The "Period of Disallowance" Explained

In the 2020 Stark final rule, CMS finalized certain policies on the “period of disallowance.” The period of disallowance is the period during which a physician may not refer Designated Health Services (DHS) to an entity, and the entity may not bill Medicare or any other payor (if the physician nevertheless refers DHS to the entity), due to a financial relationship between the physician (or an immediate family member of the physician) that does not meet the requirements of an exception. To illustrate, suppose a physician and a home health agency enter into a lease arrangement on March 1. The lease meets all of the requirements of the space lease exception but for the fact that neither the lease nor any other writing sufficiently described the premises. On June 1, the error was discovered and rectified. In this situation, the period of disallowance would be from March 1 through May 31.

The 2020 Final Rule's Changes

In the 2020 Final Rule, CMS made certain changes to its policy on determining the period of disallowance, some of which are not addressed here. The focus of this article is on CMS’s policy concerning the ability of parties to correct errors, unintentional or intentional, in the execution (as opposed to the design) of an arrangement. The policy at issue is codified at section 411.353(h)(1), which provides:

No later than 90 consecutive calendar days following the expiration or termination of a compensation arrangement, the entity and the physician (or immediate family member of a physician) that are parties to the compensation arrangement [may] reconcile all discrepancies in payments under the arrangement such that, following the reconciliation, the entire amount of remuneration for items or services has been paid as required under the terms and conditions of the arrangement[.]

The text above and the preamble in the final rule are clear that if there is an “operational error” that is not corrected (irrespective of whether it is discovered) within the allotted 90-day period, there is a new or modified arrangement. In many or most cases, this will result in a non-compliant arrangement.

The 2019 proposed rule gave the hypothetical example of a personal services arrangement between an entity and a physician under which, and according to the written agreement, the physician is to be paid $140 per hour. We are told to assume that this rate is fair market value, that the arrangement otherwise fully complies with an applicable exception, and that, for a six-month period, the physician is paid $150 per hour. The proposed rule then states:

If the $150 per hour payment is due to an administrative or other operational error—that is, the discrepancy was unintended—the parties may, while the arrangement is ongoing during the term initially anticipated (in this example, during the year of the arrangement), correct the error….

However, if the parties fail to identify the error during the term of the arrangement as anticipated… they cannot simply “unring the bell” by correcting it at some date after the termination of the arrangement. Rather, the failure to timely identify and rectify the error through an effective compliance program would expose the parties to the referral and billing prohibitions of the physician self-referral law during the entirety of the arrangement.

Under the proposal, an error that was discovered 240 days into a year-long arrangement could be cured, whereas one that was discovered five days after the termination of a month-long arrangement could not. However, in response to comments pointing out the arbitrariness of using the end date of the underlying arrangement as the deadline for which one can correct an error in the execution of the arrangement, CMS changed its proposed policy, and now, through section 411.353(h)(1), gives the parties up to 90 days following the termination of the arrangement.

Note also that under CMS’s policy, it is not enough for a party that discovers it has overpaid another party to make a good faith effort to collect the shortfall, but it instead must collect the entire amount (even if the other party deliberately and unreasonably withholds payment) or else a new or modified arrangement results. That this is so is evident from the language “the entire amount of remuneration for items or services has been paid as required under the terms and conditions of the arrangement” in new section 411.353(h)(l), as well as preamble discussion in the proposed and final rules.

The Policy is Contrary to the Plain Meaning of the Statute

At the root of section 411.353(h)(1) is CMS’s belief that an operational error creates a new or modified arrangement. It is submitted that this position is contrary to the plain language of the Stark Law.

A necessary predicate for Stark to be implicated is a “financial relationship” between a referring physician (or his or her immediate family member) and an entity. A financial relationship can be a direct or indirect ownership/investment interest or a direct or indirect compensation arrangement. This article is concerned only with compensation arrangements.

In the 2020 Stark final rule, CMS has adopted the position that a compensation arrangement can be formed without the intention or knowledge of a party, or even against the will of the party. As discussed below, this position has important ramifications where there are errors in the execution of an arrangement, including an intentional departure from the arrangement by one party.

In the Fiscal Year 2009 (hospital) Inpatient Prospective Payment System final rule (FY 2009 IPPS Final Rule), CMS expressed its view that a compensation arrangement must meet all of the requirements of an exception at the time a referral is made or else the physician’s referral of DHS to the entity with which he or she has the compensation arrangement is tainted:

we believe that the most natural reading of the statute is that all of the requirements of the exception must be met at the time the referral is made. Further, we believe that the statute does not contemplate that parties have the right to back-date arrangements, return compensation, or otherwise attempt to turn back the clock so as to bring arrangements into compliance retroactively.

