Mergers and Acquisitions

Recently, the Federal Trade Commission (“FTC”) faced major losses in challenging hospital mergers.  However, it is clear that the FTC is not backing down, especially given its tendency to conclude that proposed efficiencies do not outweigh the chance of lessening competition.

In July of this year, the FTC abandoned a challenge to the proposed merger of St. Mary’s Medical Center and Cabell Huntington Hospital in West Virginia after state authorities had changed West Virginia law and approved the merger despite the FTC’s objections. This year as well, the FTC failed to enjoin the Penn State Hershey Medical Center and PinnacleHealth System (“Pennsylvania Hospital Merger”) and the Advocate Health Care and NorthShore University Health System (“Illinois Hospital Merger”) under a relevant geographic market theory in the federal district courts.  However, the FTC promptly appealed to the United States Courts of Appeals for the Third and Seventh Circuits, respectively.

Against many predictions to the contrary, the FTC prevailed when, on September 27, 2016, the Third Circuit reversed the District Court’s decision in the Pennsylvania Hospital Merger, concluding that the lower court erred when it disagreed with the FTC on the choice and use of the proper test to define the relevant geographic market. The Third Circuit concluded that the hypothetical monopolist test should determine the relevant geographic market, and that using patient flow data to show a relevant market is “particularly unhelpful in hospital merger cases.”[1]  This means that using data showing why one patient travels to a farther hospital for services does not have a constraining effect on the price charged by the nearby hospital that the patient does not choose.  Additionally, the Third Circuit expressed extreme skepticism about using an efficiencies defense.  While it recognized that other courts and the government’s Merger Guidelines themselves consider efficiencies in their antitrust analyses, it made clear that “efficiencies are not the same as equities”[2] needed to successfully overcome a Clayton Act Section 7 claim in considering whether an injunction is warranted.

The Third Circuit’s logic may have emboldened the FTC, which on September 30, 2016, formally urged Virginia state authorities to reject the proposed merger of Mountain States Health Alliance and Wellmont Health System, two large regional health systems, claiming that the merger would lessen competition and reduce the quality, availability, and price of health care services in the area.  The FTC is alleging, that if the merger were consummated, the new entity would control 71% of the geographic market for inpatient hospital services in the area that both systems serve, and proposed efficiencies (e.g., greater clinical service offerings, reductions in labor expenses, and reductions in purchasing) are not extraordinary enough to outweigh the anticompetitive harms created.  While Virginia does not require FTC consent to approve the merger, the FTC’s evaluation under the Merger Guidelines carries weight because its process is similar to Virginia’s antitrust review.

Going forward, potential merger partners in the health care space should recognize that the FTC has been energized in its opposition to consolidation and should be attentive to the careful definition of geographic markets with an eye towards the hypothetical monopolist test. As stakeholders begin crafting acquisition strategies to take advantage of the Affordable Care Act’s consolidation opportunities, they should recognize that the enforcement components of the government such as the FTC are in apparent contradiction with the policy arm of the administration and that the FTC won’t back down from its challenges to mergers.

[1] FTC v. Penn State Hershey Medical Center, et al., at 19, No. 16-2365 (3d Cir. 2016).

[2] Id.at 36.

In 2008, Ambac v. Countrywide defendants Bank of America Corporation and Countrywide Financial Corporation merged into a wholly-owned subsidiary of Bank of America.  In discovery, Bank of America withheld communications between Bank of America and Countrywide that occurred before the merger, on the basis that they were privileged attorney-client communications that were protected from disclosure under the common-interest doctrine.  In 2014, the New York Appellate Division, First Department, acknowledged that “New York courts have taken a narrow view of the common-interest [doctrine], holding it applies only with respect to legal advice in pending or reasonably anticipated litigation,” but rejected the litigation requirement.   Ambac v. Countrywide, 123 A.D.3d 129 (1st Dep’t 2014).

Last week, the Court of Appeals overturned the First Department decision and restated the narrower scope of the common-interest doctrine under New York law:

“Under the common interest doctrine, an attorney-client communication that is disclosed to a third party remains privileged if the third party shares a common legal interest with the client who made the communication and the communication is made in furtherance of that common legal interest.  We hold today, as the courts in New York have held for over two decades, that any such communication must also relate to litigation, either pending or anticipated, in order for the exception to apply.”

Ambac v. Countrywide.  The Court of Appeals noted that multiple jurisdictions take a more expansive approach to the doctrine, and commented that the Second Circuit (the federal appellate court with jurisdiction over New York) “ha[s] made clear that actual or ongoing litigation is not required” to invoke the common-interest doctrine, but does “not appear to have expressly decided whether there must be a threat of litigation in order to invoke the exception.”  Ambac v. Countrywide (citing Shaeffler v. United States, 806 F.3d 34 (2d Cir. 2015)).

Takeaways:

  • The scope of protections under the common-interest doctrine varies significantly depending on jurisdiction and governing law.
  • In order to be protected under the common-interest rule under New York law, communications among merger counterparties, including health care entities,  must be made in furtherance of a common legal interest and relate to pending or anticipated litigation.

