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As hospitals continue to look at acquiring physician practices as part of their strategic planning, industry experts have been reminding healthcare organizations of the lessons learned from the last hospital buying spree in the 1990s, particularly with respect to the impact these transactions had on physician productivity, hospital overhead, and overall increases in healthcare costs.
Despite these concerns, thoughtful, strategic, and well-structured acquisitions can be beneficial to both hospitals and physician practices. The key to success includes detailed due diligence, addressing business and legal issues upfront, including scrutiny of anticipated post-transaction costs and physician production expectations.
Factors Driving Acquisitions
At a basic level, hospitals view the acquisition of certain physician practices as a way to secure and expand hospital services. Having more services "in house" has reimbursement advantages, helps improve quality of care measures, and achieves greater competitive positioning within the market. Internal succession planning, staffing shortages, and ensuring on-call coverage have also driven the need for hospitals to employ more physicians. Acquiring the right physician practice can achieve these goals.
From the physician's perspective, being part of an integrated delivery network has appeal as well. The challenges facing physician practices include increasing malpractice and information technology costs, declining reimbursement rates, and uncertainty surrounding the on-going implementation of healthcare reform. As an employee, the physician is relieved of the burdens of dealing with the business aspects of running an independent practice, permitting more time for actual treatment of patients and improved quality of life. A stable salary provides peace of mind and selling the practice to a hospital offers a clean and quick way to cash out business ownership.
While there are degrees of complexity in each physician practice transaction, there are recurring issues that both parties need to consider upfront to ensure a successful transaction.
Deal Structure
Practice acquisitions generally occur in one of two ways. The hospital can acquire the assets of the physician practice or the physician's ownership interests in the practice (e.g., stock if the practice is a corporation or partnership or membership interests if the practice is a partnership or limited liability company). Each structure affects the tax burdens of each party differently and significantly shifts the responsibility for the liabilities of the practice. In our experience, however, the most likely structure used is an asset purchase and sale.
In an asset purchase and sale, the hospital buys the assets of the practice including equipment, supplies, goodwill, and other assets. Accounts receivable are generally excluded in the asset purchase and sale. The sale of intangible assets, primarily goodwill, requires some evaluation and is one of those intangible assets that can be difficult to value, but if it exists, then it may result in preferred capital gains tax treatment to the physician-owner.
Asset purchases are generally favored by the hospital since the hospital can contractually avoid liabilities by not specifically assuming them. If the hospital is a for-profit organization, then an additional benefit of an asset purchase is for tax purposes. The hospital will receive a step up in its basis in the assets which results in greater depreciation for the hospital over the remaining life of the assets.
There is an alternative to a complete acquisition of a physician practice. The hospital could create a new entity which enters into a contract with the practice. The practice provides physicians and clinical support services to the hospital's entity at agreed upon rates. The existing physician practice retains control over the hiring, firing, and compensation of physicians and staff. The hospital could also lease office space and equipment from the existing practice and take over billing and management functions. The benefit of this alternative is that the physician owners retain some autonomy and if the relationship does not work out, the existing practice structure is preserved, making it easier to unwind the transaction. This approach, however, generally fails to achieve some of the physician's goals noted above because the physician is still left to run the practice, there is no guaranteed stability in employment or compensation, and by not selling assets or stock there generally will not be an up-front payment to the physician or relief of liability from the deal. Depending on the level of control and certainty that the hospital desires, this model may be less appealing to the hospital as well.
Contracts and Leases
As part of the hospital's due diligence, the hospital must determine if the practice is a party to any contracts, leases, or other relationships with related parties. In those instances, the hospital must carefully consider whether these relationships are needed and if so, then whether the terms are appropriate from a regulatory perspective and can be assumed by the hospital.
The hospital should also determine if the consent of any of the parties to the contract are required and if so, then the physician practice will need to satisfy these conditions. Personal guarantees may also exist and may need to be addressed.
Insurance and Indemnification
As with all indemnification provisions, the malpractice risk should be allocated appropriately between the parties and is normally the subject of negotiation. Discussions related to medical malpractice insurance generally involve an assessment of any claims, the kind of insurance in place, coverage limitations, and who will pay any premiums going forward. There are two kinds of common coverage that exists. Claims-made policies cover claims made only while the insurance is in effect. Occurrence-based policies look at when the alleged act occurred rather than when the claim is made. Since occurrence-based policies tend to be significantly more expensive than claims-made policies, claims-made policies may be more common. If the physicians practice has claims-made only coverage, then a tail policy may be necessary to cover claims made after the sale to the hospital. Tail coverage includes claims that are made for a specific period of time after the sale of the practice.
Specific indemnification provisions can be used to cover claims against the hospital for malpractice of the physician alleged to have occurred prior to the sale of the physician practice. A reciprocal provision by which the hospital indemnifies the physician for acts occurring after the closing of the sale may be considered as well.
Compensation and Employment Terms
The physician employment agreement is central to the transaction. The physician is seeking stability and certainty, usually through a healthy salary. The hospital is seeking an overall compensation plan that keeps the physician happy, productive and efficient. Physicians should be willing to put a portion of their compensation at risk and hospitals need to be flexible and realistic with respect to objective measures of productivity. An independent billing code audit during due diligence may be helpful in supporting estimates of the physicians productivity as an employee of the hospital and could result in a more accurate performance-based compensation matrix. In order to satisfy various regulatory requirements, remuneration for the practice and employment terms must be fair market value and commercially reasonable.
A non-competition provision will be negotiated as part of the employment agreement, the purchase agreement, or both. The scope of the covenant that will be enforceable will depend on state law. Commitments to hire employees of the physician practice may also be subject to negotiation.
Regulatory Considerations
Hospitals and physician practices need to keep in mind fraud and abuse laws when structuring an acquisition. Assessing compliance with the federal anti-kickback statute, State law, governing laws, the tax status of the hospital, and HIPPA, for example, should be done early in the due diligence process.
No two transactions are the same, but having thought about and addressed these concerns earlier rather than later will lead to smoother and more productive negotiations and increase the chances of long-term success.
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This is not a legal document nor is it intended to serve as legal advice or a legal opinion. Devine, Millimet & Branch, P.A. makes no representations that this is a complete or final description or procedure that would ensure legal compliance and does not intend that the reader should rely on it as such.
© Copyright 2014 Devine Millimet & Branch, Professional Association
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