Hidden Risks In Practice Acquisitions And Joint Ventures

There is a potential compliance “blind spot” associated with what many in the healthcare industry would regard as ordinary practice acquisitions and joint ventures involving hospitals and other provider organizations. This area of possible vulnerability arises from the payment of consideration for what are sometimes insufficiently delineated assets of the target or partner entity. If money is paid for “mystery assets,” there will always be a regulatory concern  under the federal Anti-Kickback Statute ( 42 U.S.C. § 1320a-7b(b)) (“AKS”) – and by extension under the Civil Monetary Penalties Law (42 U.S.C. § 1320a-7a(a)(7)) (“CMPL”) and False Claims Act (31 U.S.C. §§ 3729 et seq.) (“FCA”). Appreciation for that risk, however, may be impeded, and the risk itself may be masked,  by unsupported assurances that  sometimes are contained within the fair market value (“FMV”) opinions of third party valuation firms.  As explained in more detail below, that risk makes it critical for providers, counsel and valuators to work together to ensure that FMV opinions are supported by compliant asset considerations.

Any time money is paid by a hospital or other provider organization to acquire a physician practice or to enter a joint venture with a physician practice, one must be alert to the compliance implications, given that the acquiring entity and/or joint venture partner will benefit from the patient relationships – and related revenue streams – that are associated with the practice group participating in the transaction. The money paid in the transaction, in other words, must be capable of being justified as protected compensation under the AKS.

In some cases, that requirement can be difficult to satisfy without taking into account the revenue streams associated with the patient relationships of the targeted practice group. Doing so, however, could risk exposing the transaction to potential enforcement action, since the purchase price is not supposed to be based, in whole or in part, directly or indirectly, on the FMV assigned to the patient relationships of the practice group.

The AKS has a “Sale of Practice” safe harbor (42 CFR § 1001.952(e)) which protects certain transactions involving practitioner-to-practitioner and practitioner-to-hospital practice sales, but the former protection excludes practice acquisitions by hospitals and other entities, and the latter protection is only available if the practice being acquired is located in a Health Professional Shortage Area as defined by the U.S. Department of Health & Human Services. That was intentional. The commentary to the AKS safe harbors reflects a deep skepticism and concern by the HHS Office of Inspector General (“OIG”) that regular commercial hospital acquisitions of physician practice groups could merely be disguised efforts to acquire patient referrals. The preamble to the Final Rule states:

Unlike the traditional sale of a practice by a retiring physician, a physician may sell, or appear to sell, a practice to a hospital while continuing to practice on its staff. A safe harbor provision was proposed for the sale of physician practices when occurring as the result of retirement or some other event that removes the physician from the practice of medicine or from the service area in which he or she was practicing, but not when the sale is for the purpose of obtaining an ongoing source of patient referrals.[1]

Responding to a comment seeking safe harbor protection for hospital acquisitions of group practices and subsequent retention of the physicians on staff, OIG explained that “hospitals often purchase physicians’ practices in order to ensure the hospital of a steady stream of referrals” and that “[w]e continue to believe that such practices lead to increased program costs and potential conflicts between the patient’s best interests and the physician’s business relationship to the hospital.” Accordingly, OIG declined “to protect a practice that often leads to the very abuses that the statute is designed to prevent.”[2]

A frequently cited 1992 letter from OIG responding to an inquiry from the Internal Revenue Service (“IRS”) analyzed the characteristics of practice acquisitions that are deemed suspect, noting that “[f]requently, hospitals seek to purchase physician practices as a means to retain existing referrals or to attract new referrals of patients to the hospital” and that “[s]uch purchases implicate the anti-kickback statute because the remuneration paid for the practice can constitute illegal remuneration to induce the referral of business reimbursed by the Medicare or Medicaid programs…”[3] The OIG expressed concern that such remuneration could compromise a physician’s independent judgment of what constitutes appropriate care by inducing referrals to an affiliated hospital rather than another provider, inflate costs to federal healthcare programs by generating overutilization of an affiliated hospital’s services and interfere with a patient’s freedom of choice in selecting a provider. The OIG concluded that “[a]ll these considerations are the very abuses that the anti-kickback statute was designed to prevent.”[4]

The Thornton Letter identified two main areas of scrutiny in assessing compliance with the anti-kickback statute: “(1) the total amount paid for the physician practice and the nature and type of items for which the physician receives payment; and (2) the amount and manner in which the physician is subsequently compensated for providing services to patients.”[5] Such payments will be examined to determine their underlying purpose: 

As part of this undertaking, it is necessary to consider the amounts paid for the practice or as compensation to determine whether they reasonably reflect the [FMV] of the practice or the services rendered, in order to determine whether such items in reality constitute remuneration for referrals. Moreover, to the extent that a payment exceeds the [FMV] of the practice or the value of the services rendered, it can be inferred that the excess amount paid over [FMV] is intended as payment for the referral of program-related business . . .