Hospital-physician practice acquisitions represent a large segment of the very active healthcare mergers and acquisitions market, which will likely continue in 2016.[1]  In New York, an acquiring hospital often forms a new professional corporation owned by one or more hospital-based physicians to acquire the business and operations of a group physician practice in an asset purchase. The acquiring hospital will be able to exercise a level of management and control over the new professional corporation, often referred to as a “captive PC”, through a contractual arrangement with the captive PC.  This captive PC structure is used to comply with New York’s corporate practice laws as well as to allow the group practice to continue operations as a separate entity but with close business ties to the hospital, e.g. with respect to participation in the hospital’s managed care contractual arrangements and access to other resources of the hospital system.  Although the captive PC structure is conducive to allowing the physician practice to continue its day to day operations largely unchanged, the transaction parties need to be aware that any clinical laboratories that were owned by the group practice will need to comply with a much more robust set of regulations following the sale to the captive PC.[2]  These changes will affect clinical laboratories offering, among other services, bacteriology, endocrinology, genetic testing, oncology, toxicology, transplant monitoring, urinalysis, and urine pregnancy testing.

As a general rule, all clinical laboratories operating in New York State must be authorized by the Clinical Laboratory Evaluation Program (“CLEP”) unless they fall within one of the enumerated statutory exceptions of N.Y. Public Health Law § 579.1.  As is relevant here, clinical laboratories operated by a licensed physician who performs lab tests or procedures “solely as an adjunct to the treatment of his or her own patients” are exempt from CLEP certification.  Instead, such physician-owned labs are certified and inspected by the Physician Office Laboratory Evaluation Program (“POLEP”).  This exemption is applicable only to labs that are operated by an individual health care provider or an independently owned and managed partnership or group practice.[3]  Both CLEP and POLEP have advised that when a lab is purchased by a captive PC, that laboratory no longer qualifies for the exemption even though the captive PC would be owned by physicians and the lab would continue to be used as before by physicians in the treatment of their patients.  The agencies have advised that, instead, it would constitute a clinical lab because of the control that the agencies believe the hospital may exert over the lab through its control over the captive PC.[4]  Due to the change in status of the laboratory post-sale, the POLEP certifications held by the labs will not be transferable to the captive PC as part of the transaction.  Accordingly, a hospital[5] that intends utilize a captive PC model to purchase the assets of a physician practice which include one or more laboratories should consider beginning the lab certification process before the transaction is complete to ensure the correct licensure is in place. [6]

Labs that only perform tests classified by federal regulations as waived[7] or provider-performed microscopy procedures[8], and for which POLEP previously issued a Clinical Laboratory Improvement Amendments (CLIA) Certificate of Waiver, will need to obtain a Limited Services Laboratory Registration from CLEP once transferred to the captive PC.[9]  This process is relatively straightforward.  The main requirement is for the hospital to submit an application, which is available online, indicating its current CLIA number.[10]

If, however, a lab will perform moderate and/or high level clinical or forensic testing[11], the lab must obtain a valid clinical laboratory permit from CLEP which is a detailed process that can take a significant amount of time depending on the quality of the lab.  Before applying for a new permit, the director of the lab must obtain a valid certificate of qualification.[12]  To do so, the director must meet certain minimum qualifications in the applicable area of testing and must demonstrate to the department that he or she possesses the “character, competence, training, and ability to administer properly the technical and scientific operation of a clinical laboratory.”[13]  The required director qualifications differ for each category of service that the lab may offer.  For example, an applicant for a certificate of qualification in oral pathology must either be a physician who is currently certified by the American Board of Pathology in anatomic pathology, or a dentist who is currently certified by the American Board of Oral Pathology.[14]  Often, the applicable qualifications will require four years of experience in an acceptable laboratory, including two years of experience with the methods and techniques to be conducted under the director’s supervision.[15]  A laboratory director may be employed at multiple labs, however, the director must disclose all other employment on the permit application, and must accurately report the hours he or she will spend on-site in each lab for every day of the week.

Beyond the requirements for lab directors, an application for a CLEP permit requires a disclosure of ownership statement, a $1,100 registration fee, and creation of a Health Commerce System (HCS) account for access to the Electronic Proficiency Test Reporting System and CLEP’s online permit information management system, eCLEP.[16]  The disclosure of ownership statement requires that all direct and indirect ownership and financial interests in the facility be disclosed, which would require disclosure of an affiliated hospital buyer of the captive PC.[17]

POLEP and CLEP recognize that transitioning from once agency to another can be a lengthy and burdensome process.  Accordingly, under circumstances in which the CLEP permit application process is not completed before a lab is transferred to the captive PC, CLEP has advised that it will generally permit the captive PC lab to continue conducting operations under its prior POLEP certification post-transaction until CLEP certification is obtained, provided the POLEP certification does not expire in the interim.[18]  The captive PC lab must submit written notification on its letterhead to POLEP indicating that a change of ownership has occurred.[19]  However, continued operation under a prior POLEP certification post-transaction, even if temporary, is not without risk to the lab and the captive PC since they are technically operating without the required CLEP license.  Such risk includes the possibility of revocation or suspension of a certification or other disciplinary action.[20]  Additionally, if the POLEP certification expires during the pendency of the lab’s CLEP application, the lab must cease all operations until a valid permit is obtained.  The operation of a clinical laboratory without a valid permit is a misdemeanor, punishable by imprisonment of up to one year, a fine of up to $2,000, or both.[21]

It is imperative that any hospital utilizing a captive PC to acquire a physician practice with a lab begin the CLEP certification process outlined above as early as possible.  Since applications vary based upon the type of services the lab is seeking permission to perform, it is difficult to estimate the timeframe for completion of the CLEP application process.  However, given the risks associated with a lab not having adequate licensure in place, buyers should be incentivized to submit their CLEP applications well in advance of the anticipated closing date of the transaction.