Also in the FY 2009 IPPS Final Rule, CMS stated that, in every case, a compensation arrangement begins and ends “according to the conduct of the parties and the specific facts of the case,” and that the beginning and end dates of a compensation arrangement do not necessarily coincide with the beginning and end dates of a written agreement.

However, in neither the FY 2009 IPPS Final Rule, nor anywhere else, did CMS say (until the 2019 proposed rule) that a compensation arrangement can be created without regard to the intent of the parties. The term “compensation arrangement” is defined in both the statute and regulations. The statute defines “compensation arrangement” as “any arrangement involving any remuneration between a physician (or an immediate family member of such physician) and an entity.” The regulations define “compensation arrangement” as an “arrangement involving remuneration, direct or indirect, between a physician (or a member of a physician’s immediate family) and an entity.” Thus, both the statute and the regulations define “compensation arrangement” as an “arrangement” involving remuneration, but do not define “arrangement.” However, the ordinary, common sense meaning of an “arrangement” is an agreement among two or more persons or entities, or in other words, a consensual relationship. Dictionary definitions are consistent with this meaning. If parties agree to compensation at $140 per hour, that is the arrangement between them. If one party mistakenly pays the other $150 or $130 per hour, that does not change the basic fact that the arrangement was for $140 per hour. Likewise, if the parties discover the error and do not take appropriate action, that may result in a new arrangement (again, based on the intent of the parties), but the mere fact, standing alone, that a mistake is made in the execution of the arrangement does not result in a new or modified arrangement.

Any attempt to justify the view that a compensation arrangement can be created through an unintentional mistake in the execution of an arrangement or the deliberate deviation on the part of one party, on the basis that Stark is a strict liability statute, is unfounded. The fact that Stark is a strict liability statute, meaning that no intent to violate the statute is necessary for liability to attach, does not mean that no intent is required to implicate the statute in the first place. Moreover, the government (or a relator on behalf of the government in a False Claims Act case) has the burden of persuasion to show that a compensation arrangement exists and that the statute is implicated. CMS may be within its rights to claim that, upon evidence of additional remuneration, the burden of production has shifted to the parties to an arrangement to show that a new or modified compensation arrangement has not taken place because there was no intent to create one; however, it cannot, consistent with the statute, conclusively presume that a new or modified compensation arrangement has been created, irrespective of the intent of the parties, simply because of a deviation from the terms of a written agreement.

The Policy is Internally Inconsistent

The proposed and final rules offer a confusing and inconsistent explication of what constitutes a modified or new arrangement based on an unintentional or intentional mistaken payment, as well as what, if any, steps can be taken to maintain compliance with Stark.

The preamble to the 2020 final rule repeatedly uses the term “actual arrangement” (emphasis in the original) to refer to the mistaken payment amount in an attempt to bolster CMS’s position that remuneration paid or received is what counts, not what the parties intended. However, CMS’s policy, that mistaken payments create a new or modified arrangement despite the parties’ intentions, not only is contrary to the plain language of the statute, it is internally inconsistent. The internal inconsistency is illustrated by CMS’s statement that theft “generally” does not create a new compensation arrangement. Why not? If, under CMS’s policy, a unilateral, unintentional deviation from the agreed-upon arrangement does not prevent a new or modified “actual arrangement” from springing to life, why does a unilateral, intentional deviation in the form of theft not create a new or modified arrangement? Either way, remuneration is transferred. And who and what determines, short of a criminal conviction by a judge or jury, that theft has occurred? There is a long distance between run-of-the-mill intentional breaches of contracts and criminal behavior. Further, an intentional deviation from the terms of an agreement, involving remuneration, may be neither theft nor a breach of the agreement. For example, the lessee of a lease arrangement between a physician and a DHS entity may pay less rent than called for in the agreement, and believe that the lessor had agreed to cover the cost of trash pickup and medical waste disposal, which belief is disputed by the lessor. And why say theft “generally” does not create a new compensation arrangement? Under what circumstances does theft create a new compensation arrangement?

