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Hospital and Health System M&A Series: Preparing a Hospital or Health System for Sale or Partnership Transactions – Part Two

The consolidation trend in hospital and health systems continues.  To address perceived inefficiencies and quality of care issues, hospitals are attempting to form larger enterprises to create scale, expand geographically, manage risk, access capital, contend with the changing regulatory environment and more effectively manage the health of the populations they serve.  This is the second article in a two-part series detailing key issues that should be addressed before a hospital or health system begins discussions with potential partners.  Click here to read part one.

The consolidation trend in hospital and health systems continues.  To address perceived inefficiencies and quality of care issues, hospitals are attempting to form larger enterprises to create scale, expand geographically, manage risk, access capital, contend with the changing regulatory environment and more effectively manage the health of the populations they serve.  This is the second article in a two-part series detailing key issues that should be addressed in order to ensure that a hospital transaction can be completed successfully.  Part one addressed preparatory activities related to bonds, pension plans, malpractice coverage and physician referral source relationships.  Additional advance consideration and preparation should be given to the following key areas.

5. Licenses, Permits and Accreditations

Two key issues with respect to licenses, permits and accreditations should be examined before a transaction.  First, all governmental permits should be up-to-date and, if possible, unrestricted.  Any recent suspensions or investigations by regulators should be closed out, and the seller should have evidence available to the buyer that no restrictions are in place.  Past licensure problems or survey hiccups should be fully remediated, and the hospital should be prepared to explain how survey deficiencies were addressed and how the hospital has improved upon its business and/or clinical practices.  A hospital should be able to demonstrate improvements to policies or successful follow-up audits in order to enable a potential acquirer to feel comfortable that a past problem has been resolved in a reasonable manner.  

Hospitals also should research in advance how a change of ownership transaction will affect any of its licenses or permits.  Certificate of Need approvals or exemptions, state department of health notices, U.S. Drug Enforcement Administration notices, Federal Communications Commission licenses, and Joint Commission or other accrediting body issues should be understood so that acquirers and the hospital’s leadership can accurately convey the timeline to stakeholders.

6. Program Integrity Contractor Audits

All hospitals are dealing with the rash of Medicare and Medicaid program integrity contractors, such as Recovery Audit Contractors (RAC) and Zone Program Integrity Contractors (ZPIC).  Billing and coding is an obvious area of interest for potential acquirers, because it affects not only compliance, but also the quality of the hospital’s earnings and cash flow.  The importance of cleaning up old program integrity audits, both internal and external, cannot be overemphasized.  A hospital must be able to demonstrate that issues identified in old billing and coding audits (whether internal or conducted by Medicare or Medicaid) have been addressed and remediated.  To this end, a hospital may want to consider having an outside professional or consultant conduct a re-audit in order to demonstrate compliance.  Even if exposure seems minor, buyers often view any governmental billing and coding issues as significant.

7. Commercial Insurance Relationships

Commercial insurers (i.e., Blue Cross Blue Shield, United Healthcare) still pay for the majority of health care services provided in the United States.  Therefore, sellers should ensure that contractual relationships with these insurers are in order.  Specifically, major payor contracts that are expired or near expiration should be re-contracted in order to mitigate future reimbursement risks.    
One key issue that health care services companies have faced is the waiver and discounting of patient copayments and deductibles.  Commercial insurers maintain out-of-network policies that apply to patients who visit out-of-network providers.  In the case of non-compliance with an insurer’s policy, a seller should consider making a preemptive change, rather than waiting for the acquirer to later reduce its financial commitment when it discovers that the hospital’s revenues are inflated as a result of non-compliance with an insurer’s policies.  

8. Compliance Program

In the highly regulated health care industry, acquirers will be interested in evaluating a target hospital’s health care compliance plans, programs and practices to ensure that a “culture of compliance” exists.  A seller should be prepared to respond to questions about the compliance plan and the leaders of the hospital’s compliance program.  Typical questions may include the following:

  • Does the hospital keep a log of reported compliance issues and how they were addressed?

  • Has a recent risk assessment been conducted, and has the compliance plan been updated following the risk assessment?