_____

[1] See Molly Gamble and Benjy Sachs, Becker’s Hospital Review, “60 Statistics and Thoughts on Healthcare, Hospital and Physician Practice M&A,” July 22, 2015, available athttp://www.beckershospitalreview.com/hospital-transactions-and-valuation/60-statistics-and-thoughts-on-healthcare-hospital-and-physician-practice-m-a.html (last visited Jan. 11, 2016).

[2] See N.Y. Pub. Health Law § 579.1.  Although outside the scope of this blog article, the law also covers blood banks, defined as facilities that collect, process, store, and/or distribute human blood or its components or derivatives. N.Y. Pub. Health Law § 571.

[3] NYS DOH Wadsworth Center, Physician Office Laboratory Evaluation Program (POLEP), available at http://www.wadsworth.org/labcert/polep/ (last visited Jan. 11, 2016) [hereinafter POLEP website].

[4] Epstein Becker & Green, P.C. telephoned POLEP and CLEP on this topic in mid-January 2016 and was told by each agency that POLEP and CLEP are taking this position.

[5] This would also apply to a captive PC that is operated by a managed care organization (MCO) or consulting firm.

[6] “CLIA” stands for the Clinical Laboratory Improvement Amendments through which the federal Centers for Medicare and Medicaid Services (“CMS”) regulates lab testing. See CMS, “Clinical Laboratory Improvement Amendments (CLIA),” available at: https://www.cms.gov/Regulations-and-Guidance/Legislation/CLIA/index.html?redirect=/clia/ (last visited Jan. 11, 2016).

[7] A “waived” test is defined by CMS as a test that is easy to perform and has little to no risk to the patient if performed incorrectly, including tests performed using a kit, device or procedure, which has been specifically designated as waived by the Food and Drug Administration. Two common examples of waived tests are blood lead screenings and rapid HIV screenings. See “New York State Guidance for following Standard Practices in Laboratory Medicine,” CLEP: Limited Service Laboratories, available at http://www.wadsworth.org/labcert/limited/index.htm.

[8] Provider-performed microscopy procedures (PPMPs) are tests requiring use of a microscope and performed by physicians, dentists or midlevel practitioners (such as nurse practitioners, nurse midwives, physician’s assistants) during the patient’s visit. These include wet mounts, potassium hydroxide (KOH) preparations, pinworm examinations, fern tests, microscopic urinalysis, fecal leukocyte examination, and certain other tests. See id.

[9] See N.Y. Pub. Health Law § § 579.3, 580.

[10] NYS DOH Wadsworth Center, “Clinical Laboratory Evaluation Program, A Guide to Program Requirements and Services”, available at http://www.wadsworth.org/labcert/clep/ProgramGuide/CLEPGUIDE.pdf (last visited Jan. 11, 2016).  Registration as a Limited Service Lab costs $200.  Id.

[11] This is a broad category that includes all laboratory tests that are not exempt as “waived” or PPMPs.

[12] 10 N.Y.C.R.R. 19.2.

[13] N.Y. Pub. Health Law § 573.

[14] 10 N.Y.C.R.R. 19.2(a)(2), (b); 10 N.Y.C.R.R. 19.3(e)(8).

[15] 10 N.Y.C.R.R. 19.2(c)(2).

[16] NYS DOH Wadsworth Center, “Certificate of Qualification Instructions”, available at  http://www.wadsworth.org/labcert/clep/Administrative/CQ_Initial_App_Inst_final_0115.pdf  (last visited Jan. 11, 2016); see also NYS DOH Wadsworth Center, Clinical Laboratory Evaluation Program, “Disclosure of Ownership and Controlling Interest Statement Instructions”, available at http://www.wadsworth.org/labcert/clep/Administrative/OwnerDisc_Instruc_03_2015.pdf (last visited Jan. 11, 2016); see also NYS DOH Wadsworth Center, “Laboratory/HCS Affiliation Request”, available at http://www.wadsworth.org/labcert/clep/Administrative/hcs_affiliation_request_2015_distributed.pdf A full list of requirements is available in the N.Y. Pub. Health Law §§ 572, 573, 574, 575, and 10 N.Y.C.R.R. 58-1.1.

[17] NYS DOH Wadsworth Center, Clinical Laboratory Evaluation Program, “Disclosure of Ownership and Controlling Interest Statement Instructions”, available at http://www.wadsworth.org/labcert/clep/Administrative/OwnerDisc_Instruc_03_2015.pdf (last visited Jan. 11, 2016).  Registration as a clinical lab costs $1,100. Id.

