by Victoria Hamscho, Daniel Weinstein, and Ryan Knox*
Non-profit healthcare systems may seek to create an integrated care delivery system by acquiring other healthcare companies. Particular risks arise when nonprofit healthcare systems purchase for-profit management services organizations. In this Contribution, Victoria Hamscho, Daniel Weinstein, and Ryan Knox (’19) call attention to some significant risks non-profit healthcare systems face in acquiring for-profit management services organizations (including fraud and abuse, corporate practice of medicine laws, antitrust violations, and tax violations) and suggest possible means of mitigating these risks.
The healthcare market in the United States is large and highly competitive. Healthcare spending constitutes over seventeen percent of the gross domestic product, and this figure continues to grow.2 At the same time, the healthcare system in the U.S. is undergoing reform. The Trump Administration continues to suggest healthcare reforms, with varied public response and limited success.3
Uncertainty in the government’s oversight and regulation of healthcare entities continues to make expansion within the sector a risky proposition.4 Many healthcare providers are consolidating or merging in order to stay competitive with leaner, integrated systems of care delivery.5 These consolidations often spur regulatory investigation and can lead to the acquiring company both incurring future liabilities and encountering greater risk of compliance violations.6
Non-profit healthcare systems, which make up a majority of healthcare systems in the U.S.,7 face significant risks in mergers and acquisitions. These risks are magnified when the acquisition creates an integrated care model with a full range of services through a single delivery system. Some healthcare systems are creating integrated delivery systems by acquiring management services organizations (MSOs), which are for-profit companies that contract with various general and specialty physician practices to assist in their billing and other management needs.8 Non-profit healthcare systems purchasing for-profit MSOs present additional legal, regulatory, and compliance risks. The due-diligence process can identify these risks, and healthcare transactional attorneys should take these risks into account in structuring the acquisition.
This Contribution will call attention to some significant risks non-profit healthcare systems face in acquiring for-profit management services organizations and suggest possible means of mitigating these risks. Part I discusses fraud and abuse concerns; Part II introduces corporate practice of medicine concerns; Part III discusses antitrust risks; and Part IV explains tax considerations. Each section in turn also recommends methods of mitigating these potential liabilities.
I. Fraud and Abuse
When non-profit healthcare systems acquire for-profit MSOs to create a more integrated care delivery system, significant compliance and regulatory issues include liability presented by the Anti-Kickback Statute (“AKS”), Stark Law, and the False Claims Act (“FCA”). In addition, several states have laws that either mimic or supplement AKS, Stark Law, and FCA. As a result, these state laws can pose further risks of liability for the healthcare system. For purposes of this analysis, we also note that AKS and Stark Law violations may be the base for FCA violations.9 Thus, the violations of AKS and Stark Law described below could present additional FCA liability.
AKS is a criminal statute that prohibits anyone from knowingly and willfully soliciting, receiving, offering, or paying anything of value to any healthcare actor to induce the volume or value of referrals for any item or service that is paid in whole or in part under a federal healthcare program.10 Safe harbors protect certain activities, but failure to comply with a safe harbor does not necessarily constitute an AKS violation. The government must show that at least one purpose of the transaction was to induce referrals.11 In addition, the government must show that the defendant “knowingly and willfully” committed the prohibited act.12 Potential penalties include civil financial penalties, criminal penalties and imprisonment, and in extreme cases exclusion from federal health care programs.13
The Stark Law is a strict liability civil statute that prohibits physicians from making a referral for designated health services (“DHS”) to an entity with which the physician or his/her immediate family has a financial relationship.14 Stark Law also prohibits such entity from billing Medicare or any other entity for services provided as a result of an improper referral.15 Safe harbors protect certain activities that are deemed low risk by the government.16 Prohibited activities not covered under a safe harbor constitute a violation of the statute. Potential penalties include denial of payment, refunds of claims, civil money payments, and exclusion from federal health care programs.17 In addition, Stark violations constitute a false or fraudulent claim under the FCA and may result in civil money penalties.18
