"What Do You Mean Our Deal Is Illegal?!" Legal And Business Issues Related To The Unwind Of Physician-Focused Joint Ventures
by Roger D. Strode Jr., McDermott Will & Emery LLP, Chicago, IL and James M. Pinna, Hunton & Williams LLP, Richmond,VA
As the old adage goes: "What goes up must come down." In no segment of the healthcare industry does that appear to be more true than with respect to physician-focused joint ventures. The past ten years have seen an exponential increase in physician-focused joint venture activity. Almost overnight, healthcare providers may witness a precipitous drop in these partnerships owing, in significant part, to an overhaul of the regulatory scheme surrounding the relationships between physicians and the entities to which they refer. As a result, lawyers across the country may find themselves spending increasing amounts of time counseling clients on the finer points of how to take apart, or change, these joint ventures.
On September 4, 2007, the Centers for Medicare and Medicaid Services (" CMS ") published the Phase III Final Rule implementing additional regulations under the federal prohibition on physician self-referral, the so-called " Stark Law ." Interestingly, this rule change may have been overshadowed by a more dramatic, and somewhat unexpected, set of proposed changes to the Stark Law regulations published by CMS on July 12, 2007, as part of the 2008 Medicare Physician Fee Schedule (" MPFS ") Proposed Rule. In late 2007, CMS indicated that it needed some time to finalize many of these changes and will do so sometime during 2008; if these changes are finalized in their current form, they will have a dramatic impact on physician joint ventures. At the same time, CMS also implemented certain significant changes to the Diagnostic "Anti-Markup Rule" that will substantially limit the ability of physician practices to provide diagnostic tests in certain circumstances.
On the legislative front, there has been a serious push by Congressman Fortney "Pete" Stark (D. California) and members of the Senate Finance Committee to enact changes to the so-called "whole hospital" exception to the Stark Law. Some of the contemplated revisions would substantially impact physician ownership of hospitals.
Against this backdrop, it is certain that many physician joint ventures currently in place are likely to face the prospect that their business models are, or will be, no longer permitted. Affected partnerships will have to be restructured or terminated, bringing into play myriad business and legal issues, including dealing with valuation issues, mitigating conflict among joint venture participants, preserving to the extent possible federal and state regulatory approvals (such as Medicare certification, state licensure and/or certificate of need) and maintaining compliance with applicable law.
In addition, participants in future deals are well advised to make appropriate contractual arrangements to accommodate the various legal and business issues implicated by the need for an unwind or restructuring.
This article explores the relevant changes, the issues they present, and the various approaches to unwinding or restructuring a joint venture.
Current and Proposed Legislative and Regulatory Changes
As noted above, certain changes in the laws governing the relationships between physicians and the entities to which they refer may require many deals to be unwound or restructured. A sampling of these changes includes:
- The 2008 MPFS rule changes to the Diagnostic "Anti-Markup" Rule. Under the proposed scheme, if a billing practice purchases the technical component of a diagnostic test from an outside supplier ( i.e., someone who is not an employee of the billing practice and who does not furnish the test to the billing practice pursuant to a permitted reassignment) or furnishes a diagnostic test outside the office of the billing practice ( i.e., outside of where the practice provides substantially the full range of patient care services), then the billing practice will be limited to charging the lower of the Medicare fee schedule amount, the practice's actual charge, or the outside supplier's net charge to the practice. This new rule, coupled with another new regulation prohibiting independent diagnostic testing facilities from sharing a facility with another Medicare-certified provider, effectively will prohibit most physician practices and imaging centers from sharing a diagnostic imaging facility, regardless of whether the arrangement is through shared expenses, a block lease arrangement or other method.
- In addition, the 2008 MPFS Proposed Rule sets forth a not yet final proposal to define the term "entity" under the Stark Law regulations to include both the person who performs the designated health service (" DHS ") and the person who bills for it. If adopted, this new provision would prohibit many physician joint ventures providing services "under arrangements."
