Insurer’s Not-for-profit Obligations Found Too Indefinite to Enforce

By Don R. Sampen, published, Chicago Daily Law Bulletin [November 1, 2016]

The 1st District Appellate Court recently held that a mutual not-for-profit insurance company that allegedly accumulated excessive profits and reserves — not for the benefit of its members but rather for the benefit of its executives — could not be found to be in breach of any contract, and that the claims asserted did not give rise to an actual controversy such as would allow for declaratory relief.

The case is Babbitt Municipalities Inc. v. Health Care Service Corp., 2016 IL App (1st) 152662 (Oct. 11, 2016). The appellant, Babbitt, a policyholder member of the insurer, was represented by Edelson P.C. Kirkland & Ellis LLP represented the insurer, HCSC.

Babbitt brought suit against HCSC for breach of contract and sought a declaratory judgment. Its claims were rooted in HCSC’s articles of incorporation and bylaws. The articles stated that HCSC would operate as a nonprofit health-care service plan under Illinois law. Its bylaws stated its general purposes as a mutual health-care insurance company and further provided that the company “shall operate … for the mutual benefit of its members.”

The bylaws also said no person would receive “any profits” from HCSC, but that compensation for services performed “shall not be considered profit.” They included a provision for the fixing of officer compensation by the board of directors and the compensation of other executives by the president and CEO.

Babbitt claimed that HCSC failed to live up to its stated purposes. It allegedly did so by stockpiling enormous profits of more than $10 billion and by branching out and conducting activities separate and apart from its mission through, for example, generating “enormous fees” for the administration of its members’ health-care benefits. Babbitt further claimed that HCSC’s retained surplus earnings were excessive when compared to various fiscal benchmarks.

According to Babbitt, HCSC’s executives stood to gain from the excess retained earnings, such that the company’s CEO received compensation of $16 million in 2012 and more than $11 million in 2013. Rather than retaining excess earnings, Babbitt claimed that HCSC had a duty to use the excess for the benefit of its members by, for example, lowering deductibles and co-pays, providing free generic drugs and enhancing other member benefits.

By not doing so and instead engaging in profit-seeking behavior, HCSC, in Babbitt’s view, exhibited bad faith and self-dealing contrary to the company’s nonprofit status as a mutual legal reserve company existing for the benefit of its members.

The trial court dismissed Babbitt’s complaint for failure to state a claim, finding that the complaint failed to allege a specific enforceable contract obligation or the existence of a tangible legal interest. Babbitt took this appeal.

Breach of contract

In an opinion by Justice Mary Lane Mikva, the 1st District affirmed. She initially addressed the breach-of-contract claim. She observed that the elements for such a claim are the existence of a contract, performance by the plaintiff, breach by the defendant and injury.

She acknowledged that the first two of these elements were met, in that the contractual relationship between HCSC and its members was defined, in part, by the company’s articles and bylaws, and that Babbitt was not alleged to have failed to perform any of its obligations.

To be enforceable, however, Mikva said, the terms of the contract must be definite and certain. Here, the broadly worded statements of purpose in HCSC’s articles and bylaws were indefinite and did not impose a specific, legally enforceable duty to limit the amount of the company’s reserve fund or to take any particular action with respect to its net earnings.

In particular, no provision in the articles or bylaws established a formula regarding the surplus that could be maintained by HCSC. Babbitt, moreover, did not allege that the company did not spend any money for the mutual benefit of its members. Rather, it alleged that HCSC did not spend enough money for that purpose.

But HCSC had not bound itself by any pledge or definite promise to spend more, according to Mikva, unlike other health-care organizations that capped their net income at a certain percentage of revenue.

The most Babbitt’s allegations established was that HCSC’s reserves exceeded various minimum requirements set by regulators, but no maximum reserve limit applied except in the views and conclusions of Babbitt’s experts.

Babbitt also argued that if HCSC’s duties to act as a not-for-profit company for the mutual benefit of its members were not enforceable as a contract, then those provisions in the articles and bylaws would be meaningless, contrary to the rules of contract construction.

Mikva responded with another rule of construction, that a court will not supply missing essential terms in a contract. In short, Babbitt had not alleged a legally enforceable contractual duty.

Declaratory relief

As for the declaratory relief being sought, Mikva said, that form of relief is permissible only in the presence of an actual legal controversy between the parties, in the form of a concrete dispute, the resolution of which will aid in the termination of the controversy.

The dispute here centered, not on whether HCSC refused to spend any money for its members’ benefit, but on what portion of its surplus it should spend. The parties’ contract failed to shed any light on that determination. Accordingly, Babbitt failed to identify an enforceable duty that HCSC breached in the past — or one that it was likely to breach in the future. A declaration of rights therefore was inappropriate.

Accordingly, the court affirmed dismissal of Babbitt’s complaint.

Key point

Contractual obligations that are indefinite and generic will not be enforced through a breach-of-contract action, will not be declared in the form of a declaratory judgment and will not have missing terms supplied by a court.