[18] Epstein Becker & Green, P.C. consulted with POLEP and CLEP on this topic in mid-January 2016 and was advised by each agency that POLEP and CLEP are taking this position.

[19] See POLEP website, supra note 2.

[20] N.Y. Pub. Health Law § 577.

[21] N.Y. Pub. Health Law § 578.

  The age and complexity of hospital real estate often result in zoning and land use issues that must be addressed in hospital M&A transactions.  In larger transactions, purchasers and their lenders frequently obtain zoning reports prepared by one of the national companies, which summarize existing code requirements and potential non-compliance by the hospital.  For smaller transactions, it is common for purchasers and their lenders to rely on a letter from the local Planning & Zoning office, which is often limited to confirmation of the zoning classification and whether there are outstanding zoning and land use violations.  While zoning reports and letters are helpful in identifying potential issues, parties to a hospital M&A transaction must carefully analyze the findings to determine if there is a bona fide issue that needs to be addressed.  Described below are several issues commonly encountered and how those issues might be addressed.   One of the more common zoning issues is the failure of buildings or uses of real estate to conform to current code.  Non-conforming buildings and uses are typically “grandfathered” from complying with the current code; that is, the non-conformance is permitted to continue.  But even if the facility is deemed to be “legally non-conforming”, purchasers and lenders should confirm that a change in ownership will not cause the facility to lose its “grandfathered” status.  Most zoning codes will allow a non-conforming structure to be repaired if it is has been damaged.  However, jurisdictions have different limitations on the extent to which a damaged building may be re-constructed.  In many cases, an owner may not have the right to replace a substantially damaged structure. Another common zoning issue involves structures built on multiple lots.  Typically, a structure must be constructed on a single lot, and the local code will require certain setback distances between the building and the property line.  Over time, hospital buildings often expand over the boundaries of the individual lot, resulting in a single building being located on multiple lots.  Many jurisdictions now have a lot consolidation process by which a property owner can combine multiple lots into a single tax parcel.  In that event, the setback distances run around the entire larger parcel.  But, in many instances, the consolidation process did not exist or was not enforced at the time the construction occurred.  So if the local jurisdiction applies the setback distances to each individual lot, rather than the entire parcel, portions of the building may technically encroach into the setback areas of those individual lots.  If a zoning compliance letter is issued without any exceptions, the local jurisdiction often views the lack of lot consolidation to be a “grandfathered” and “legal non-conforming” condition.  If the lot consolidation process is required, it can frequently be accomplished through an administrative process, particularly if the hospital is the owner of the abutting properties.  From a practical perspective, many purchasers decide to voluntarily consolidate multiple lots post-closing in order to have a single tax parcel and address. Effectively addressing zoning and land use issues requires detailed analysis of the subject facilities, the timeline for any expansions, the local codes then in effect, and the policies and practices of the local jurisdiction.  With a careful evaluation of each of these factors, many zoning and land use issues can be resolved without adversely affecting a transaction.    

By Dale C. Van Demark

As we weather what most industry watchers (including me) have observed is a renewed wave of hospital and provider consolidation, it is likely we will continue to see failed merger attempts involving religious and non-religious hospitals. The recent failures of the hospital mergers in Waterbury, Connecticut and in the Philadelphia suburbs are just two recent examples.

The Conundrum

Many religious hospitals trace their religious affiliation to the origins of the institution, which can date back many decades.  For some religious hospitals, their very existence, or their survival through difficult times, is linked closely with the efforts of religious institutions. Regardless, the mission of many religiously affiliated hospitals is directly tied to core religious principles – and for some, the basis for tax exemption is tied to this richer mission. As such, these hospitals present a more complicated picture than a secular hospital.

When community hospitals consider a merger or other dispositive transaction, they must consider their mission, regardless of whether they are religiously affiliated, and regardless of the nature of the transactions contemplated. In many instances both religious and secular community hospitals seek to expand or simply preserve their core values in the context of substantial change. And, of course, when one institution acquires another, the acquiring institution frequently takes steps to integrate new facilities into its own culture. These dynamics are as likely with secular hospitals as they are with religious hospitals.

Such attempts can cause tension. Even a non-specific, broadly worded acknowledgement of religious principles (whether as part of a non-binding letter of intent, or a binding transaction document) can be objectionable to a health system that is purely secular. However, when religious tenets require the restriction of services, religious affiliation can become an even greater risk to moving forward, as such issues can spill over into a broader policy or public debate.

The right of access to family planning services, including abortion, contraception or even end-of-life decision-making have been significant public issues in the United States for many years. Accordingly, it should come as no surprise that the extension of restrictions on such services through the merger of religious and secular hospitals can lead to a broader public debate over the appropriateness of the combination.

Sometimes, the availability of such services may be limited throughout a given community as well. This, of course, can increase the significance of the public concern.