Note also that, whereas the proposed and final rules generally take the position that even an unintentional incorrect payment creates a modified or new compensation arrangement and that parties are time-limited in their right to cure the effects of the incorrect payment, elsewhere the final rule may suggest that only an intentional failure to collect money owed results in a new or modified compensation arrangement. The final rule says “as we stated in the proposed rule, in certain instances, the failure to collect money that is legally owed under an arrangement may potentially give rise to a secondary (separate) financial relationship between the parties (84 FR 55810).” So far, by referencing the language in the proposed rule (and giving the Federal Register page cite to the proposed rule) the final rule appears to adopt the proposed rule’s “no questions asked” approach to a modified or new compensation arrangement—if a mistaken payment is made, parties have to deal with it, period. But the final rule then immediately adds:

In such circumstances, because forgiveness of an obligation or debt may constitute remuneration for purposes of the physician self-referral law, the parties may conclude that the only means to avoid noncompliance with the physician self-referral law is to recoup the amount owed under the arrangement. Turning back to the previous example, and assuming that the hospital corrected the error beginning in month 7 but did not collect the excess compensation from the physician, the relevant inquiry is whether the uncorrected payment errors during months 1 through 6—that is, the additional $10 per hour paid to the physician—gave rise to a secondary financial relationship (for example, an interest free loan or the complete forgiveness of debt) that must satisfy the requirements of an applicable exception.

What is not clear is whether a “secondary financial relationship” (whatever that means) is created only by the demonstrated intent of the party owed the remuneration to confer a gift or interest-free loan to the other party, or whether CMS would presume or conclusively determine that a gift or interest-free loan has been made simply by the failure to collect the excess remuneration owed to it. It would be comforting to think that a modified or new compensation springs into being only upon the intent of the party owed the remuneration to confer a gift or interest-free loan to the other party, but elsewhere in the final rule, CMS throws a large amount of cold water on that idea:

we do not believe that “reasonable efforts” to recover excess payments or collect amounts due are equivalent to the reconciliation of payment discrepancies. A policy requiring that the parties make “reasonable efforts” would present compliance and enforcement challenges, and would not provide for the certainty that reduces burden on stakeholders. Moreover, we do not believe that the mere undertaking of “reasonable efforts” to recover excess payments or collect amounts due is sufficient to warrant a deeming provision allowing the submission of claims or bills for designated health services and the payment for such services where parties make “reasonable efforts” to recover excess payments or collect amounts due under their compensation arrangement.

The language quoted above raises the question of why CMS bothered to bring up the subject of a gift or interest-free loan in the first place. Perhaps CMS’s point is that making a gift or an interest-free loan, for which there may not be an applicable exception, could create a knowing Stark violation, which carries enhanced penalties (such as False Claims Act liability and/or civil monetary penalties). But if so, this is not articulated in the final rule. And whereas CMS claims that a policy requiring that the parties make “reasonable efforts” to prevent a new financial relationship from springing to life “would present compliance and enforcement challenges, and would not provide for the certainty that reduces burden on stakeholders,” a party will need to make reasonable efforts to collect a mistaken payment or to recover remuneration wrongly taken from it in order to prevent a knowing Stark violation from occurring.

Further, whereas the final rule generally follows the proposed rule in treating any deviation from the compensation terms as a modified or new agreement, it also states that a “slight deviation” (whatever that is) “may not result in a different actual arrangement between the parties.” If the transfer of remuneration is what determines the “actual arrangement,” how is it that transfers of certain amounts do create a new or modified arrangement and transfers of other amounts do not? And what is and what is not “slight”?

The Policy is Unfair

The policy punishes innocent parties because they may be unaware, despite their diligence, until past the 90-day deadline in 411.353(h)(1), that remuneration has been taken or paid outside the terms of the arrangement. CMS apparently believes that if the parties have an effective compliance plan, that will guarantee timely discovery of any operational errors, but that is unrealistic. The error may be slight and/or difficult to determine, or one party may be affirmatively hiding it from the other party.