Moving towards an integrated care delivery system presents a heightened risk of referrals and renumerations between the acquiring non-profit healthcare system and the acquired for-profit target MSO. The acquiring system could be liable under AKS, Stark Law, and FCA because its physicians would be in a position to refer patients to or receive referrals from the practices contracting with the MSO. AKS is implicated because the transaction could be construed as a disguised kickback to induce referrals. Although there is a safe harbor for the sale of professional practices, it is unlikely to apply because the provider would be in a position to generate business for acquiring a healthcare system.19 Liability is thus likely to depend on whether the government can prove intent. Courts have maintained that the mere hope of referrals does not constitute an illegitimate purpose if the agreement is otherwise commercially reasonable.20
Stark Law could also be implicated because physicians could make referrals to an entity with which they have a financial relationship. Stark Law allows physicians to engage in isolated financial transactions.21 Whether this transaction constitutes an isolated transaction depends on whether remuneration is based on fair market value and does not take into account the volume or value of referrals.22 It would also depend on whether the agreement is commercially reasonable, even if no referrals are made.23
To minimize risk of future liability after acquiring the for-profit MSO, it is crucial that all of the arrangements are commercially reasonable, reflect fair market value, and do not take into account the volume or value of referrals generated.24
II. Corporate Practice of Medicine
Corporate Practice of Medicine (“CPOM”) laws, which vary by state, present another obstacle to successfully consummating the acquisition. State CPOM laws differ in degree of restrictiveness, so healthcare systems may need to adjust agreements with providers to satisfy the requirements of each state in which it currently operates or in which it intends to expand. Specifically, healthcare systems may need to revise management services agreements (MSAs) with multi-state provider group corporations. For example, some healthcare companies set fees as a percentage of billings, a practice known as “fee splitting.”25 While expressly permissible in states like California,26 this arrangement is illegal in states like New York.27 If MSA’s do not conform to applicable state CPOM laws and regulations, companies risk incurring federal or state AKS and Stark liability for improper referral arrangements.28 Non-compliance also risks prompting state attorneys general investigations that could result in large settlements contingent upon assurances that entities discontinue violative practices.29
Pre-consummation, acquiring healthcare systems should insist on representations and warranties that limit its liability for past infringements of CPOM. These representations and warranties should require the selling company assert that its operation of the target for-profit MSO was proper. Further, healthcare systems should include indemnification agreements in the contract. Such agreements require the selling company take liability for breaches of the representations and warranties, including violations of CPOM laws. As part of the indemnification agreement, part of the purchase price – equivalent to estimated potential damages from any violations uncovered during due diligence – should be held in escrow to cover any unknown violations until the statute of limitations on potential claims for CPOM tolls. The selling entity will remain liable, however, for amounts in excess of the escrow funds.
Both during and after the due diligence phase, healthcare systems should complete compliance reviews of all CPOM issues and institute compliance programs to prevent violations of AKS, Stark, and FCA post-consummation.
III. Antitrust Concerns
To the extent that creating the integrated delivery system impacts competition in the healthcare market, the acquisition of a for-profit MSO by a non-profit healthcare system could implicate antitrust laws. In the antitrust context, mergers are categorized as either vertical or horizontal. Horizontal mergers are mergers between competitors, while vertical mergers are transactions among entities situated along the supply chain.30 A non-profit healthcare system purchasing a for-profit MSO in order to create a more integrated delivery care system would likely qualify as a vertical merger rather than a horizontal merger.