In such circumstances, where public passions over hot-button political issues are inflamed, logic and reasoning can quickly turn to fear and reactionary positioning. Legal considerations regarding process – such as what individuals or entities may actually have standing to compel or prohibit action – stop mattering; compromise becomes increasingly difficult, and the chances of closing reduce.

How to Move Forward – Three Critical Factors

Before moving forward with a merger transaction, religious and secular hospitals should keep in mind a few key factors – factors that may result in a determination not to move forward at all.

1.         Mission

Fundamental to every decision made by a health system is respect for its mission. This is especially true of merger transactions. Put in terms of mission, religious principles in mergers between religiously affiliated hospitals and secular hospitals can be material. Accordingly, before deciding to engage in a transaction at all, the parties need to take a hard look at their respective missions. This may result in a decision not to proceed or a decision to modify the application of religious principles in the post-transaction arrangement. Regardless, the goal is to reach an agreement on how best to move forward while remaining respectful of the history and mission of each party. This critical step must come first, and must happen very early in the process.

2.         Remember Your Stakeholders

Stakeholders include a broad range of individuals and entities that have some interest (financial or otherwise) in a hospital. The particularities of mission (which may include continuing that mission intact) may be of specific interest to some stakeholders. Nearly all stakeholders can impact – if not also inhibit – the ability to close a transaction. Accordingly, understanding the perspective of stakeholders is important – they can help focus the importance of an issue, and can be allies or obstacles to a transaction. Issues of confidentiality can make assessing the interest or intent of some stakeholders difficult early in the process, but confidentiality concerns need to be weighed carefully against the value and benefits of timely and richer engagement.

3.         Context Matters

“Mergers” come in many forms and under many circumstances. The implication for religious principles can be drastic both in terms of messaging and possible application. For example:

Catholic institutions may not have the ability to negotiate away from aspects of the Ethical and Religious Directives while retaining Catholic identity.

  • When transactions include the disposition of funds (e.g., in a purchase and sale of assets or the allocation of existing funds in a foundation or reserve) the continuation of religious principles in the hospital may not be as compelling if the religious principles can be funded and carried forward in a different organization.
  • The broad availability of health care services in a community may lessen community concerns if continuing religious directives preclude the delivery of certain services post-transaction.
  • Government facilities may be precluded from operating under religious principles on constitutional grounds.
  • The preservation, as opposed to expansion, of the application of religious principles can keep missions distinct and more acceptable to the parties and their constituents.

Religious tenets very easily can become flashpoints for intense debate (including public debate) in the context of hospital mergers. Sometimes, this is unavoidable.

Regardless, fully understanding mission implications, the perspective of stakeholders and the broader context of a possible transaction can help the parties focus their messaging and response to the particular challenges associated with the merger of religiously affiliated and secular hospitals.

 

In most purchase and sale transactions, the purchase agreement is accompanied by and incorporates disclosure schedules that include certain relevant information to the transaction. In the rush of negotiations, diligence, and transition planning, it is easy to overlook the importance of the disclosure schedules. However, these schedules are much more than a mere compilation of information meaningful only to the lawyers who drafted the corresponding provisions of the purchase agreement. In fact, the disclosure schedules are a vital part of any transaction, helping to inform the buyer of the nature of the asset(s) being acquired and to define or limit certain rights of the transaction parties. Failure to adequately prepare or review the disclosure schedules may have significant consequences for sellers and buyers. For instance, a seller that fails to provide adequate disclosures may jeopardize the closing or at least risk post-closing indemnification obligations. On the other hand, a buyer that has devoted only negligible resources to reviewing the disclosure schedules may find itself with unexpected liabilities post-closing and no recourse to seek indemnification.

In particular, the disclosure schedules play two important roles:

  • providing important information to the buyer regarding the seller’s business and assets; and
  • listing exceptions to or completing the representations and warranties contained in the purchase agreement.

In many ways, the disclosure schedules serve to facilitate due diligence as well as to organize and aggregate much of the significant data exchanged during diligence. For instance, a buyer may want to complete a thorough due diligence review of all of the seller’s physician contracts. The process for this review can be expedited and improved by the purposeful drafting of the purchase agreement—specifically, the disclosure schedules to the representations and warranties. During negotiations, buyer’s counsel may insist that the purchase agreement include a representation that the seller has disclosed all of its physician agreements on a schedule. This provides the buyer with a single list of relevant agreements for its review and can help it confirm that it has been presented with and completed its due diligence review of physician contracts. This disclosure schedule could also serve as a reference point for the purpose of identifying the obligations of the parties in obtaining any required third party consents.

The same example demonstrates a way in which the disclosure schedules frequently define or limit the rights of the parties. In the above example, if the seller fails to list a physician agreement, it will have breached a representation and warranty in the purchase agreement. If the seller’s failure resulted in damages (e.g., due to compliance risk, the buyer cannot bill for services provided under the agreement) then the buyer may have an indemnifible claim against the seller for a breach of a representation and warranty.

