Physician Practice Acquisitions: Avoiding Legal Pitfalls

By: William B. Eck, Seyfarth Shaw LLP

This article focuses on the special merger and acquisition considerations applicable to physician practice acquisitions. The past couple of years have seen a resurgence in the acquisition of physician practices, both by hospitals and by private equity firms. Hospitals and health systems are increasingly looking for clinical integration. Private equity firms see the advantages that large, integrated groups have to offer. Independent physician groups are faced with significant challenges.

THESE INCLUDE NOT ONLY CONTINUED REIMBURSEMENT ratepressure, but also reimbursement methodology challenges, such as the Medicare Access and CHIP Reauthorization Act of 2015 (popularly known as MACRA), that fundamentally alter the manner in which physicians are paid and demand implementation of sophisticated and expensive technology that small groups can ill afford.

Recent physician group acquisitions include the 2017 acquisition by Indiana University Health of Premier Healthcare, one of Indiana’s largest independent physician groups, which employs 40 primary care and specialty doctors.Also in 2017, MEDNAX, a national health solutions partner represented in all 50 states, acquired both Radiology Alliance, the largest private practice radiology group in Tennessee with 64 physicians and, in a separate transaction, Synergy Radiology Associates, P.A., a Houston-area radiology group made up of more than 90 physicians.

Acquiring a physician group carries special challenges in view of the heavy regulation of the healthcare provider industry. Once it is decided to acquire a physician practice, among the questions the acquirer and its counsel must consider are the optimal structuring approaches and how to avoid the legal pitfalls that are particular to this sort of transaction.

Structure of the Transaction

n general, the threshold consideration in a physician practice acquisition is the structure of the transaction. Typically, the acquisition may be an asset acquisition, a stock acquisition, or a merger. Certain states prohibit persons or entities other than physicians from owning physician practices. In those states that prohibit the corporate practice of medicine, the transaction may take more complex forms, such as asset purchases followed by long-term management relationships. In some states, hospitals may own practices, but private equity firms may not. In others, even hospitals may not own physician practices. In such states, it is common for the transaction to take the form of a purchase of assets other than goodwill, coupled with a practice management agreement. Counsel should review the specific form of transaction from the perspective of the state’s practice-of-medicine law and policy regarding the ownership and management of physician practices by non-physicians.

From the standpoint of the buyer, an asset acquisition is the most advantageous of the alternatives. First, except in limited circumstances, it allows the buyer to obtain the practice free and clear of prior liabilities and contingencies. Second, it allows the buyer a step up in the tax basis of the purchased assets (the parties to a stock purchase may also elect to have the transaction treated as an asset purchase for federal income tax purposes). Conversely, a stock purchase or merger transaction will typically be a more tax-efficient alternative for the seller.Stock purchases and mergers also have the advantage that they usually involve few to no third-party consents. An asset purchase, on the other hand, in a physician practice context usually will require consents to the assignment of leases and agreements. Importantly, an asset purchase will require either new Medicare, Medicaid, and other governmental and commercial payer agreements or assignments of existing payer agreements.

Although new payer agreements can be cumbersome to obtain, they provide avoidance of liability for prior Medicare, Medicaid, and commercial insurance overpayments that could otherwise become an issue under the target’s payer agreements. This is often an important reason for the buyer to seek an asset purchase structure, unless the seller has particularly favorable commercial insurance payer agreements. With an asset purchase structure, the buyer can decline to accept assignment of provider agreements, and instead, apply and enroll as a new provider. In general, a new subsidiary should be formed as the buyer; otherwise, the buyer’s existing governmental and commercial insurance payer contracts may become applicable to the post-closing practice as a new location of the buyer. Similarly, in an asset purchase, the buyer generally takes the practice free from liabilities and contingencies for alleged pre-closing malpractice events. In this manner, the buyer may begin afresh, without exposure to potential Medicare, Medicaid, private overpayment claims, or malpractice contingencies.

Due Diligence

Anti-kickback Statutes

In addition to the matters typically addressed in due diligence for any merger and acquisition transaction, in a physician practice acquisition, attorneys performing due diligence must address certain health regulation matters. These include the federal healthcare anti-kickback statute (AKS)¹ and its state counterparts.² The AKS prohibits direct or indirect remuneration in return for or to induce referrals for items or services for which federal healthcare program (e.g., Medicare or Medicaid) payment may be made. State laws are similar and usually apply to all payers, not only federal healthcare program payers. The due diligence required involves review of all of the practice’s contracts with referral sources and with entities to which the physicians refer. Likewise, counsel should review each physician’s contracts with referral sources and with recipients of referrals, and other key contracts of the practice and its physicians. The critical review consideration is whether it appears that inappropriate remuneration in return for or to induce referrals is involved in the agreement.