When considering the question of [FMV], we would note that the traditional or common methods of economic valuation do not comport with the prescriptions of the anti-kickback statute. Items ordinarily considered in determining the [FMV] may be expressly barred by the anti-kickback statute’s prohibition against payments for referrals. Merely because another buyer may be willing to pay a particular price is not sufficient to render the price paid to be [FMV]. The fact that a buyer in a position to benefit from referrals is willing to pay a particular price may only be a reflection of the value of the referral stream that is likely to result from the purchase.[6]

The Thornton letter concluded that assessing FMV in such transactions may require that one exclude from consideration amounts “which reflect, facilitate or otherwise relate to continuing treatment of the former practice’s patients,” and which are therefore dependent on an ongoing patient referral stream, and that “any amount paid in excess of the [FMV] of the hard assets of a physician practice would be open to question.”[7] Additionally, “in determining the [FMV] of services rendered by employee or contract physicians, it may be necessary to exclude from consideration any amounts which reflect or relate to past or future referrals or any amounts which reflect or are affected by the expectation or guarantee of a certain volume of business (by either the physician or the hospital).”[8] Examples of payments regarded as suspect where a continuing referral relationship exists between buyer and seller include payments made for goodwill, value of ongoing business unit, covenants not to compete, exclusive dealing agreements, patient lists and patient records.[9] The Thornton Letter summed up OIG’s concern by stating its belief “many of these arrangements are merely sophisticated disguises to share the profits of business at a hospital with referring physicians, in order to induce the physicians to steer referrals to the hospital.”[10]

The author of the Thornton Letter reaffirmed OIG’s position in a subsequent clarifying letter sent in 1993 to John E. Steiner, then Assistant General Counsel of the American Hospital Association.[11] Although the letter acknowledged that payments for intangible assets are not “per se illegal,” it maintained that they must be scrutinized, and made the point that how the parties characterize such payments “is not determinative” of whether they are, in fact, being made in exchange for referrals.[12]

In view of OIG’s stated concerns, it is incumbent upon hospitals and other corporate entities which are acquiring or partnering with physician practice groups to carefully analyze the items for which they are paying. An opinion from a third-party consulting firm that the amount paid is FMV will not necessarily or reliably validate a business arrangement that a regulatory agency determines, in reality, involved an exchange of remuneration for referrals.  For example, calculating FMV by reference to the  “annual revenues” of the practice might be viewed by a regulator as an illicit proxy for the practice group’s ongoing patient referral stream.  Similarly, assigning an exceptionally high value to “goodwill” in order to achieve a pricing level that will induce a sale could be viewed the same way.

Accordingly, it would be wise not to accept a third-party FMV opinion at face value, but rather to examine it carefully with counsel and the valuation firm in order to ensure that it does not contain elements that might be seen as prohibited under the AKS in light of the considerations discussed above. It would be far safer to pay only for the hard assets of the practice and whatever intangible assets can be clearly delineated, explained and justified without explicit or implicit reference to the value associated with historical or prospective patient relationships. If the value of such assets is insufficient to justify the purchase price, one might consider not proceeding at that price point, and instead pursuing alternative ways to appropriately convey that value to the seller. For instance, generous compensation packages to the selling physicians who remain affiliated with the acquiring entity post-closing as employees is another way to convey value which, provided that such compensation can be justified as within  an acceptable FMV range for services that will actually be rendered by the physicians, will not carry the same compliance risk as excessive upfront or time-payments for “assets” of the practice that cannot  reasonably be explained without reference to patient revenue streams.

Given the plain wording of the AKS, and the lack of a safe harbor that can clearly and dependably protect payments by a hospital or other entity to a physician practice group that exceed the value of the group’s hard and non-patient-related intangible assets, it may only be a matter of time before regulators start examining these “ordinary” types of transactions more closely. Any such government initiative, moreover, would carry the risk of enforcement action that could require the unwinding of non-compliant transactions and result in substantial penalties under the AKS, CMPL and/or FCA.

[1] 56 FR 35952 (July 29, 1991) (emphasis added).
[2] Id. (emphasis added).
[3] Letter dated December 22, 1992 from D. McCarty Thornton, Associate General Counsel, Inspector General Division, Department of Health & Human Services (“HHS”) to T.J. Sullivan (then a Technical Assistant in the IRS’s Office of the Associate Chief Counsel) (emphasis added) (“Thornton Letter”).
[4]Id.
[5]Id.
[6] Id.(emphasis added)
[7] Id.
[8] Id.
[9] Id.
[10] Id.
[11] Letter dated November 2, 1993, from D. McCarty Thornton, Esq., Associate General Counsel, Inspector General Division, HHS to John E. Steiner, Jr., Esq., Assistant General Counsel, American Hospital Association.
[12] Id.

Reprinted with permission from Law 360. All rights reserved.