While vertical acquisitions are not the overwhelming focus of antitrust action, they present unique issues of liability: they typically limit competition for downstream services. Such a merger could limit competition for referrals to other healthcare companies31 and cause price increases due to the resulting combined entity’s improved bargaining power.32 However, health-related antitrust actions based on vertical theories are rare and have been sparingly applied over the past thirty years, almost exclusively to hospital-physician group transactions or pharmaceutical pricing.33
Healthcare systems can counter claims of probable anticompetitive effects by asserting procompetitive justifications for the acquisition, such as being able to subsequently provide more efficient care, more integrated care, and improved patient outcomes.34 Healthcare systems must show that efficiencies used as justification can only be achieved through this acquisition: essentially, that there is no other less restrictive alternative to accomplishing the procompetitive goals. Furthermore, the efficiencies must not be vague or speculative and they must be cognizable, not the result of primary anticompetitive effects.35 However, this “efficiencies defense” is incredibly hard to prove and has yet to be successful in rebutting a prima facie under Section 7 of the Clayton Act for non-pharmaceutical healthcare acquisitions.36 Companies must “clearly demonstrate” how the acquisition “enhances rather than hinders competition” as a result of claimed efficiencies, which must be “extraordinary” in order to offset anticompetitive effects of the transaction.37 The FTC looks more favorably on procompetitive justifications when they “improve the delivery of care and pose no threat of increased prices.”38 A commitment to implementing bundled payments and clinical integration, shown through plans to adopt quality metrics, reporting structures, and joint electronic medical records, among other mechanisms used to monitor population health, would show regulators that the healthcare system intends to control costs and use newfound leverage to improve the delivery of care, rather than raise prices.39 Further, the parties must show that these efficiencies are unique to the consummated transaction and cannot be accomplished by simply contracting or creating less restrictive clinically integrated networks.40
If antitrust violations are found, federal authorities could block the acquisition at its incipiency, impose other structural changes post-consummation through divestiture, or mandate conduct requirements in the form of orders that stipulate conditions of the challenged entity’s continued existence.41 While federal authorities prefer structural remedies, state attorneys general can also bring antitrust suits according to state antitrust laws and favor regulatory remedies such as consent orders, arbitration procedures, or court ordered rate setting.42
IV. Tax Concerns
Non-profit healthcare systems are tax-exempt under Internal Revenue Code § 501(c)(3).43 This provides the company significant tax benefits as long as it maintains its tax-exempt status.44 In order to maintain tax-exempt status, non-profit organizations, including non-profit healthcare systems, must (1) be organized and operated exclusively for tax-exempt purposes; (2) not inure private shareholders with the earnings of the non-profit organization; (3) not attempt to influence legislation as a major part of its work; (4) not participate in campaign activities; and (5) comply with the filing requirements of the IRS.45 Requirements for tax-exempt status relevant here46 that will be discussed in further detail include being run for a tax-exempt purpose and receiving only insubstantial unrelated business income.
Tax-exempt organizations must be run for a tax-exempt purpose.47 Unrelated business activities can threaten the acquiring non-profit healthcare system’s tax-exempt status.48 Promoting health, the purpose of health systems, is accepted as a tax-exempt purpose.49 However, non-profit organizations are allowed to have some non-tax-exempt business operations, as long as they are not the primary purpose of the organization.50 Income that a non-profit receives from business not related to its tax-exempt purpose is called unrelated-business income and is subject to taxation.51 Non-profits must disclose their unrelated business income.52 Unrelated business income is taxed at the corporate rate.53
If a non-profit organization receives a substantial amount of unrelated business income, or conducts a “substantial amount” of unrelated business activity, it can lose its tax-exempt status.54 There is no firm guideline as to what constitutes “substantial,” but over fifty percent is definitely considered substantial and below twenty percent is generally not considered substantial.55 While the income non-profits received from for-profit companies is excluded from the calculation of unrelated business income and not subject to taxation in some instances, debt-financed unrelated business income and unrelated business income when the non-profit has a controlling interest in the for-profit MSO are exceptions to the exclusion.56 If the acquisition is debt-financed, as many of these acquisitions are, non-profit acquisitions likely receive taxable unrelated business income after acquiring for-profit companies.
