Avoiding Pitfalls In Physician Practice Acquisitions

April 23, 2018

By William Eck,
Partner at Seyfarth Shaw LLP in Washington, D.C.,
and chairman of the firm’s national health care mergers and acquisitions practice.
Original publication appeared in Law360 on April 20, 2018

The past few years have seen a resurgence in the acquisition of physician practices, both by hospitals and by private equity firms. Hospitals and health systems are increasingly looking for clinical integration. Private equity firms see the advantages of large, integrated groups. Independent physician groups are faced with significant challenges, including continued reimbursement rate pressure and reimbursement methodology challenges, such as the Medicare Access and CHIP Reauthorization Act of 2015, popularly known as MACRA, that demand implementation of sophisticated and expensive technology that small groups can ill afford.

Acquiring a physician group carries special challenges in view of the heavy regulation of the health care provider industry. Once it is decided to acquire a physician practice, among the questions the acquirer and its counsel must consider are the optimal structuring approaches and how to avoid the legal pitfalls that are particular to this sort of transaction.

Structure of the Transaction

In general, the threshold consideration in a physician practice acquisition is the structure of the transaction. Certain states prohibit persons or entities other than physicians from owning physician practices. In those states that prohibit the corporate practice of medicine, the transaction may take more complex forms, such as asset purchases followed by long-term management relationships. In some states, hospitals may own practices but private equity firms may not. In others, even hospitals may not own physician practices. In such states, it is common for the transaction to take the form of a purchase of assets other than goodwill, coupled with a practice management agreement. Counsel should review the specific form of transaction from the perspective of the state’s practice of medicine law and policy regarding the ownership and management of physician practices by non-physicians.

From the standpoint of the buyer, an asset acquisition is the most advantageous of the alternatives. First, except in limited circumstances, it allows the buyer to obtain the practice free and clear of prior liabilities and contingencies. Second, it allows the buyer a step-up in the tax basis of the purchased assets (the parties to a stock purchase may also elect to have the transaction treated as an asset purchase for federal income tax purposes). Conversely, a stock purchase or merger transaction will typically be more tax efficient alternatives for the seller.

Stock purchases and mergers also have the advantage that they usually involve few to no third-party consents. An asset purchase, on the other hand, in a physician practice context usually will require consents to the assignment of leases and agreements. Importantly, an asset purchase will require either new Medicare, Medicaid, and other governmental and commercial payer agreements, or assignments of existing payer agreements.

Although new payer agreements can be cumbersome to obtain, they provide avoidance of liability for prior Medicare, Medicaid and commercial insurance overpayments that could otherwise become an issue under the target’s payer agreements. This is often an important reason for the buyer to seek an asset purchase structure, unless the seller has particularly favorable commercial insurance payer agreements. In an asset purchase, the buyer can decline to accept assignment of provider agreements, and instead apply and enroll as a new provider. In general, a new subsidiary should be formed as the buyer; otherwise the buyer’s existing governmental and commercial insurance payer contracts may become applicable to the post-closing practice as a new location of the buyer. Similarly, in an asset purchase, the buyer generally takes the practice free from liabilities and contingencies for pre-closing alleged malpractice events. In this manner, the buyer may begin afresh, without exposure to potential Medicare, Medicaid, private overpayment claims or malpractice contingencies.

Due Diligence

Anti-Kickback Statutes

In addition to the matters typically addressed in due diligence for any merger and acquisition transaction, in a physician practice acquisition, attorneys performing diligence must address certain health regulation matters. These include the federal health care anti-kickback statute, 42 U.S.C. § 1320a-7(b), and its state counterparts (e.g., NY CLS Soc Serv § 366-d and Cal Bus & Prof Code § 650). The AKS prohibits direct or indirect remuneration in return for or to induce referrals for items or services for which federal health care program (i.e., Medicare or Medicaid) payment may be made. State laws are similar and usually apply to all payers, not only federal health care program payers. Counsel should carefully look at all of the practice’s contracts with referral sources and with entities to which the physicians refer. Likewise, counsel should review each physician’s contracts with referral sources and with recipients of referrals, and other key contracts of the practice and its physicians. The critical review consideration is whether it appears that inappropriate remuneration in return for or to induce referrals is involved in the agreement.