Stark Laws

Counsel should review compliance with the Stark law³ and its state counterparts.⁴ With certain limited exceptions, the Stark law prohibits physicians from making referrals for specified designated health services, where the physician or an immediate family member of the physician has a compensation relationship or investment interest in the provider or supplier of the designated health service. “Designated health services” as defined in the Stark law are:

1. Clinical lab services
2. Physical therapy
3. Occupational therapy
4. Radiology, including MRI, CT, and ultrasound
5. Radiation therapy
6. Durable medical equipment and supplies
7. Parenteral and enteral nutrients, equipment, and supplies
8. Prosthetics, orthotics, and prosthetic devices and supplies
9. Home health services
10. Outpatient prescription drugs
11. Inpatient and outpatient hospital services
12. Outpatient speech-language pathology services

Counsel performing due diligence should review physician relationships with all non-practice providers and suppliers of designated health services, including hospitals and other practices, for compliance with the Stark law. Also, if the group provides designated health services, such as clinical lab or imaging services, or certain other in-office ancillary designated health services, counsel should review compliance with the Stark law exception for in-group ancillary services.⁵

Compliance Policies and Procedures

Counsel should review any compliance program, compliance policies and procedures, and compliance log of the physician practice. The compliance policies and procedures will indicate how robust the group’s effort is to comply with applicable laws and regulations, as well as the extent to which it follows the guidance of the U.S. Department of Health and Human Services’ (HHS) Office of the Inspector General.⁶ The compliance log is one indicator of the level of the group’s overall compliance with laws and regulations and whether there are material issues that will need to be addressed. These issues may relate not only to healthcare compliance but also to compliance with employment or other laws and regulations.

Coding and Billing Practices

The buyer should consider whether to perform a coding and billing audit, if only on a relatively small sample of claims. Even if the transaction is structured as an asset purchase, to the extent that the practice’s financial results were achieved based on aggressive coding and billing practices, this could affect the valuation of the practice.

Health Insurance Portability and Accountability Act of 1996 (HIPAA) and State Privacy Law Compliance

Counsel should review the target practice’s compliance with HIPAA and parallel state privacy laws. The buyer will want to ensure that an appropriate notice of privacy practices is in place and followed. The buyer will also want to ensure that up-to-date and appropriate business associate agreements are in place with billing companies and other business associates. Finally, the buyer will want to confirm that appropriate information security systems are in place.

Licensing Regulations

Counsel should confirm the physicians’ licensure status. Also, depending on the type of physician practice, compliance with other applicable licensing laws and regulations should be reviewed. It may be the case, depending on the specialty of the practice, that it will hold other licenses, such as equipment licenses, the status of which should be confirmed. For example, a radiology practice may have imaging equipment required to be licensed. Other equipment sometimes in physician practices and required to be licensed includes nuclear medicine equipment and accelerators. As part of due diligence, it is advisable to assure that these licenses are in place, up to date, and no violations are outstanding. Assignments of these licenses (other than physician licenses to practice medicine) may also be necessary depending on the structure of the transaction and the licensing laws of the relevant state.

Valuing the Practice and Physician Compensation

Where the purchaser will employ the physician and be the recipient of referrals from the physician subsequent to the purchase, such as a hospital or health system purchaser, it is important that the transaction be within the Stark law exception for isolated transactions.⁷ Most significantly, this exception requires that consideration (1) be fair market value, (2) not be determined in a manner that takes into account the volume or value of referrals, and (3) be commercially reasonable even if no referrals were made.⁸ The employment compensation subsequent to the purchase must meet the same requirements.

In recent, high-profile cases, including, for example, United States ex rel. Schaengold v. Memorial Health, Inc., the purchase price of physician practices and compensation of physicians were claimed by the government to violate the Stark law where the purchaser and subsequent employer was a hospital or health system.⁹ In Schaengold, the government claimed that the health system violated the False Claims Act due to underlying Stark law violations. The court denied the health system’s motion to dismiss, holding that there was a plausible claim. The health system settled the case by payment of $9.9 million to the government.

Similarly, in United States ex rel. Drakeford v. Tuomey, the compensation of surgeons as part-time employees was ruled to violate the Stark law because it included productivity and incentive bonuses that, although based on professional services, would be higher with greater referrals.¹⁰ Therefore, the compensation was determined to “take account of” referrals for Stark law purposes. In Tuomey, there was a $275 million verdict and judgment against the health system, and the case ultimately settled for $72.4 million.

Stark law or AKS violations are less of a concern where the purchaser is a firm that will not be a recipient of referrals from the physicians subsequent to the closing of the purchase. However, in the case of a hospital or health system purchaser and employer, the hospital or a hospital within the health system typically will be the recipient of referrals after completion of the purchase. Under the Stark law, the purchase price and compensation of the physicians may not take account of or compensate these referrals.