If the acquired for-profit company has a non-tax-exempt purpose and the actions of the company are attributed to the non-profit, the tax-exempt status of the acquiring company could be at risk. However, the purpose of MSO is consulting and management services, which are considered per se private business purposes.57 Thus, when non-profit healthcare systems acquire for-profit MSOs or other for-profit companies with unrelated purposes, it is generally best that they are placed in subsidiary corporations.58 This prevents the for-profit activities of the MSO from being attributed to the non-profit healthcare system, thereby protecting its tax-exempt status. Even so, in order to maintain its status as a non-profit, tax-exempt organization, non-profit healthcare systems acquiring for-profit MSOs must carefully track the income generated from for-profit acquisition to make sure that it does not receive too much unrelated business income. For these reasons, taxable corporations are generally preferable to house unrelated business activities.59 This structure provides maximal protection for tax-exempt status as long as the non-profit health system is not involved in the daily management of the for-profit MSO.60
Non-profit healthcare systems find significant opportunities for growth and success in acquiring for-profit MSOs and creating integrated care delivery systems. However, these acquisitions often bring significant risks to the acquiring company in the form of past and future violations of fraud, antitrust, and tax laws and medical practice regulations. Healthcare transactional attorneys must take into account potential fraud and abuse concerns, corporate practice of medicine laws, antitrust violations, and tax requirements in structuring these transactions. As such, keeping a portion of the transaction purchase price in escrow and obtaining representations, warranties, and an indemnification agreement from the selling company can protect the acquiring non-profit healthcare system from the concerns of future litigation. Additional terms and structuring of the acquisition as a for-profit subsidiary corporation can further protect the interests of the healthcare system.
In this highly competitive healthcare market, expanding into new product and geographic markets and further integrating care enables new opportunities for growth and improved patient care. Even so, non-profit healthcare systems should be aware of these risks as they seek to integrate delivery systems through mergers and acquisitions.
* Victoria Hamscho, Daniel Weinstein, and Ryan Knox are 3Ls at New York University School of Law. This piece is a commentary on the 2018 Problem at the L. Edward Bryant, Jr. National Health Law Transactional Moot Court Competition hosted by Loyola University Chicago School of Law in Chicago, Illinois. The problem dealt with a non-profit, tax-exempt health system’s intended acquisition of a for-profit management services organizations. The views expressed in this article do not necessarily represent the views of the author on these areas of law nor do they intend to provide legal advice to health care companies. Rather, this article is a distillation of some of the recommendations presented by the authors at the L. Edward Bryant, Jr. National Health Law Transactional Moot Court Competition.2. See Business Monitor International, United States Pharmaceuticals & Healthcare Report Q1 2018 15 (2017).
3. See, e.g., Compare Proposals to Replace The Affordable Care Act, Kaiser Family Found., https://www.kff.org/interactive/proposals-to-replace-the-affordable-care-act/ (last updated Sept. 25, 2017).
4. See Business Monitor International, supra note 2, at 16.
5. See Gregory D. Anderson & Emily B. Grey, The MSO’s Prognosis After the ACA: A Viable Integration Tool? 1 (2013), https://www.healthlawyers.org/Events/Programs/Materials/Documents/PHY13/B_anderson_grey.pdf.
6. Transactions usually come with successor liability. See Robert C. Threlkeld, Successor Liability in Hospital M&A: Assessing and Mitigating Risk Exposure, Morris Manning & Martin LLP (Apr. 2, 2014), http://media.straffordpub.com/products/managing-the-impact-on-transaction-structure-allocating-risk-and-addressing-medicare-issues-2014-04-02/presentation.pdf. This includes successor liability for claims involving Medicare, Medicaid, Anti-Kickback violations, False Claims Act violations, Stark Law violations, among others. However, there are ways to mitigate this liability at the time of consummation. See id.
7. More than half of U.S. hospitals are private, nonprofit organizations. See Gary J. Young, et al., Community Benefit Spending By Tax-Exempt Hospitals Changed Little After ACA, 37 Health Aff. 121, 121 (2018).
8. See Gregory D. Anderson & Emily B. Grey, The MSO’s Prognosis After the ACA: A Viable Integration Tool? 2 (2013), https://www.healthlawyers.org/Events/Programs/Materials/Documents/PHY13/B_anderson_grey.pdf.
