In 1985, the Peninsula Hospital District Board, an elected public board, executed a lease with Mills-Peninsula Corporation, a not for profit corporation now known as Mills-Peninsula Health Services, leasing the Peninsula Hospital for 30 years, subject to renewal options. The execution of this lease merged two previously separate hospitals, Peninsula and Mills, under one management group, the Mills-Peninsula Corporation. This lease changed the role of the Peninsula Hospital District Board from that of an operator to a landlord. The lease also turned over seven parcels of property owned by the Peninsula Hospital District and $16 million in cash and equivalents to the Mills-Peninsula Corporation and subsidiaries.

In return, Mills-Peninsula Hospital Services agreed to pay off the Peninsula Hospital District's $20 million in outstanding bonds and operate the hospitals. When the bonds were paid off in 1987, an amendment to the lease was written requiring Mills-Peninsula Health Services (lessee) to pay $1.785 million in rent each year, either in cash or in the form of capital equipment or improvements to the Peninsula Hospital District as landlord (lessor).

In 1995, Sutter Health took over the management of Peninsula Hospital under an agreement with Mills-Peninsula Health Services. In January 1997, the Peninsula Hospital District Board, now known as the Peninsula Health Care District Board, hired an attorney to review the lease. In June 1997, the Peninsula Health Care District (PHCD) Board filed suit against Mills-Peninsula Health Services (MPHS) for alleged deficiencies in the original lease. Both Sutter Health and Mills-Peninsula Physicians Group joined in the defense against the lawsuit filed by the PHCD.

The San Mateo County 1997 Grand Jury recommended three alternatives to the filed lawsuit: mediation or arbitration; both parties in the filed lawsuit re-examine their existing positions in preparation for negotiations; all parties enter into good faith negotiations to resolve all issues.

The San Mateo County 1997 Grand Jury requested that the status of the litigation be further investigated by the 1998 Grand Jury. The 1998 Grand Jury held additional hearings. Circumstances prevented a report from being published. The 1999 Grand Jury received new complaints.

The original litigation by the PHCD alleged a conflict of interest at the time the merger occurred. The San Mateo County Superior Court ruled against the PHCD. The decision is being appealed. No date has yet been set for hearings on this appeal.

The PHCD in 1997-1998 incurred legal expenses in excess of $582,000. The 1998-1999 estimated legal expenses were in excess of $401,000. Attempts were made in 1998-1999 to mediate a solution to the legal dispute. The cost of preliminary mediation attempts were in excess of $100,000 as of September 1999. Amounts paid to date on all such matters are in excess of $1 million.

PHCD, MPHS, Mills-Peninsula Physicians Group and Sutter Health formed a long range planning committee to meet without the use of attorneys. Prior to this meeting, a confidentiality agreement was drafted and agreed to by all parties.

The 1999 Grand Jury reviewed the PHCD's audited financial statements for the past five years, commencing July 1, 1993, through June 30, 1998. These statements and interviews with board members and the PHCD auditor disclosed the following information since the commencement of the lease:

1. The PHCD was relieved of its $20 million bonded indebtedness.
2. Capital expenditures of almost $11 million in the form of equipment and improvements have been made by the lessee since 1987.
3. In addition, the PHCD in 1996 and 1997 made further capital improvements of $10.5 million.
4. The PHCD has continued to fund and expand special education/community projects averaging $271,000 per year. These programs primarily relate to Senior Focus and Suicide Prevention. In the current year (not included in the five year review) expenditures for these programs were increased to $389,500.
5. Cash revenues in 1997-1998 were approximately $2.5 million. Of this, income from property taxes was in excess of $2.1 million.
6. Net cash flow before payment of legal fees and after grants was approximately $2 million annually.
7. With the exception of legal expenses, operating expenses of the PHCD appear to be reasonable.
8. The 1997-1998 annual Statement of Cash Flows does not include information pertaining to equipment additions funded by lease payments made in the form of equipment purchases, proceeds from salvage sales, or the book value of equipment sold or junked.
9. Accumulated funds are invested with the State of California Local Agency Investment Fund which currently is investing entirely in assets of short term maturity, while at the same time PHCD's commitment for capital expenditures is not scheduled to begin for a number of years. The cash invested is primarily in highly liquid investments with an original maturity date of three months or less.
10. The PHCD Board's primary function is as a landlord whose authority extends only to overseeing the contracted lease which includes the approval of capital equipment purchased by the lessee in lieu of rent payments. The PHCD Board does not have the authority to make operational or policy decisions, nor give the lessee direction in operational matters.
11. The hospital has an informal salvage plan for used and obsolete equipment and furnishings. The plan is to trade old equipment in, sell it through a broker or junk it.
12. The PHCD Board has access to the annual financial statements of MPHS and Affiliates and receives quarterly verbal reports on the financial operations of the hospital from MPHS. None of these reports is placed on the agenda.
13. The State of California has mandated seismic upgrades for the critical care hospital facilities which must be implemented by 2008; another more stringent requirement has a deadline of 2030.
14. The Grand Jury was advised that the PHCD, MPHS and Sutter Health have done seismic studies of Peninsula Hospital facilities. These studies have concluded that it will be expensive to retrofit for the year 2008 deadline set by the State of California to comply with new hospital seismic safety standards, and prohibitive to do for the subsequent year 2030 deadline. Another independent study is being prepared to confirm the data.
15. Educational programs, which could be funded from lease income, are currently self sustaining; therefore, the PHCD has used all lease income to benefit the hospital in the form of capital additions.
16. The PHCD is accumulating funds which can be used either for earthquake retrofitting or as seed money for a new structure. In the absence of capital additions and litigation/mediation expenditures such funds could approximate $40 million by the year 2015 when the lease with MPHS will expire unless renewed under an option agreement.
17. The financial statements of Sutter Health and Affiliates as of December 31, 1998, stated that "...The MPHS lawsuit is at an early stage and it is difficult to predict either the outcome of the litigation or the effect the litigation might have on Sutter's combined financial position and results of operations, but a negative outcome could be material." A similar statement was included in the financial statements of MPHS and Affiliates as of the same date.
18. Mills-Peninsula Hospital was honored in 1998 by HCIA Health Care and Mercer Consulting as being one of the top 100 hospitals in the United States. The hospital is one of only five hospitals in the state to make the list in 1998, one of only two in Northern California.