General Tips for Preparing and Reviewing Disclosure Schedules

  • Maintain constant communication between your legal and business teams. This is particularly important for the seller, whose management and employees are best positioned to provide responsive information. It is incumbent on the party’s legal counsel to interpret the purchase agreement to ensure the business team understands what disclosures are required (particularly because required disclosures may evolve as the purchase agreement is negotiated). Maintaining a clear line of communication helps the teams to focus, which is often particularly critical for the business team which is simultaneously occupied with the day-to-day operations of the hospital.
  • Ensure continuity among reviewers / teams. Ideally, those key employees with oversight of the operations related to the disclosures (both on the seller’s and the buyer’s side) will serve as part of the diligence team and will later review the relevant disclosure schedules. Similarly, legal advisors who helped to negotiate and draft the corresponding representation and warranty should provide advice as to the specifics and scope of the required disclosures.
  • Resolve inconsistencies between the schedules and disclosures made during diligence. As noted above, the disclosure schedules serve a dual purpose of providing / eliciting information about the assets and identifying exceptions to the representations and warranties. Both sides should confirm that material posted to the data room or otherwise disclosed during due diligence is consistent with the disclosure schedules. If the schedules contain a disclosure previously unknown to the buyer, the buyer will typically conduct additional due diligence to ensure it understands the underlying facts and magnitude of the issue. Unfortunately, this reconciliation is frequently a tedious task. However, both parties are likely to benefit greatly from spending the time and resources at this stage to avoid subsequent indemnification claims, assumption of unknown liabilities, or worse, a failure
    to close.

A Few Takeaways

For Seller

Sellers should take care to ensure all of its representations and warranties are qualified as appropriate, whether such qualifications are in the form of exceptions identified in the purchase agreement (e.g., by materiality or “knowledge” qualifiers) or the disclosure schedules. The seller should also focus particularly on the line of communication between its business and legal teams to ensure changes to its contracts, permits, condition of assets, or other operations are incorporated appropriately into the disclosure schedules.

For Buyer

Buyers should feel comfortable with the final set of disclosure schedules and that the other terms of the purchase agreement (e.g., purchase price and indemnification limitations) remain reasonable in light the seller’s disclosures. When reviewing the disclosure schedules, buyers should remember to consider the disclosures in conjunction with the representations and warranties and their corresponding function in the agreement. For example, the buyer will likely have some protection if the seller breaches a representation and warranty by failing to disclose an issue (e.g., the buyer may not be obligated to close or may have an indemnifiable claim post-closing). However, the buyer has no claim against the seller with respect to those issues disclosed in the schedules. Accordingly, the buyer should be wary of broadly-drafted or ambiguous disclosures and should work with counsel to ensure that, as drafted, the schedules accurately capture only those issues vetted during diligence.

Hospital M&A activity has been increasing recently, and when these transactions are public knowledge, opposition from the physician community (as well as the hospital staff) to such types of transactions may also be a side effect.  Physicians are vital to the operation of a hospital, and any resistance from the physician community, could be a tremendous obstacle, either slowing down the transaction or causing the potential buyer to pull out of the deal.  Hospital administrators, along with their advisors, should do their best to foresee any opposition and manage physicians’ expectations through the transaction process.

There are many potential concerns that the physician community may have regarding a transaction.  Specifically, physicians, like most people, are probably fearful of change.  In an M&A transaction, the process can often be a stressful time because of the changes in the organization, which can include an unknown – a new operator.  If a new operator wishes to add (or subtract) certain services, hire additional physicians, modify the approval process for new equipment or medical devices, or institute a new arrangement that is historically different than the current norm, those physicians may question or push back on the proposed deal.

While opposing physicians usually do not have any legal authority to stop a deal, they may be able to exert their influence with other stakeholders.  For example, the physicians could request a hearing with a state oversight committee, make medical staff transition planning difficult or create an environment of mistrust during the approval process, thereby causing months of delays.  Also, the opposition may be so strong and/or vocal that the potential buyer could become worried about their relationships with the physicians post-closing and eventually, lose interest in the transaction.

4 Tips for Managing Potential Physician Resistance

  1. Retain experience.  Administrators should engage experienced advisors (attorneys, healthcare consultants, bankers) early in the process.  Experienced advisors can assist in foreseeing problems and help strategically guide their client through the process to closing.
  2. Ask around.  Engagement can be a powerful tool.  Hospitals may want to ask their top admitting physicians about their thoughts early in the process regarding a possible transaction.  This may help determine how supportive the physician community, as a whole, feels about the transaction and could result in the creation of powerful allies.  At a minimum, it can help in the process of evaluating where concerns may be strongest.
  3. Communicate.  When a hospital is not transparent, rumors may percolate throughout the organization, which can easily become embellished and have disastrous effects.  While the administration may have valid reasons for not sharing certain information, the more about the transaction that is communicated, the more comfortable the physicians should be with their job security and in supporting the transaction.  Physicians may even be a good resource to help deliver the hospital’s message to the hospital staff.
  4. Communicate Again. Very often people do not hear the message the first time it is delivered.  The more you communicate with physicians, the better chance that they will listen and understand the importance of the transaction for the hospital.  However, it is important for the administration to communicate elements of the transaction carefully, and while the administration can attempt to address the physician community’s concerns during negotiations, the administration should not promise too much.  Administrators may attempt to reach their audience in multiple ways such as setting up in-person meetings and sending out regular emails from the CEO.