9. See, e.g., U.S. ex rel. Drakeford v. Tuomey, 792 F.3d 364, 393 (4th Cir. 2015).
10. 42 U.S.C. §1320a-7b(b).
11. See United States v. Greber, 760 F.2d 68 (3d Cir. 1985), cert. denied, 474 U.S. 988 (1985).
12. See Hanlester Network v. Shalala, 51 F.3d 1390, 1400 (9th Cir. 1995).
13. 42 U.S.C. §§ 1320a-7b(b), 1320a-7.
14. 42 U.S.C. § 1395nn(a)(1)(A).
15. 42 U.S.C. § 1395nn(a)(1)(B).
16. 42 U.S.C. § 1395nn; 42 C.F.R. §§ 411.351 et seq.
17. 42 U.S.C. § 1395nn(g).
18. 42 U.S.C. § 1320a-7b(g).
19. 42 C.F.R. § 1001.952(e).
20. See, e.g., United States v. LaHue et al., 261 F.3d 993 (10th Cir. 2001).
21. 42 C.F.R. § 411.357(f).
24. See, e.g., United States ex rel. Drakeford v. Tuomey. Healthcare System, Inc., 792 F.3d 364 (4th Cir. 2015).
25. Cheryl Miller, Splitting Fees or Splitting Hairs?, 11 Virtual Mentor: AM. Med. Ass’n J. Ethics 387, 387 (2009) (defining fee-splitting).
26. See Corporate Practice of Medicine, Medical Board of California (Jan. 29, 2015), http://www.mbc.ca.gov/Licensees/Corporate_Practice.aspx; Cal. Bus. & Prof. Code § 650(b).
27. See Corporate Practice of the Professions, N.Y. State Education Department (1998), http://www.op.nysed.gov/corp/corppractice.htm; Andrew B. Roth & Kimberly J. Gold, Corporate Practice of Medicine; An Old Doctrine Breathing New Life, N.Y. L. J. (June 25, 2014), http://www.nortonrosefulbright.com/files/20140625-corporate-practice-of-medicine-an-old-doctrine-breathing-new-life-124249.pdf.
28. See Health Care Regulatory Primer: Management Service Organizations, Chapman and Cutler LLP (Oct. 12, 2017), https://www.chapman.com/insights-publications-Health_Care_Management_Service_Organizations.html.
29. See Nili S. Yolin, Corporate Practice Prohibition in New York: What We Can Learn From the ADMI Settlement, The Nat’l L. Rev. (July 30, 2015), https://www.natlawreview.com/article/corporate-practice-prohibition-new-york-what-we-can-learn-admi-settlement.
30. See Ian Linton, What is a Horizontal Merger and a Vertical Merger, Chron, http://smallbusiness.chron.com/horizontal-merger-vertical-merger-60981.html.
31. See St. Luke’s Health Sys., 778 F.3d at 782 (St. Alphonsus claims of vertical antitrust issues and foreclosing referrals).
32. Non-Horizontal Merger Guidelines, Dep’t of Just. (last updated June 25, 2015), https://www.justice.gov/atr/non-horizontal-merger-guidelines.
33. See Deborah L. Feinstein, Antitrust Enforcement in Health Care: Proscription, not Prescription, Fed. Trade Comm’n 8 n.26 (2014), https://www.ftc.gov/system/files/documents/public_statements/409481/140619_aco_speech.pdf.
34. For more procompetitive justifications, see generally id.; Todd A. Rodriguez, Medical Practice Mergers: Bigger Can Be Better, Fox & Rothschild (Oct. 2009), http://www.foxrothschild.com/publications/medical-practice-mergers-bigger-can-be-better/.
35. See Feinstein, supra note 33, at 11.
36. Toby Singer, New Health Care Symposium: Unpacking The Issues Of Vertical And Horizontal Consolidation—The St. Luke’s Case, Health Aff. Blog (Mar. 3, 2016), https://www.healthaffairs.org/do/10.1377/hblog20160303.053494/full/.