Similarly, as noted, the AKS prohibits any remuneration, direct or indirect, overt or covert, in exchange for or to induce, referrals for which Medicare, Medicaid, or other federal healthcare program payment may be made. The AKS applies to the offer or receipt of, as well as to the solicitation or payment for, referrals. Violations of the AKS are felonies.¹¹ Similar to the Stark law, the AKS may be implicated to the extent that the purchase price is based on present or anticipated referrals or where the physician practice will refer to the purchaser or affiliate of the purchaser after completion of the purchase.

The AKS contains a safe harbor that may protect payments of compensation for services to bona fide physician employees subsequent to the purchase. Here, the definition of employees is for federal income tax purposes.¹² However, as illustrated by Schaengold, compliance with the AKS does not constitute compliance with the Stark law, and the Stark law may be violated even where the AKS is complied with. Because of the potential for scrutiny of physician compensation under the Stark law, and scrutiny of the purchase price under the AKS and Stark law, if practice physicians will refer patients to the buyer or an affiliate of the buyer after completion of the purchase, it is advisable to consider an independent third-party valuation of the fair market value and commercial reasonableness of the compensation of physicians and purchase price of the practice. A valuation by an independent expert consultant will minimize risk that physician compensation or the purchase price would be determined to run afoul of the Stark law or the AKS.

Although the AKS contains a regulatory safe harbor for sales of practices, it applies only to sales from one practitioner to another.¹³ The fact that a transaction is not within a safe harbor does not mean it violates the AKS. However, the facts and circumstances of the arrangement are subject to scrutiny by the HHS Office of Inspector General or, in the context of a False Claims Act case, the Department of Justice. Consequently, it is critical that the consideration in the purchase not be based on or take account of present or anticipated referrals.

Antitrust Issues

As with other acquisition transactions, as an initial matter, counsel needs to determine whether a pre-merger notification filing under the Hart-Scott-Rodino Act (HSR) is necessary. For 2019, the threshold for HSR filings is $90 million; therefore HSR filing requirements apply only to large physician practice acquisition transactions.

However, it is important to keep in mind that, while most physician practice acquisitions will not require pre-merger filing with the Federal Trade Commission (FTC), there is a potential for larger transactions to trigger antitrust scrutiny under the Clayton Act. There is even the potential for smaller acquisitions to trigger scrutiny in rural markets or in highly specialized practice areas. This occurred in at least one case, in Idaho, with a practice comprised of 34 physicians.¹⁴

On December 15, 2017, the U.S. District Court for the District of North Dakota granted the FTC’s and the North Dakota attorney general’s motion for a preliminary injunction, halting the proposed acquisition of Mid Dakota Clinic, P.C. (Mid Dakota) by Sanford Health (Sanford), until an administrative trial before the FTC is complete.¹⁵ Sanford employs 160 physicians and 100 non-physician providers in the Bismarck-Mandan, North Dakota area. Sanford also sells health insurance. Mid Dakota is a multi-specialty physician practice employing 60 physicians and 19 advanced practice practitioners. Mid Dakota also operates six clinics, a Center for Women, and an ambulatory surgical center primarily in Bismarck, North Dakota.

The court found the transaction presumptively illegal, further concentrating an already concentrated market. The court rejected Mid Dakota’s and Sanford’s efficiency arguments, with the view that efficiencies almost never justify a merger to a monopoly or near monopoly. The case is presently under appeal, and the FTC administrative trial is pending the outcome of the appeal.

In cases that involve antitrust scrutiny, the parties may choose to defend the transaction or explore alternative methods of integration that do not involve the same level of antitrust implications. The alternatives include the formation of accountable care organizations and integrated provider networks. Accountable care organizations are specialized types of Medicare provider networks in which the healthcare providers coordinate care and share risk. There are many kinds of integrated provider networks. In general, they involve clinical and financial integration of the providers and thus some level of shared risk. These arrangements in general can involve less antitrust risk than outright acquisitions. Of course, it is also possible that transactions that do not trigger contemporaneous antitrust scrutiny by the government will involve antitrust risk. These risks must be assessed as part of the decision whether to proceed with the transaction.

Escrow, Installment Payments, and Earn Outs

Escrows and earn outs are common methods in acquisition transactions of protecting the buyer against the risk of misrepresentation or breach of warranty and protecting the buyer against the risk of overpaying. Installment payment offsets are less commonly used for the same purposes. In the context of physician practice acquisitions, however, where the buyer will be a recipient of referrals from the seller physicians, earn outs generally are to be avoided because of the need to comply with the Stark law and the AKS. The reason is that where the purchase price is in part dependent upon the post-closing performance of the practice, and the selling practice physicians will be employed post-closing, the presence of an earn out can result in the purchase price unlawfully taking account of post-closing referrals.