It should be noted that there are some risks associated with being transparent, and sometimes there are compelling reasons to avoid disclosing too much about a transaction too soon.  Most notably, physicians may be unhappy with the deal terms.  Overall, hospital administrators should always focus their message on the future positives of the transaction for the physician community.  Approaching hospital transactions in this manner will hopefully lead to a healthy dialogue between administrators and physicians about the transaction rather than ignoring concerns (legitimate or otherwise) that ultimately ends with a code blue.

 

Earlier this summer, I wrote about the new conditions of participation for hospitals that, among other things, would have required medical staff participation on hospital governing boards. As I suggested might happen, it appears CMS may revisit this requirement. Specifically, CMS has apparently directed state survey agencies not to assess compliance with this requirement, or to cite deficiencies relating to any non-compliance with this requirement, until further advised by CMS. There are a variety of ways to look at the circumstances of and fallout from the medical staff participation requirement. At the time the new conditions of participation were announced, this appeared a cautionary tale, one that illustrated the potential and unintended consequences, and potentially adverse effect, of a lack of foresight, proper analysis and planning. In view of the recent suspension of enforcement, which may lead to an eventual abandonment or repeal of the rule, this may now look like nothing more than an example of how even potentially significant adverse consequences can ultimately be avoided, or “undone”. In short, no big deal, right? Certainly, when push comes to shove and the stakes are high (as they are in many deals), errors, omissions and problems that arise can and often will be fixed, resolved, waived or otherwise addressed in order to allow a transaction to close.  It is rare, although not unheard of, for an unresolvable legal issue – the proverbial “deal killer” – to emerge when the parties are well into the throes of a transaction. However, there is generally no magic-wand solution, and often the “fix”, as it were, comes at substantial cost, whether it’s in effort, expense or delay. Issues that are uncovered late in the game, particularly those that might have been avoided with careful foresight, planning, communication or coordination, add stressors to a transaction and deal teams(s) that may, by the time the issue is uncovered, already be stretched pretty thin. So, if your organization is evaluating a potential merger, acquisition, divestiture or affiliation transaction, most particularly as a target, do yourself a favor – get your ducks, meaning in this case, your organization’s records, in order:

  • Organize your organizational documents and record books, including your minute books and, if applicable, your stock ledger and records or the equivalent.
  • Ensure that all board/member minutes and consents are accurate and up-to-date, that they are executed where applicable and that they include all relevant exhibits and attachments.
  • Ensure that your organization’s records with respect to its investments in any subsidiaries or partnerships are in order, and that your organization is in possession of valid and accurate certificates reflecting such equity ownership where applicable.
  • Review the applicable provisions of any operating agreement, shareholder agreement or partnership agreement applicable to any subsidiary, joint venture or other such arrangement in which your organization is involved to identify restrictions on transfers of interests and/or applicable notice/consent requirements relating to same.
  • Confirm that the number of members of the board of directors/managers/trustees of your organization is consistent with that provided in the organizational documents or under applicable law.
  • Ensure that your organizational documents reflect the date that all such directors/managers/trustees were appointed or elected, and the term of office of each.
  • Review your organizational documents to confirm meeting notice requirements, waiver of notice provisions and written consent requirements
  • Establish a communications plan for your board, and ensure that you can reach all members of the board as and when necessary.

Undertaking this review, and correcting any issues that are identified, before launching a transaction will facilitate the other party’s review, as well as the documentation and closing process, and help avoid last-minute issues that can add effort and expense to, if not also delay or even jeopardize, a transaction.  

My earlier post explored various real estate strategies frequently used in hospital M&A transactions.  Each of those different approaches – using real estate assets to secure acquisition financing, increasing existing lines of credit, or monetizing the real estate assets through divestiture – reflect different objectives and opportunities.  But, real estate is more than “location, location, location” and “strategy, strategy, strategy”—there must also be “value, value, value”.  The real estate market itself is the lynchpin to establishing the value of individual properties, but the value of hospital properties is frequently affected by dynamics somewhat unique to hospitals. Often, a hospital will expand its footprint by purchasing multiple smaller parcels over the years.  And, for many older hospitals, that can mean almost a century.  Due to the multitude of smaller parcels and the lengthy time-span over which the properties may have been acquired, you may frequently find older title encumbrances that potentially affect the value of the hospital properties and, in turn, cause insurability concerns for many title companies.  We see several re-occurring title issues in hospital M&A transactions.

Old loan documents which have not been released of record usually cause the most concern for lenders wanting to make sure they have lien priority over all other financings.  Since the title company would be insuring the lender’s superiority, the title company will normally expect recorded releases for all prior financings.  For more recent loans, the solution may involve obtaining additional release documents although with the recent spate of bank mergers, closures, and take-overs, sometimes even recent loans may prove to be a challenge.  As you would expect, the older loan documentation is more difficult due to mergers over the years, and frequently the successor bank only possesses information about active loans.  In some instances, the successor bank may be hesitant to execute releases for loans it did not service.  Bond financings sometimes present similar challenges even after the bonds have been satisfied and defeased.  The recorded releases are normally pretty clear that the mortgage or deed of trust has been satisfied but ignore other recorded bond documents—such as leasebacks, security agreements, and assignment of leases—which should have also been released.  If the issuing authority still exists, obtaining the additional releases is normally not problematic; however, in a number of bond transactions, the issuing authority was dissolved after the bonds were satisfied so no entity exists to provide the additional releases.  In such circumstances, hospitals typically must go through old records to provide documentation about the loan as well as record affidavits to the satisfaction of the title company.