Stark Law

Review compliance with the Stark Law [1] and its state counterparts (e.g., NY CLS Pub Health § 238-a and Cal Bus & Prof Code § 650 et seq.). With certain limited exceptions, the Stark Law prohibits physicians from making referrals for specified designated health services, where the physician or an immediate family member of the physician has a compensation relationship or investment interest in the provider or supplier of the designated health service. “Designated health services” are defined in the Stark Law and include clinical lab services, home health services, radiology/MRI/CT services, etc.

Counsel performing due diligence should review physician relationships with all nonpractice providers and suppliers of designated health services, including hospitals and other practices, for compliance with the Stark Law. Also, if the group provides designated health services, such as clinical lab or imaging services, or certain other in-office ancillary designated health services, counsel should review compliance with the Stark Law exception for in-group ancillary services. [2]

Compliance Policies and Procedures

Counsel should review any compliance program, compliance policies and procedures, and compliance log of the physician practice. The compliance policies and procedures will indicate how robust the group’s effort is to comply with applicable laws and regulations, as well as the extent to which it follows the guidance of the U.S. Department of Health and Human Services’ Office of the Inspector General. [3] The compliance log is one indicator of the level of the group’s overall compliance with laws and regulations and whether there are material issues that will need to be addressed. These issues may relate not only to health care compliance but also to compliance with employment or other laws and regulations.

Coding and Billing Practices

The buyer should consider whether to perform a coding and billing audit, if only on a relatively small sample of claims. Even if the transaction is structured as an asset purchase, to the extent that the practice’s financial results were achieved based on aggressive coding and billing practices, this could affect the valuation of the practice.

HIPAA and State Privacy Law Compliance

Counsel should tters typically addressed in due diligence for any merger and acquisition transaction, in a physician practice acquisition, attorneys performing diligence must address certain health regulation matters. These include the federal health care anti-kickback statute, 42 U.S.C. § 1320a-7(b), and its state counterparts (e.g., NY CLS Soc Serv § 366-d and Cal Bus & Prof Code § 650). The AKS prohibits direct or indirect remuneration in return for or to induce referrals for items or services for which federal health care program (i.e., Medicare or Medicaid) payment may be made. State laws are similar and usually apply to all payers, not only federal health care program payers. Counsel should carefully look at all of the practice’s contracts with referral sources and with entities to which the physicians refer. Likewise, counsel should review each physician’s contracts with referral sources and with recipients of referrals, and other key contracts of the practice and its physicians. The critical review consideration is whether it appears that inappropriate remuneration in return for or to induce referrals is involved in the agreement.

Stark Law

Review compliance with the Stark Law [1] and its state counterparts (e.g., NY CLS Pub Health § 238-a and Cal Bus & Prof Code § 650 et seq.). With certain limited exceptions, the Stark Law prohibits physicians from making referrals for specified designated health services, where the physician or an immediate family member of the physician has a compensation relationship or investment interest in the provider or supplier of the designated health service. “Designated health services” are defined in the Stark Law and include clinical lab services, home health services, radiology/MRI/CT services, etc.

Counsel performing due diligence should review physician relationships with all nonpractice providers and suppliers of designated health services, including hospitals and other practices, for compliance with the Stark Law. Also, if the group provides designated health services, such as clinical lab or imaging services, or certain other in-office ancillary designated health services, counsel should review compliance with the Stark Law exception for in-group ancillary services. [2]

Compliance Policies and Procedures

Counsel should review any compliance program, compliance policies and procedures, and compliance log of the physician practice. The compliance policies and procedures will indicate how robust the group’s effort is to comply with applicable laws and regulations, as well as the extent to which it follows the guidance of the U.S. Department of Health and Human Services’ Office of the Inspector General. [3] The compliance log is one indicator of the level of the group’s overall compliance with laws and regulations and whether there are material issues that will need to be addressed. These issues may relate not only to health care compliance but also to compliance with employment or other laws and regulations.