- The 2008 MPFS Proposed Rule also sets forth a proposal that would disallow "per click" arrangements to the extent that the lease charges reflect services to patients referred by the lessor to the lessee, and also solicited comments on whether CMS should impose a corresponding prohibition on "per click" arrangements for referrals from the lessor to a physician lessee. The commentary in the Phase III Final Rule also strongly suggests that "per click" leases cannot satisfy the exclusive use requirements of the office and equipment lease exceptions.
- During the summer of 2007, Congress proposed an amendment to the so-called "whole hospital" exception to the Stark Law. Specifically, the amendment would have prohibited all referrals by physicians to hospitals in which they have an ownership interest, except for hospitals having Medicare provider agreements in place on July 24, 2007 (" Grandfathered Hospitals "). Grandfathered Hospitals would have their growth limited in terms of physician ownership as well as bed and operating room capacity. While this amendment never made it to final legislation during 2007, it may reappear during 2008 and could significantly restrict physician ownership of hospitals and require the restructuring of many existing entities.
Legal Issues Arising in an Unwind
Unwinding or restructuring a physician-focused joint venture, regardless of the reason, presents a number of significant legal issues. Particular areas of focus are the various federal anti-referral statutes, such as the Stark Law and the so-called Anti-Kickback statute (the " AKS "), the proscription on tax exempt entities against private inurement and private benefit, and state licensure and certificate of need laws.
The Stark Law prohibits physicians with a direct or indirect " financial relationship " with an " entity " from referring patients to that entity for DHS paid under a federal healthcare program, unless the financial relationship meets one of the exceptions enumerated under the Stark Law statute or its regulations. In the event that a joint venture is impacted by one of the aforementioned changes in the Stark Law, the arrangement will have to be restructured or otherwise the DHS entity may not continue to bill federal healthcare programs for DHS referrals.
When unwinding or restructuring a joint venture, counsel will need to ensure that the process itself, which likely will involve some sort of "transaction" (which will be deemed a Stark Law financial relationship), meets an exception. For example, the payment of money to a divesting physician likely will create a financial relationship between the parties that will need to meet an exception, such as the "isolated transaction" exception. Additionally, attorneys will need to make sure that a joint venture participant receives fair market value compensation in exchange for any ownership interest, or other services provided or given, during the unwind or restructuring process (this issue raises questions about valuations, which are discussed below).
Like the Stark Law, the AKS is an anti-referral statute. However, t he AKS is not limited to a defined set of services but applies to all items and services reimbursed, even in part, by a federal health care program. The AKS is a broad criminal statute that prohibits the knowing and willful offer, payment, solicitation, or receipt of any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, to induce or reward referrals of such items or services. In the context of an unwind or restructuring transaction, any distribution in redemption of an ownership interest must be part of a commercially reasonable, fair market value exchange and all investors must be treated equally. Several courts, as well as the Office of Inspector General of the Department of Health and Human Services, have indicated that certain facts and circumstances, such as paying greater than fair market value for services or items, can support an inference of an improper intent to induce referrals.
Tax Exemption Issues
In the event that one of the participants in a troubled joint venture is a tax-exempt entity, such as a hospital, the parties to the joint venture must be mindful of the proscriptions against private inurement and private benefit. In recent years, the IRS has expressed increased concern over prohibited inurement or "self-dealing" and excess private benefit transactions involving tax exempt organizations. At the same time, the IRS realized that the penalty of revocation of exempt status was inadequate or inappropriate to deal with many potentially abusive transactions, prompting the promulgation of a new statute and regulations, known as " Intermediate Sanctions " rules.
Intermediate Sanctions can involve the imposition of substantial excise tax penalties with respect to transactions between a tax exempt entity and one or more " disqualified persons " resulting in excess benefit being conferred upon the disqualified person. An " excess benefit transaction " is any type of transaction in which a disqualified person receives an economic benefit, either directly or indirectly, from a tax exempt organization that exceeds the value of the consideration provided by such disqualified person. Disqualified persons include those in a position to exercise substantial influence over the affairs of the exempt organization. Whether a particular joint venture participant is considered a disqualified person will most likely depend on the relevant facts and circumstances. Intermediate Sanctions also provide for a presumption that a transaction is not an excess benefit transaction when the transaction is approved in advance by an authorized body of the exempt organization comprised entirely of individuals who do not have any conflict of interest (with respect to the transaction) and who relied upon appropriate data as to comparability prior to making a determination and, further, adequately documented the basis for such determination. Therefore, it is important that consideration paid by, or to, a tax exempt organization in connection with an unwind be consistent with the value of the ownership interests being acquired, or items or services for which it is exchanged and that such value is recognized and documented by the appropriate body of the organization.