Properties purchased by a hospital years ago are frequently encumbered by recorded restrictions which either limit the use of the property or impose certain requirements on the property.  In many ways, it is easier to deal with much older restrictions—such as those which limit the number of carriage houses on the property and those that require former farm properties to store manure on a certain side of the property.  Title companies will frequently make the underwriting decision to insure over such restrictions, given the slim likelihood of anyone being able to enforce those restrictions today.  Slightly more problematic restrictions include restrictions that limit occupancy to a single family of related individuals or that limit the square footage of any structure to be constructed on that parcel.  Dealing with these kinds of restrictions is often fact-specific and require further inquiry.  But, perhaps the most problematic of older restrictions are those that limit use of the property to individuals of certain races, religions, etc.  Although such restrictions have been declared unconstitutional from a legal perspective, these restrictions remain as an encumbrance to title, and title companies understandably do not typically insure over those restrictions.  Depending on the wording of the restriction and whether it specifies which parties may be entitled to seek enforcement, it may be possible in some instances to devise a way to have such restrictions released of record.

While not unique to hospital properties, there are often a number of vague easements that encumber the hospital property.  However, due to the number of smaller parcels that frequently comprise the overall property, you may encounter a large number of those easements to address.   Typically, easements that serve the hospital property are not too problematic since the hospital, as the end-user, will have some degree of flexibility if a problem arises.  Transmission line, drainage line, and other easements serving multiple properties, including some not owned by the hospital, must be analyzed with care to determine whether the easement locations can be relocated if necessary, whether third parties have the right to enter onto the hospital property to make installations and repairs, which parties may have the rights to enforce the easements, and so forth.  In many instances, the title company may be able to provide some coverage for the lender—and possibly the owner—for the forced removal of any structures from the easement area.

Although common to transactions, title issues should be addressed—and resolved, if possible—in order to preserve the marketability—and value—of the properties.  Hospital transactions tend to have both more and older title issues than many commercial transactions so it is important manage the real estate due diligence from the outset.  Otherwise, you may encounter last-minute problems or delays in closing in order to cure title issues to the satisfaction of the buyer, lender, and title company.

Medical group acquisitions by hospitals will likely continue at a significant rate. Through these acquisitions, physicians can achieve efficiencies and economies of scale that may not be available to independent practices. While an acquisition offer might come as a welcome opportunity, the process involves a series of complex issues that can seem overwhelming. There are many steps that physician practices can take to help them seize opportunities and minimize issues that might delay or derail a deal.

  • Preparing the Existing Entity
    Most doctors choose their career because they want to practice medicine, not run a business. Physicians considering an acquisition should make sure that their corporate records are in order. This includes ensuring that required filings have been made with regulatory agencies and that necessary documentation reflects the decisions of the practice’s directors, shareholders, members, or managers.
  • Establishing the Management Structure
    Groups that are being acquired must address how future decisions will be made. Governing documents should clearly spell out who will make decisions and the input of the acquiring entity.
  • Understanding the Elements of an Acquisition Agreement
    Every acquisition requires an acquisition agreement, which serves as a road map for the transaction and describes in detail the valuation of assets, the collection of accounts receivable for services provided by the physicians prior to the acquisition, the handling of liabilities, employees retention, indemnification of claims arising before the acquisition and insurance to cover those risks.
  • Understanding the Importance of Employment Agreements
    The parties to an acquisition should enter into a compensation agreement with each physician involved in the acquisition. This agreement should specifically address the duties of the individual physician, including the number of hours the physician is expected to spend seeing patients, office locations covered, supervision of other physicians or staff, administrative duties and call coverage responsibilities. Furthermore, the types of benefits provided to physician owners should be set out in detail. Finally, any non-competition provisions should be carefully addressed.
  • Tackling Regulatory Issues
    Physicians should consult with their advisors to determine whether the acquisition will require new Medicare and Medicaid provider numbers, CLIA filings or other governmental filings. Parties to an acquisition will also want to ensure that they are in compliance with the Stark Law, as well as other federal and state anti-kickback regulations.
  • Reviewing Other Existing Contracts
    It is also important to review other existing agreements to determine whether any action is necessary as a result of the acquisition. For example, an acquisition may require re-credentialing with managed care companies, or a notice to the landlord may be required for the lease to be assigned. Bank documents, such as loans or lines of credit, may also require attention prior to an acquisition.
  • Poised for Success
    The acquisition of a physician practice can ultimately result in tremendous rewards for all parties involved. But with all the variables to consider, it is wise to make sure that physicians understand all of the components of an acquisition to ensure that the acquisition benefits all parties involved.