Coding and Billing Practices

The buyer should consider whether to perform a coding and billing audit, if only on a relatively small sample of claims. Even if the transaction is structured as an asset purchase, to the extent that the practice’s financial results were achieved based on aggressive coding and billing practices, this could affect the valuation of the practice.

HIPAA and State Privacy Law Compliance

Counsel should review the target practice’s compliance with the Health Insurance Portability and Accountability Act of 1996 and parallel state privacy laws. The buyer will want to ensure that an appropriate notice of privacy practices is in place and followed. The buyer will also want to ensure that up-to-date and appropriate business associate agreements are in place with billing companies and other business associates. Finally, the buyer will want to confirm that appropriate information security systems are in place.

Licensing Regulations

Counsel should confirm the physicians’ licensure status. Also, it may be the case, depending on the specialty of the practice, that it will hold other licenses, such as equipment licenses, the status of which should be confirmed. For example, a radiology practice may have imaging equipment required to be licensed. Other equipment sometimes in physician practices and required to be licensed includes nuclear medicine equipment and accelerators. As part of due diligence, it is advisable to assure that these licenses are in place, up-to-date and no violations are outstanding. Assignments of these licenses (other than physician licenses to practice medicine) may also be necessary depending on the structure of the transaction and the licensing laws of the relevant state.

Valuing the Practice and Physician Compensation – Stark and AKS Implications

Where the purchaser, such as a hospital or health system, will employ the physician and receive referrals from the physician subsequent to the purchase, it is important that the transaction be within the Stark Law exception for isolated transactions. [4] Most significantly, this exception requires that consideration (1) be fair market value, (2) not be determined in a manner that takes into account the volume or value of referrals, and (3) be commercially reasonable even if no referrals were made. [5] The employment compensation subsequent to the purchase must meet the same requirements.

In recent, high-profile cases, including, for example, United States ex rel. Schaengold v. Memorial Health Inc., the purchase price of physician practices and compensation of physicians were claimed by the government to violate the Stark Law where the purchaser and subsequent employer was a hospital or health system. [6] In Schaengold, the health system settled the case by payment of $9.9 million to the government.

Similarly, in United States ex rel. Drakeford v. Tuomey, the compensation of surgeons as part-time employees was ruled to violate the Stark Law because it included productivity and incentive bonuses that, although based on professional services, would be higher with greater referrals. [7] In Tuomey, there was a $275 million verdict and judgment against the health system, and the case ultimately settled for $72.4 million.

Similarly, the AKS prohibits any remuneration, direct or indirect, overt or covert, in exchange for or to induce referrals for which federal health care program payment may be made. The AKS applies to the offer or receipt of, as well as to the solicitation or payment for, referrals. Violations of the AKS are felonies. [8] Similar to the Stark Law, the AKS may be implicated to the extent that the purchase price is based on present or anticipated referrals or where the physician practice will refer to the purchaser or affiliate of the purchaser after completion of the purchase.

The AKS contains a safe harbor that may protect payments of compensation for services to bona fide physician employees subsequent to the purchase. Here, the definition of employees is for federal income tax purposes. [9] However, as illustrated by Schaengold, compliance with the AKS does not constitute compliance with the Stark Law, and the Stark Law may be violated even where the AKS is complied with. Because of the potential for scrutiny of physician compensation under the Stark Law, and scrutiny of the purchase price under the AKS and Stark Law, if practice physicians will refer patients to the buyer or an affiliate of the buyer after completion of the purchase, it is advisable to consider an independent third-party valuation of the fair market value and commercial reasonableness of compensation and pricing.

Although the AKS contains a regulatory safe harbor for sales of practices, it applies only to sales from one practitioner to another. [10] The fact that a transaction is not within a safe harbor does not mean it violates the AKS. However, the facts and circumstances of the arrangement are subject to scrutiny by the HHS Office of Inspector General or, in the context of a False Claims Act case, the U.S. Department of Justice. Consequently, it is critical that the consideration in the purchase not be based on or take account of present or anticipated referrals.

Antitrust Issues

As with other acquisition transactions, as an initial matter, counsel needs to determine whether a premerger notification filing under the Hart-Scott-Rodino Act is necessary. For 2018, the threshold for HSR filings is $84.4 million, therefore HSR filing requirements apply only to large physician practice acquisition transactions.