State Law Issues
Finally, whenever a joint venture is to be unwound, consideration has to be given to the various state regulatory laws to which the joint venture may be subject, including state licensure and certificate of need laws. Any time there is a significant shift or change in ownership of a joint venture, there is a possibility that licenses or certificates of need to which the joint venture is subject may be implicated. For example, in some states, a change of ownership of as little as 10-20% may require the joint venture to reapply for its license or seek a new certificate of need, while in other states, the joint venture may need to seek appropriate consent in the event of a change of majority ownership, or simply notify the applicable state agency of the ownership change. Whatever the situation, care must be taken to ensure that the unwind transaction is completed in compliance with applicable state laws so as to preserve, to the extent possible, appropriate state regulatory approvals.
The unwinding of a joint venture brings with it a host of business issues, including those involving valuation. Although an in-depth discussion of the valuation of joint ventures is beyond the scope of this article, it is worth noting that traditional valuation methods which generally look at historic performance and forecast future performance based upon history may be poorly suited to value a venture that may no longer include physician investors. While counsel involved in the formation of physician-focused joint ventures understand, and advise their clients, that physicians cannot be offered ownership in a joint venture in exchange for promises of referrals, it seems undeniable that a traditional physician-focused joint venture that is stripped of physician ownership is more likely to experience less volume on a "go-forward" basis than if the physician investors had been allowed to stay in the deal. Thus, the divestiture of physician ownership interests is likely to negatively impact the valuation of the venture, and the interests to be redeemed, leading to unhappy investors and inviting squabbles.
It is imperative that physician investors who are divesting themselves of ownership be paid fair market value for their ownership interests in the joint venture. Unless the joint venture documents contain specific buyout formulas, or prices, an unwind transaction almost certainly will require a third-party valuation. Prior to engaging a valuation firm, the parties are well advised to understand the position the appraiser will take with respect to the issue of discounts, or volume assumptions, in light of the fact that referring physicians no longer will be able to own interests in the venture. Additionally, the parties may want to consider negotiating certain assumptions, such as discounts related to minority interests, working capital levels, etc., which may guide the appraiser in its work.
Ownership/Control of Regulatory Approvals
In addition to valuation questions, a joint venture unwind may involve issues related to ownership or control of licenses or other regulatory approvals, such as certificates of need. These permissions may have significant value by reason of the fact that they can provide the holder with the ability to control a market for a particular service. Unless the joint venture documents provide for whom, or which entity, owns the significant regulatory approvals, the question of ownership has the potential for creating significant controversy. For example, a complicated venture may involve numerous licenses or certificates of need tied to various services lines such as MRI or CT. If the service lines are to be preserved, to be sold off, or distributed to one of the joint venture participants, it will be necessary that the regulatory approvals are transferred as well. If the parties have not arranged in the joint venture documents for the ownership or transfer of these regulatory approvals, the negotiations related to such ownership or transfer can become contentious.
Faced with the prospect of unwinding or restructuring a physician-focused joint venture, counsel first should look to any contractual provisions that address changes in the law. Well constructed documents generally address or provide a process with respect to what to do in the event of changes in the law. Typical provisions provide for a reasonable timeframe for the parties to negotiate an amended structure to the arrangement, but then provide for immediate termination or buyout by one of the parties in the event a mutually agreeable amendment cannot be reached. Additionally, the parties should pay attention to the various business and legal issues, discussed above, and understand the interplay between them.
With respect to future deals, joint venture parties are well advised to anticipate not only the various changes in law, but how the different business and legal issues that are bound to arise in an unwind interact with each other. Documents should address, to the extent possible, the ability to transfer service lines intact so as to maximize value and avoid disruptions in patient care. Finally, valuation issues and issues related to the ownership and control of regulatory approvals should be considered.