Also, a party may become aware of a shortfall within the 90-day period but unable to collect it. CMS’s policy is that reasonable efforts to collect money owed it are not good enough, so that if a party is underpaid it must actually collect the shortfall. Collecting money owed is easier said than done (or else there would be a lot fewer lawsuits than there are). For example, suppose a hospital leases office space on a one-year term to a physician group practice that has several physician owners. Nine-plus months into the lease, the group practice believes (mistakenly) that the hospital has breached a condition in the lease and refuses to pay any further rent. The hospital notices right away that rent for month 10 is not paid and contacts the group but believes (mistakenly) it will be able resolve the matter amicably. Instead, negotiations break down after a month, the group refuses to pay rent for month 11 and vacates the premises early in month 12. The hospital sends two demand letters to the group, which go unanswered, and the hospital decides it is not cost effective to sue because less than $5,000 is at issue. Or, to change the facts slightly, more than $20,000 is at issue, so the hospital brings suit and is awarded damages for the full amount, but the group dissolves its professional corporation (PC) and the hospital is unable to collect a dime. In both scenarios described above, the hospital acted diligently and made reasonable efforts under the circumstances to collect what was owed but was unsuccessful. Assuming that the shortfall put the lease payments below fair market for the term (which can easily be the case if two or three months of rent go unpaid), CMS’s policy is that there is a Stark violation.

The Policy Creates Perverse Incentives

As noted above, the policy requires a party to do more than expend good faith efforts to collect a shortfall. It generally must collect every cent. A physician who owes money to the DHS entity, and is aware of the requirement that the DHS entity must collect the money or else risk having a non-compliant and non-curable compensation arrangement, can extract concessions from the entity in exchange for repaying what they owe. For example, a physician who has been overpaid under a medical director agreement could leverage the DHS entity into executing a new agreement and at a higher rate of compensation as the price for repaying money owed to the entity.

CMS Attempts to Provide Relief Outside of New §411.353(h)(1) is Either Internally Inconsistent with Stark Rules or at Best is Confusing

The final rule attempts to reduce the effect of its policy by pointing out that if there is an unintended change in the compensation but the “actual arrangement” stays within fair market value, the supposed new or modified arrangement simply can be memorialized in writing. It returns to the medical directorship example that was given in the proposed rule and says that “if the operational error—payments of $150 per hour instead of the agreed upon $140 per hour—was not timely discovered and rectified, we would analyze the actual compensation arrangement between the parties as we would any financial relationship under the physician self-referral law.” It then says that if $150 per hour were fair market value and was not determined in a manner that took into account the volume or value of referrals or other business generated, “the potential non-compliance would relate primarily [but not only, as we shall see] to the failure to properly document the actual arrangement.” The final rule suggests that the parties could protect the excess compensation ($10 per hour) through the new exception for limited remuneration to a physician at 411.357(z), and then, if necessary, the parties:

could rely on the special rule for writing and signature requirements finalized at § 411.354(e)(3), coupled with the clarification of the writing requirement at § 411.354(e)(2), to establish that the actual amount of compensation provided under the arrangement was set forth in writing within 90 consecutive calendar days of the commencement of the arrangement via a collection of documents, including documents evidencing the course of conduct between the parties. The 90-day clock would begin when the parties could no longer use (or were no longer using) the exception at § 411.357(z). Thus, while the parties are relying on the exception at § 411.357(z) and for up to 90 consecutive calendar days after, they would likely be developing the documentation necessary to evidence their arrangement for medical director services under which the physician is paid $150 per hour. Depending on the facts and circumstances, the parties may be able to establish that the arrangement complied with the physician self-referral law for its entire duration.

Beyond the obvious faulty assumption that both parties necessarily are willing to resolve the error through executing a new, signed agreement, there are a few problems with CMS’s reasoning. First and foremost, CMS’ use of “actual compensation arrangement” and “actual arrangement” (emphases in the original) indicates that CMS believes that the excess compensation at most modifies the original arrangement and does not create a new, separate arrangement. If that is so, even if the parties take CMS’s suggestion and paper the so-called “actual arrangement” following the use of the new exception at 411.357(z), that will not avoid non-compliance in most scenarios, including in the example given in the final rule. That is because most of the common compensation exceptions, including those used to protect medical directorships (i.e., the exceptions for personal service arrangements and fair market value compensation) include a requirement that the compensation be set in advance. The final rule makes clear that where parties rely on the 90-day grace periods for obtaining necessary signatures or the necessary written agreement, they are not excused from an exception’s set in advance requirement. By definition, compensation is not “set in advance” notwithstanding that it is specified in the agreed-upon arrangement if the “actual arrangement” encompasses compensation that was not specified but rather paid or unpaid but through an error in the execution of the agreed-upon arrangement. To use the medical directorship example in the proposed and final rule, if the parties enter into a written agreement for $140 per hour, and later, compensation is mistakenly paid at $150 per hour and such payment has now modified the original agreement, it is not set in advance. Upon discovery of the mistaken payment, the parties could amend the written agreement to specify $150 per hour (assuming that such sum is consistent with fair market value), but they cannot, consistent with the set in advance requirement, make such amendment operate retroactively.