Escrows and installment payment offsets, on the other hand, can be acceptable means of reducing a buyer’s risks. However, counsel should take care when drafting these provisions to avoid contingencies that could implicate the Stark law, the AKS, or parallel state laws. The critical issue is that escrow deductions and installment payment offsets should be based on breaches of representations and warranties that are not related to the financial performance of the practice after the closing of the purchase, but instead are related to breaches of representations and warranties that do not address post-closing financial performance.

Non-competes and Non-solicitation Agreements

As in the case of escrows and installment payment offsets, non-competes and non-solicitation agreements generally can be drafted so that they are acceptable from a regulatory standpoint. The Stark law and AKS do not prohibit exclusive relationships or non-competition agreements. Where the physicians will be employed post-closing and the purchaser is a healthcare provider or system to which the physicians will refer, the Stark law exception and AKS safe harbor for employment relationships need to be satisfied (whether or not non-competition agreements are used). Non-solicitation agreements in general do not raise regulatory issues under the Stark law or AKS.

In addition, non-competition agreements in general are enforceable under state law to the extent that they are reasonable in time and geographic scope,¹⁶ although some states do not enforce non-competition agreements against employees at all.¹⁷ Some states, by statute, prohibit the enforcement of non-competition agreements against physicians, even if reasonable non-competition agreements are enforceable in the context of other occupations.¹⁸ Still other states, under case law, sometimes prohibit enforcement of non-competition agreements on the basis of the public interest in the availability of physicians.¹⁹ Consequently, counsel should advise the buyer, in addition to the regulatory issues, to the enforceability of physician non-competition provisions in the relevant state.

Conclusion

In summary, physician practice acquisitions have much in common with corporate acquisition transactions generally. However, there are a number of additional considerations to be taken into account because of the significant regulation of healthcare. Key considerations include transaction structure, due diligence, purchase price and compensation, purchase price contingencies, and non-competes and other factors. Nevertheless, counsel can shepherd clients through successful practice acquisition transactions, thereby enhancing integration and clinical efficiencies and benefiting both providers and patients.

William B. Eck is a partner in the Corporate Department of Seyfarth Shaw LLP’s Washington, D.C. office and chair of the firm’s national Health Care Mergers and Acquisitions practice. Mr. Eck’s experience in the healthcare arena ranges from matters involving mergers and acquisitions to sales and affiliations. He has handled more than 30 purchase and sale transactions for hospital and healthcare provider clients. Mr. Eck has represented parties in syndications of ambulatory surgical centers, imaging centers, and other kinds of providers, as well as several hospitals and practice management companies in acquisitions of physician practices, including those specializing in primary care, emergency medicine, neonatal intensive care, radiology, and pathology.

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1. 42 U.S.C.S. § 1320a-7(b). 2. See e.g., N.Y. Soc. Serv. Law § 366-d; Cal. Bus. & Prof. Code § 650. 3. 42 U.S.C.S. § 1395nn. 4. See e.g., N.Y. Pub. Health Law § 238-a; Cal. Bus. & Prof. Code § 650 et seq. 5. 42 U.S.C.S. § 1395nn(b)(2). 6. See OIG Compliance Program Guidance for Individual and Small Group Physician Practices, 65 Fed. Reg. 59434 (Oct. 5, 2000). 7. See 42 U.S.C.S. § 1395nn(e)(6). 8. Id. 9. United States ex rel. Schaengold v. Mem’l Health, Inc., 2014 U.S. Dist. LEXIS 169555 (S.D. Ga. December 18, 2014). 10. United States ex rel. Drakeford v. Tuomey, 792 F.3d 364 (4th Cir. 2015). 11. See 42 U.S.C.S. § 1320a-7(b). 12. See 42 C.F.R. § 1001.952(i). 13. See 42 C.F.R. § 1001.952(e). 14. See Saint Alphonsus Med. Ctr.-Nampa, Inc. v. Saint Luke’s Health Sys., 2017 U.S. Dist. LEXIS 79940 (D. Idaho Apr. 27, 2017) (ordering the defendant hospital system to divest the acquired physician practice). 15. See Federal Trade Com’n. v. Sanford Health, 2017 U.S. Dist. LEXIS 215937 (D.N.D. December 15, 2017). 16. See, e.g., Fla. Stat. Ann. § 542.335. 17. See e.g., Cal. Bus. & Prof. Code § 16600. 18. See, e.g., Del. Code Ann. tit. 6, § 2707 (although liquidated damages clauses may be enforceable); Mass. Gen. Laws ch. 112 § 12X. 19. See, e.g., Emerick v. Cardiac Study Ctr., Inc., 286 P. 3d 689 (Wash Ct. App. 2012).