  • When is health care compliance and privacy training completed for employees and physicians?  

  • Do hospital board minutes reflect senior management’s attention to health care compliance issues?

Involving the hospital or health system’s compliance professionals early is critical to successfully preparing for these inquiries.

9. HIPAA and Patient Privacy

HIPAA, as supplemented by the Health Information Technology for Economic and Clinical Health (HITECH) Act, and the patient privacy obligations thereunder, must be a compliance focus for all hospitals.  The Office of Civil Rights of the U.S. Department of Health and Human Services has begun to audit and fine hospitals for HIPAA violations.  For example, Shasta Regional Medical Center in California recently paid a $275,000 fine and agreed to implement a costly corrective action plan as a result of an alleged violation of the HIPAA security rule.  To avoid potential HIPAA enforcement issues, a hospital should have updated HIPAA and HITECH Act compliance plans; notices of privacy practices and breach protocols; and, just as importantly, the ability to demonstrate effective implementation of such plans, practices and protocols.  Buyers and potential partners will conduct due diligence on these critical patient privacy issues to avoid successor liability issues. 

10. Real Estate Restrictions

Hospital real estate may have been donated many years earlier and can be subject to restrictions on operation and/or transfer.  This situation is of particular concern in transactions where nonprofit hospitals are converted to for-profit status.  In many cases, deed restrictions can limit the use of land or buildings to charitable or nonprofit uses.  These restrictions also can include reversionary interests that direct that the land or buildings be returned to the original donor or to the state if the hospital is no longer used for charitable purposes.  In other cases, zoning restrictions, non-competition covenants, easements and encumbrances on the title to real property can affect the ability to sell the property, to change the current use of the property or to use the property as collateral for future hospital financings.  

Consequently, a hospital must identify and review all real estate restrictions (including restrictions in lease agreements) to understand their potential impact on transactions.  Where there are material restrictions on the use of the hospital’s main campus, the hospital may select potential transaction partners based upon their ability to comply with the restrictions, or may petition a court to loosen or remove the restrictions before the transaction with a partner is consummated.  If a hospital is unaware of the restrictions at the time it selects a partner, it may be unpleasantly surprised when the real estate restrictions come to light during the due diligence process, potentially delaying or derailing the transaction.

Conclusion

In order to position themselves to capitalize on increased integration activity, hospitals considering a sale or integration with a system are urged to review these issues in advance of any transaction.  Before a hospital starts discussions with suitors, the critical issues of referral source relationships, patient privacy, and billing and coding should be audited and any aberrations addressed.  Management should have a strong understanding of pension and bond obligations and options for tail insurance coverage.  This preparation and implementation of corrective actions will translate to fewer repricing events and obstacles to a timely closing, thereby enabling maximum value to be achieved for all stakeholders.

© 2020 McDermott Will & EmeryNational Law Review, Volume III, Number 270

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About this Author

John M. Callahan, McDermott Will Emery Law firm, Health Care Attorney
Partner

John M. Callahan is a partner and the Head of International Healthcare M&A in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office.  He focuses his practice on mergers and acquisitions in the health services and life sciences industries.

312-984-7553
Megan R. Rooney, Health Care Attorney, McDermott Will Emery Law firm
Partner

Megan R. Rooney is a partner in the law firm of McDermott Will & Emery LLP based in its Chicago office.  She focuses her practice on the representation of hospitals and health systems and other health industry providers and investors. She has experience in all aspects of healthcare transactions, including mergers, acquisitions, affiliations, joint ventures and system restructurings for hospitals and other health care providers. Megan also advises hospital and health system clients on regulatory compliance with licensure, accreditation and other state and federal regulatory matters.

312-984-6475
Kristian A. Werling, McDermott Will & Emery LLP, Biotech Attorney
Partner

Kristian Werling is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office.  He focuses his practice on representing medical technology manufacturers, biotechs, diagnostics manufacturers and distributors of medical products in transactional and regulatory matters.  Concomitant with his practice in the contemporary landscape of healthcare and life sciences is a related depth of experience in representing private equity and venture capital investors. In this capacity he works with cross-disciplinary teams to conduct legal due diligence and...

312-984-2157