37. St. Alphonsus Med. Ctr. v. St. Luke’s Health Sys., 778 F.3d 775, 790 (9th Cir. 2015).
38. See Jeffrey W. Brennan, et al., FTC and DOJ Host Workshop Examining Health Care Competition, McDermott Will & Emery (Mar. 3, 2015), https://www.mwe.com/en/thought-leadership/publications/2015/03/ftc-and-doj-host-workshop-examining-health-care-__.
39. See generally David A. DeSimone & John R. Washlick, The Resurgence of MSOs in the Post-Merger Mania: A Vehicle to Herd Providers and Investors into Clinically Integrated Networks, http://www.downloads.pbi.org/courses/9611/ChapterL.pdf.
40. St. Alphonsus Med. Ctr. v. St. Luke’s Health Sys., 778 F.3d 775, 790 (9th Cir. 2015).
41. See David A. Ettinger, Current Antitrust Issues Relating to Physician Mergers, Acquisitions and Combinations 21 (2012), https://www.healthlawyers.org/events/programs/materials/documents/phy12/papers/b_ettinger.pdf.
42. See id.
43. See New Requirements for 501(c)(3) Hospitals Under the Affordable Care Act, Internal Revenue Service (last updated Aug. 27, 2017), https://www.irs.gov/charities-non-profits/charitable-organizations/new-requirements-for-501c3-hospitals-under-the-affordable-care-act.
44. See id.
45. Exemption Requirements – 501(c)(3) Organizations, Internal Revenue Service (last updated Dec. 28, 2017), https://www.irs.gov/charities-non-profits/charitable-organizations/exemption-requirements-section-501c3-organizations.
46. While other requirements may also be of concern in various acquisitions, the concerns mentioned here are the issues raised in the competition.
47. See Exemption Requirements – 501(c)(3) Organizations, Internal Revenue Service (last updated Dec. 28, 2017), https://www.irs.gov/charities-non-profits/charitable-organizations/exemption-requirements-section-501c3-organizations.
48. See id.
49. See, e.g., Internal Revenue Service, The Concept of Charity 19 (1980), https://www.irs.gov/pub/irs-tege/eotopicb80.pdf.
50. See Jerald A. Jacobs, Et Al., 708 For-Profit Subsidiaries: Protecting Assets While Expanding Access To Capital 6 (2006), http://www.acc.com/vl/public/ProgramMaterial/loader.cfm?csModule=security/getfile&pageid=20086&title=untitle d&recorded=1.
51. See id. at 3.
52. See Unrelated Business Income Tax, Internal Revenue Service (last updated Aug. 27, 2017), https://www.irs.gov/charities-non-profits/unrelated-business-income-tax.
53. See id.
54. See id.
55. See, e.g., Paula Cozzi Goedert, Tax Issues for Exempt Organizations: A Primer 10, http://www.ashe.org/chapters/pdfs/agreement/Tax_Issues_for_Exempt_Organizations.pdf; Losing tax-exempt status because of too much unrelated income, Reporters Committee for Freedom of the Press (accessed Feb. 16, 2018), https://www.rcfp.org/nonprofit-news-guide/taxation-unrelated-business-taxable-income/losing-tax-exempt-status-because-too.
56. See Unrelated Business Income Tax Exceptions and Exclusions, Internal Revenue Service (last updated Aug. 4, 2017), https://www.irs.gov/charities-non-profits/charitable-organizations/unrelated-business-income-tax-exceptions-and-exclusions
57. See Jacobs, et al., supra note 50, at 1.
58. See David A. Levitt & Steven R. Chiodini, Taking Care of Business: Use of a For-Profit Subsidiary by a Nonprofit Organization, Am. Bar Ass’n (June 2014), https://www.americanbar.org/publications/blt/2014/06/03_levitt.html.
59. See Unrelated Business Income Tax Exceptions and Exclusions, Internal Revenue Service (last updated Aug. 4, 2017), https://www.irs.gov/charities-non-profits/charitable-organizations/unrelated-business-income-tax-exceptions-and-exclusions.
60. See id.