However, it is important to keep in mind that, while most physician practice acquisitions will not require premerger filing with the Federal Trade Commission, there is a potential for larger transactions to trigger antitrust scrutiny under the Clayton Act. There is even potential for smaller acquisitions to trigger scrutiny in rural markets or in highly specialized practice areas. This occurred in at least one case, in Idaho, with a practice comprised of 34 physicians. [11]

In December 2017, the proposed acquisition of Mid Dakota Clinic PC by Sanford Health was enjoined until an administrative trial before the FTC is complete. [12] Sanford employs 160 physicians and 100 non-physician providers and sells health insurance. Mid Dakota is a multispecialty physician practice employing 60 physicians and 19 advanced-practice practitioners and operates six clinics, a center for women, and an ambulatory surgical center primarily in Bismarck, North Dakota.

The court found the transaction presumptively illegal, further concentrating an already concentrated market. The court rejected Mid Dakota’s and Sanford’s efficiency arguments, with the view that efficiencies almost never justify a merger to a monopoly or near monopoly. The case is presently under appeal, and the FTC administrative trial is pending the outcome of the appeal.

In cases that involve antitrust scrutiny, the parties may choose to defend the transaction or explore alternative methods of integration that implicate less antitrust risk. The alternatives include forming accountable care organizations and integrated provider networks. Accountable care organizations are specialized types of Medicare provider networks in which the health care providers coordinate care and share risk. Integrated provider networks in general involve clinical and financial integration of the providers and, thus, some level of shared risk. These arrangements can involve less antitrust risk than outright acquisitions. Of course, it is also possible that transactions that do not trigger contemporaneous antitrust scrutiny by the government will still involve antitrust risk. These risks must be assessed as part of the decision whether to proceed with the transaction.

Escrow, Installment Payments and Earnouts

Escrows and earnouts are common methods in acquisition transactions of protecting the buyer against the risk of misrepresentation or breach of warranty and protecting the buyer against the risk of overpaying. Installment payment offsets are less commonly used for the same purposes. In the context of physician practice acquisitions, however, where the buyer will be a recipient of referrals from the seller physicians, earnouts generally are to be avoided because of the need to comply with the Stark Law and the AKS. When the purchase price in part depends upon the post-closing performance of the practice, and the selling practice physicians will be employed post-closing, an earnout can result in the purchase price unlawfully taking account of post-closing referrals.

Escrows and installment payment offsets, on the other hand, can be acceptable means of reducing a buyer’s risks. However, counsel should take care when drafting these provisions to avoid contingencies that could implicate the Stark Law, the AKS or parallel state laws. The critical issue is that escrow deductions and installment payment offsets should be based on breaches of representations and warranties that are not related to the financial performance of the practice after the closing of the purchase.

Non-competes and Non-solicitation Agreements

The Stark Law and AKS do not prohibit exclusive relationships or noncompetition agreements. Where the physicians will be employed post-closing and the purchaser is a health care provider or system to which the physicians will refer, the Stark Law exception and AKS safe harbor for employment relationships need to be satisfied (whether or not noncompetition agreements are used). Non-solicitation agreements in general do not raise regulatory issues under the Stark Law or AKS.

In addition, noncompetition agreements in general are enforceable under state law to the extent that they are reasonable in time and geographic scope [13] although some states do not enforce noncompetition agreements against employees at all. [14] Some states, by statute, prohibit the enforcement of noncompetition agreements against physicians, even if reasonable noncompetition agreements are enforceable in the context of other occupations. [15] Still other states, under case law, sometimes prohibit enforcement of non-competition agreements on the basis of the public interest in the availability of physicians. [16] Consequently, counsel should advise the buyer on the enforceability of physician noncompetition provisions in the relevant state.

Conclusion

In summary, there are a number of specific legal and structuring considerations in physician practice acquisitions because of the significant regulation of health care. Key considerations include transaction structure, due diligence, purchase price and compensation, purchase price contingencies, and non-competes and other factors. Neverthele

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