2. Executory Periods
Most healthcare transactions require an executory period between signing and closing to enable the parties to fulfill certain Permit transfer, approval, or notice obligations. The duration of an executory period depends on factors like the type and quantity of Permits getting transferred, the Agency process involved and whether the transaction itself is an asset or equity deal.
For example, the regulatory process regarding the Target’s “primary” operating Permit, like a hospital li-cense, is typically the most time- and process-intensive gating item to address because that primary Permit is required for the Target to conduct its business. In addition, healthcare businesses have other “ancillary” Permits relating to specific services, equipment, materials, or waste management that also need to be considered. Although these ancillary Permits are less time and process-intensive, they may have domino effects on the operating Permit process, as some Agencies won’t approve operating Permits until they have evidence of an ancillary Permit issuance.
Asset sales often involve robust application processes to complete a change of ownership (“CHOW”) transfer while equity sales may require a less involved process to notify agencies of a change in owner information (“CHOI”). Ultimately, what constitutes a CHOW or CHOI varies by state. Some states require prenotice filings by the interested parties to determine whether the contemplated transaction will trigger a CHOW while other states don’t distinguish between the two in terms of the process required. We also note recent developments in approximately one quarter of U.S. states, where such states have enacted broad regulatory schemes to oversee and approve healthcare transactions based on some statutory or regulatory definition of whether the transaction is a “material change” or “material transaction.” This development has an impact on parties’ interests when negotiating the timing of the executory period.
Other factors impacting the duration of the executory period include but are not limited to: (i) applicable regulatory or statutory time periods for notice to and/ or review by the Agency; (ii) the amount of paperwork, disclosure, and process involved; and (iii) the Agency’s ability to inquire further and put the process on pause until inquiries are satisfactorily addressed.
As an example, if the regulatory process requires 60 days’ notice to the Agency before a closing and the Agency must approve or deny within that time frame, the executory period may need to be set for at least 90 days—but parties may opt for longer if the Agency is likely to ask follow-up questions that could pause the clock. Additionally, even if Agency approval is received on the 60th day, the parties will likely need time to prepare for closing.
Parties may also face a catch-22 scenario when regulatory approval is a condition to closing but the Agency will not issue a new Permit until confirmation of a closing. In such instances, some Agencies may issue a “comfort letter” (or even an email) to the parties indicating that the Agency has completed its process and only needs the closing documents in order to issue the Permit.
Last, parties should recognize sellers will be eager for a short executory period while buyers may want the anticipated duration of time required to fully transfer the Target’s primary Permits. Given the specific statutory, regulatory, and practical issues involved in permitting processes, the timing of completing such processes can differ wildly, from as short as 30 days to as long as 18 months or more.
3. Representations, Warranties, and Covenants
3.1 Representations and Warranties
Permits are usually addressed in most transaction documents through a general statement that the seller has all the Permits necessary to operate its business, and such Permits are in good standing and are not subject to any negative consequence.
However, in healthcare transactions, operating and ancillary Permits are often treated, for good reason, with more depth in the applicable representations and warranties.
Buyers want sellers’ representations and warranties to adequately capture the Permits to be transferred (usually on a disclosure schedule). Buyers will also want unqualified statements from sellers that the Target holds all required Permits, the Permits have been validly issued and are in good standing, the Permits aren’t subject to violation, suspension, reconsideration, imposition of penalties or fines, imposition of additional conditions or requirements or default, and that no event that might give rise to any right of termination, amendment, suspension, revocation, nonrenewal, adverse modification or cancellation has occurred. A buyer may also ask the seller to warrant it has no knowledge of any facts or circumstances that may inhibit or interfere with the ability to transfer or obtain new Permits. Additionally, a seller may ask the buyer to warrant it has no knowledge of any facts or circumstances that may inhibit or interfere with its ability to obtain new Permits or to get approvals.
3.2 Covenants
There can be different reasons for covenants in transactions; however, in healthcare transactions with executory periods, the necessity for well-thoughtout covenants is significant. Because the Permit regulatory process can take time, the buyer, particularly, will be concerned about the operation of the business during the executory period. In that respect, a buyer often obligates the seller to fulfill certain requirements during the executory period, such as operating the business as currently conducted and not entering into new commitments, including refraining from amending or modifying contracts, and to engage in specific permitting activities. Buyers may also require sellers to make prompt or immediate notification to a buyer of regulatory enforcement issues.
4. Process Extensions, Liquidated Damages
4.1 Process Extensions
As noted earlier, regulatory processes can involve the Agency pausing the process with requests for additional information. The parties may anticipate such occurrence and build in buffer time in the executory period. But a seller is unlikely to agree to a completely evergreen executory period providing unlimited time for the approval process. To address this potential time creep, some parties negotiate a drop-dead date by which all regulatory processes must be completed.
To the seller, a drop-dead date motivates the parties to work toward Agency approvals and prevents its asset from being “off the market” for too long. Buyers will seek to negotiate good-faith extension periods beyond the drop-dead date, depending on certain facts, circumstances, and prior experiences with the relevant Agency.
For example, the parties may determine that an executory period of 18 months is sufficient, based on the Agency’s Permit process. The buyer negotiates an extension right by which it is entitled to a maximum of two additional one-month periods beyond the initial expiration of the executory period. The parties then agree to a drop-dead date of 20 months. Often, however, while the seller may be willing to provide for extensions, it is concerned about the length of time it is keeping its asset “off the market,” which leads parties to consider breakup fees.
4.2 Liquidated Damages
Sellers may only agree in advance to extensions of the executory period where a penalty exists for a failure to complete the Agency process. Often this may come in the form of a breakup fee for failing to obtain the Permits within the period prescribed. From a seller’s perspective, even if the risk is low that the buyer will not obtain the requisite Permits by the drop-dead date, the financial and operational exposure to the seller in such case could be significant and yet difficult to calculate. Without a breakup fee, a seller’s recourse may only be to proceed with a claim for material breach, redirecting time, energy, and funds toward a dispute resolution process, which neither party may prefer. Regarding the enforceability of a breakup fee, the parties will likely need to base such fee on amounts that are reasonably foreseeable. The parties may include items such as transaction expenses and specific covenant compliance expenses that can likely be assessed. It may be more difficult to include items relating to a lost business opportunity.
5. Conclusion
Addressing these major Permit-related issues is essential to supporting buyers and sellers in healthcare transactions. In addition to the necessity for an executory period, specific representations, warranties, covenants, extension periods, and breakup fees are integral pieces of the healthcare transaction puzzle that require thoughtful consideration when navigating a transaction in an industry with a complex regulatory landscape.
