trust, and declaratory relief concerning the parties' rights and duties with respect to the transfer of title to SLH.

On December 3, 2009, the parties filed a stipulation to stay the lawsuit pending arbitration. The trial court ordered the action stayed.

On March 8, 2010, the arbitrator issued his decision finding Sutter was entitled to an award of specific performance of its right to a conveyance of SLH. The arbitrator specifically did not rule on the legality of the 2008 Agreements, including the issue of whether any of the agreements had been created in violation of section 1090. The decision preserved the District's right to seek to vacate the award by challenging the validity of the 2008 Agreements.

On March 10, 2010, the District filed its answer to Sutter's complaint. As its first affirmative defense, the District alleged that the contracts underlying the complaint are illegal and invalid under section 1090.

Also on March 10, 2010, the District filed a cross-complaint for declaratory and injunctive relief against respondents. In the declaratory relief action, the District contended that the 2008 Agreements are void under sections 1090 and 1092*fn5 because certain District board members and executives who participated in the negotiation, drafting, approval, and execution of the 2008 Agreements had a prohibited financial interest therein.

On April 22, 2010, respondents filed their answer to the District's cross-complaint.

On September 15, 2010, the District filed a motion for summary adjudication of its cause of action for declaratory relief, asserting the 2008 Agreements are void under sections 1090 and 1092.

On September 16, 2010, respondents filed a motion for summary judgment. Respondents contended the District could not establish the elements of its causes of action. Respondents also asserted as a complete defense that Bischalaney did not participate in the making of the contract in his official capacity, and that the ...

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