INSIGHT: Physician-Hospital Surgical Center Joint Ventures—What Counsel Should Know

This article originally appeared on Bloomberg Law, and is republished here with permission.

Transactions for ambulatory surgical centers are on the rise, especially between hospitals and community physicians. Foley & Lardner’s Roger Strode examines reasons for the uptick and says careful structuring of these deals will help avoid significant legal issues.

The past several years have seen resurging interest in transactions for ambulatory surgery centers, also known as outpatient surgery centers. A particular area of interest has been that of ASC transactions between hospitals and community physicians.

These transactions make sense for several reasons, which is why they’ve increased in popularity. A number of legal issues are attendant to these arrangements that all lawyers who provide advice on them should know.

Why Physician-Hospital Joint-Venture ASC Deals?

Three words: Rates, volume and protection. A hospital can, often, command substantially higher rates for an ASC it controls due to its leverage with payers. Thus, physicians are often willing to give up control of an ASC if it means higher reimbursement, and thus higher equity returns.

In addition, since today’s ASC deals often involve facilities originally developed by physician investors years ago, a number of which stripped surgical volume out of local hospitals, these deals allow hospital partners to regain certain of the surgical volume lost when the ASC in question was initially developed.

Finally, physicians often view a relationship with the local hospital as protective, a safe harbor of sorts for, if you can’t beat ‘em you might as well join ‘em.

What Are the Biggest Legal Hurdles to These Deals?

The legal issues often start with the purchase or formation of the ASC. If the hospital is a purchaser of an interest in an existing ASC, it is important that the hospital purchase its equity at fair market value. This is especially true since the selling physician owners are, usually, referral sources to the hospital.

Hospitals often seek third party valuations in order to set, or support, purchase price as consistent with fair market value. Over the last 12 months we’ve seen the median purchase price for a controlling interest range from seven to nine times trailing twelve months’ EBITDA, depending upon whether or not the center is a single specialty or multi-specialty facility. EBITDA (earnings before interest, taxes, depreciation, and amortization) is a measure of a company’s overall financial performance.

If the venture is a de novo arrangement, it is important that all investors—physicians and hospital alike—capitalize the venture pro rata, ensuring that their financial contributions are proportionate to their respective equity stakes in the deal. No participant should be granted equity based upon the ability, or willingness, to refer, directly or indirectly, patients or cases to the ASC.

The structure of the arrangement also brings its own set of issues. Since the ownership of an interest in a physician-hospital joint ventured ASC implicates the federal Anti-Kickback Statute, the Department of Health and Human Services promulgated a specific safe harbor regulation designed to address just such an arrangement.

Meeting Safe Harbor Requirements

Any returns enjoyed by the owners of any such venture that precisely meets the requirements of the safe harbor are deemed not to violate the federal Anti-Kickback Statute. This safe harbor is somewhat complex, however, and doesn’t necessarily account for the fact that many hospital partners employ physicians who may refer to the ASC or to the surgeons who work in the ASC.

For example, meeting the safe harbor requires that the hospital not be in a position to make or influence referrals directly or indirectly to any investor or the entity. Since many hospital investors employ physicians, many of whom are likely to refer to surgeons who invest in these ASCs, meeting the requirements of this safe harbor may not be practical.

However, the failure to meet a safe harbor doesn’t necessarily render the arrangement illegal. In instances where a specific arrangement doesn’t meet all of the requirements of the safe harbor a determination of whether or not the joint venture complies with the fraud and abuse laws will require an analysis of the specific facts surrounding the venture. The OIG has issued several advisory opinions addressing the application of the safe harbor and the federal Anti-Kickback Statute to these sorts of ventures.

Other possible legal issues to be aware of are those related to the hospital owner’s tax exempt status—as many hospital investors are tax exempt—which may require the ASC to conform its operations in order to avoid the returns earned by the hospital being treated as unrelated business taxable income or otherwise jeopardizing the hospital owner’s exempt status.

Examples may be a requirement that the ASC adopt the hospital’s charity care and compliance policies. In addition, antitrust laws can be implicated should the hospital and the ASC be deemed competitors, which is one good reason why these deals are structured so that the hospital owners control the equity and the governance of the ASC.

In summary, ASC ownership by physicians and hospitals is on the rise and there are solid business reasons for these deals. Careful structuring will allow parties to achieve those business objectives while avoiding significant legal issues.