To illustrate further, suppose that the medical directorship is entered on January 1, and the payment of $150 per hour is made as a matter of course beginning February 1. If CMS takes the position that $150 per hour represents the actual arrangement, that would suggest that the “actual arrangement” relates back to January 1. That view would be consistent with the preamble discussion in that part of the 2020 final rule pertaining to the exception at 411.357(z), which indicates that the exception is for protecting new, standalone arrangements that have not, since their inception, complied with certain requirements, including the set in advance requirement. If that is so, and if, by the time the discrepancy in the per hour rate is discovered, more than $5,000 in medical directorship fees has been paid since January 1, the exception at § 411.357(z) will not protect the “actual arrangement” from its inception (January 1).

If, however, CMS’s policy is that it is only necessary that the modified compensation (here, $10 per hour) not exceed $5,000 so that it can be protected by the exception at § 411.357(z) (notwithstanding CMS’s repeated use of “actual arrangement,” which suggests that the deviation from the stated compensation relates back to day one), CMS has opened up a huge loophole in the set in advance requirement, as well as in other requirements, in various exceptions. If section 411.357(z) can be used to protect unintentional, not agreed-upon deviations in the compensation of an existing arrangement, there is no reason why it cannot be used to protect intentional, agreed-upon deviations. For example, parties could disregard the admonitions that modifications in the compensation terms must be made prospectively and in writing, institute an oral modification resulting in increased compensation, give it retroactive effect, and choose to protect the modification under 411.357(z) (provided the modification did not result in more than $5,000 in the calendar year).

But even assuming the new exception at 411.357(z) can be used to protect a supposed new or modified arrangement arising out of a mistake in the execution of an arrangement, there is also a problem with the fair market value requirement of the exception at 411.357(z). If excess compensation is mistakenly paid for a medical directorship and the entity paying the compensation has not discovered it in time to take advantage of 411.353(h)(1), how does the excess compensation meet the fair market value requirement? Fair market value is defined as “The value in an arm's-length transaction, consistent with the general market value of the subject transaction.” There is no “arm’s length transaction” with respect to excess compensation that was paid or taken as a result of inadvertence or deliberate behavior by a party.

The use of the new exception at 411.357(z), which is titled “limited remuneration to a physician,” also will not work in two other scenarios—where the mistake in the execution of the arrangement runs against the interest of the physician (which, admittedly is usually not the case), such as where an entity underpays a physician lessor or physician employee, or where the mistake in execution of the arrangement involves more than $5,000.

The Policy is Unnecessary Because There is a Better Alternative

CMS has a legitimate interest in ensuring that parties to a Stark “financial relationship” are complying with the requirements of an applicable exception, and should not have to simply take a physician’s or DHS entity’s word that remuneration that passed between the parties was unintended by the physician and/or the DHS entity. However, CMS can achieve that goal without exceeding its statutory authority, without causing unwarranted overpayment liability, and without putting the Medicare program at risk. CMS could allow parties to correct the deviation from the arrangement (by ensuring that any overpayment in the remuneration is collected or any shortfall is paid) within 90 days of termination of the arrangement, but if they are not able to do that (either because the deviation has not been discovered during that time or the parties cannot resolve a dispute as to the proper amount of remuneration owed by one party to another), the entity that has furnished the DHS potentially at issue would be required to prove, upon appropriate demand, that the deviation did not result in a modified or new arrangement (or that if it did, there is no non-compliance). For example, if a hospital was shorted on the rent owed by a physician and did not discover it until after 90 days following the termination of the lease, it would be required to prove, in any enforcement action, that it did not agree to a modification of the rent. Further, if the hospital was unsuccessful in collecting all the rent owed, it would be required to demonstrate that it expended efforts that were reasonable under the circumstances and that it did not intend to confer a gift upon the physician.

In conclusion, where possible, practitioners whose clients discover a deviation from the terms of an arrangement should take advantage of the new special rule at §411.353(h)(1), and possibly the new exception at §411.357(z). But given the limited relief they offer, combined with CMS’s insistence that all excess compensation be repaid regardless of a party’s efforts to recover it, practitioners should consider whether CMS’s period of disallowance policy and its attendant definition of “arrangement” is contrary to the plain language of the statute and decide, in certain circumstances, whether there is any noncompliance with an exception in the first place.